Cash Is Undoubtedly King!

Historically bonds were the thing
To own in a market downswing
But lately it seems
Those days were just dreams
Now cash is undoubtedly king!

While this note is focused on the FX markets, where once again the dollar is top dog, I think a quick discussion of government bonds is in order to help try to make some sense of the overall market situation.

Clearly, the lead story in financial markets has been equities, which have proven that volatility is not dead. In fact, these constant +/- 5% days are exhausting for both investors and traders. And of course, most of us have at least some portion of our investment in the equity markets and are afraid to look at our accounts these days. But the behavior that has really been at odds with what had become the overriding narrative is the incredibly abrupt sell-off in Treasuries and other government bond markets during the past week. The idea that government bonds are a safe haven has been underpinning financial markets since long before the financial crisis in 2008. Yesterday I highlighted two of the issues that I think are driving recent price action; the prospect of staggeringly high new issuance to pay for all the proposed and enacted fiscal stimulus that is coming; and the fact that when yields reach a low enough point, the idea that holding bonds will guarantee the return of principal starts to diminish.

But I don’t think those explanations are sufficient to explain the speed and size of the movement that we have experienced since last Monday. Instead, movement like that can only be caused by massive position liquidation. Consider, 10-year Treasury yields rallied 36bps on Monday while 30-year yields closed 40bps higher after touching levels a further 15bps higher than that earlier in the session. So the real question is; who is liquidating their position(s)?

To answer that question we have to consider who holds large positions in Treasuries. The largest holder is likely the Fed, but obviously, they are not sellers. China and Japan come next on the list of holders, and while Japan would never be selling, there continue to be rumors that China has wanted to do that. I have never been a believer that China would sell their holdings for two reasons; first that they couldn’t get rid of them all at once, so a large sale would devalue their remaining holdings; and second because they would still have USD in their account and need to find something to do with them. Now that rates are back to 0.0%, what would they do with the money? After all, that’s a really big mattress they would need. And given the fact that the price of gold has fallen sharply through all this, it would imply there is no big bid for gold either. This leads me to believe that the Chinese have not touched their Treasury portfolio.

After those central banks, the biggest holders are leveraged fund managers with Risk Parity strategies having been an extremely popular investment product for the past decade. The idea was that by holding a certain percentage of different asset classes (e.g. 60% stocks/40% bonds), one could target a specific risk/return ratio. But nothing is simple these days, and as bond yields continued to grind lower over time, hedge fund managers started levering up to buy more and more Treasuries to hold against a given portfolio of stocks. However, what appears to have happened in the past week is that many of those highly levered Treasury positions needed to be reduced given the dramatic decline in the equity portion of the portfolio. Thus, the only explanation that I can see to explain this type of unprecedented Treasury bond movement is a massive liquidation trade by the hedge fund community. My sense is that we will hear of a number of funds closing shop over the next month or so. As an aside, this reinforces the idea that we are still paying the price for the Fed’s actions in 2008-09 and the fact that they never returned market conditions to pre-crisis settings. In the end, once these positions are liquidated, we are likely to see bonds show a little more stability and perhaps, they will regain their haven status. But for now, they are as tough a place to be as stocks.

Now to today’s session. The equity euphoria felt after the US announcement of substantial stimulus coming, measured right now at $1.2 trillion, and very likely taking the shape of true helicopter money with checks cut to all Americans earning less than a given amount, has ended as quickly as it formed. Asian equities got killed (Nikkei -1.7%, Hang Seng -4.2%, Australia -6.4%) and European indices are also tumbling (DAX -5.5%, CAC -5.5%, FTSE100 -5.0%). US equity futures are limit down (-5.0%) at this point, so a lower opening seems likely.

In the FX world, as I mentioned, the dollar is top dog. Today’s worst performer is MXN, which has fallen a further 4% to yet another new low (dollar high) with USDMXN now trading near 24.00. Vacations there will be cheap when we can travel again! But RUB is lower by 3.6% as oil continues to slide, and ZAR is down 2.0% on the weakness in gold and all metals. APAC currencies were all weaker by between 0.2% and 0.6% except for PHP, which actually rallied 0.7% today after the government reopened the Philippine stock market. Yesterday, they had closed trading completely and the decision was not well received at all, so now they are all working remotely and that seemed to cheer the FX market as some funds flowed back into the country.

In the G10, the pound is the leading decliner, down 1.5% as I type and looking for all the world like it is going to test its historic 1985 lows of 1.06! Today was the day that Brexit negotiations were to begin with the EU, with plans for a large group of negotiators on both sides. Obviously, in the current situation, that is no longer viable and it seems inevitable that Boris is going to need to postpone the eventual exit. Of course, he will pay no political price for that given the circumstance. But the rest of the G10 is also sliding, and the slide has accelerated since NY walked in at 7:00. For instance, the euro had actually been a bit higher earlier this morning, but is now down 0.25%. But it is Aussie and Kiwi (-1.4% each) as well as SEK (-1.3%) and CAD (-0.8%) that are pacing the blocs decline. The only exception is the one we would expect, JPY which has edged 0.2% higher this morning. While dollar needs remain substantial worldwide, yen investors continue to liquidate internationally and bring home their money.

On the data front, we do see Housing Starts (exp 1500K) and Building Permits (1500K), but again, nobody really cares. The focus will remain on Fed and Administration policies and market responses to those announcements will continue to be the primary drivers going forward.

Good luck and stay safe
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