Today’s post will have no answers. I am not sure anyone truly understands the strange day to day squiggles of the increasingly intertwined global financial system, but I wanted to highlight a relationship that cannot simply be monkeys typing Shakespeare.
Let’s start with the market developments over the past couple of days. Last week ended on a trading holiday, with markets closed for Good Friday. Weirdly, the U.S. Federal Government does not take the day off. With Wall Street deserted, there were a bunch of economic releases that shit the bed. Yup, they were not good.
I took the liberty of lifting a couple of charts from ZeroHedge that sum up the extent of the economic miss:
As traders huddled around their screens Easter Sunday evening, it was no surprise that U.S. Treasury futures were indicated to gap higher. When the opening bell rang for the GLOBEX session, the Five Year T-Note future opened up almost half a dollar (a big move for a five year note) on massive volume of more than a billion dollars in the first two minutes.
Nothing really surprising about that move. After all, there is a monster speculative short position at the front end of the yield curve.
But after the big emotional gap open, the price of all U.S. fixed income drifted lower.
Maybe this could be the result of thin holiday conditions. For most of the night, prices meandered around, so it makes sense to not read too much into the moves.
But once U.S. traders returned to their turrets this morning, prices continued moving down. Strange. Maybe this was an ‘all-baked-in’ situation where the weak CPI and Retail sales data were anticipated?
Yet today’s economic data once again disappointed expectations. The Empire Manufacturing Survey came in at 5.2 versus a forecasted 15.0.
Despite more bad news on the economic front, bonds continued to sag.
What’s going on?
Eventually markets go where the fundamentals dictate. But “eventually” can often be a long time.
Far be it for me to suggest that U.S. Treasury yields are not set by fundamental factors, but take a gander at this chart of the U.S. 5 year treasury yield versus the Japanese Yen.
The Japanese Yen and the U.S. 5 year yield have been trading almost on top of one another.
And just in case you think this might be a “U.S. dollar thing,” here’s the same time frame with 5 year yields versus the US Dollar DXY index:
Yeah, there might be a loose relationship between the U.S. Dollar index and 5 year yields, but don’t forget the Yen is one of the DXY members. Given that fact, the DXY does not exhibit the same sort of pattern.
It is obvious the Yen price action is tied to U.S. yields.
And it’s not limited to fixed income. Here is the Japanese Yen versus the S&P 500 future:
It’s nowhere as clean as JPY / US 5 year yield relationship, but it is still way more correlated than should be the case.
There is no fundamental economic reason for the Japanese exchange rate to be so closely correlated to US yields and equities. The two economies are simply not that closely tied. It would make more sense for the Mexican Peso or the Canadian Dollar to track US capital markets.
The Japanese exchange rate is being influenced by massive distortions with their unprecedented quantitative easing programs. And that’s the rub. The Yen is not ‘tracking’ but instead ‘creating’ these moves in the U.S. capital markets.
The Bank of Japan’s quantitative easing program is without precedent in the developed economic world. It is easy to forget the magnitude of their purchases. To remind you, here is a chart of the Fed, ECB and BoJ’s balance sheet as a percent of GDP:
At almost 90% of GDP, the Bank of Japan’s balance sheet is just bat shit crazy! No other way to describe it.
With Kyle Bass and all the other “cool kids” focusing on China or some other trendy trade, the “Japanese QE blow up” forecast has drifted off the radar screen. But it really shouldn’t.
We might kid ourselves that U.S. financial markets are reacting to fundamental news, but all too often, they are simply moving to the price on the Bank of Japan’s last blue ticket.
I warned you that I wouldn’t have any answers in today’s post, but I implore you to stick the Yen up your screen and watch it like a hawk - it’s likely that any serious market dislocation will first show up in the movement of the Yen.
Thanks for reading,