The Big Dollar Swoon?

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There were so many false starts last year for those of us who were looking for the big dollar to roll over that it’s natural to be a bit gun-shy here. But the charts are unambiguous: It’s happening right now, and the odds that it sticks this time are as good as they’ve been in a long while.

Obviously, buckets matter. The funding currency bucket will behave differently from the risk/EM currency bucket. And the antipodean bucket will behave a little differently from the other two. But all of them look good against the dollar right now.

In poker, there’s a term called “pot odds”. It means that the even if you’re not confident that your cards are strong enough to win, you play out the hand because the return on your marginal bet to stay in is potentially so large. The analogy here is that there are certain setups that–whether you want to or not, whether you’re feeling it or not–your discipline says you just have to go for. The patterns on the charts posted below tell us that if you’ve been looking for a short dollar run, you have to be in now. At a minimum, you certainly can’t be long dollars.

This does not mean you go crazy with size or that you abandon your stops. In fact, when you have been faked out a number of time and are gun-shy, it is best to undersize the positions until you build up more mental capital (and pray the market gives you another decent entry point after you have). But you have to be in.

The EM charts look the best. USDTRY, USDBRL, USDZAR look great. And USDTRY and USDBRL look even better on the five year charts. The BBDXY has rolled over too, and the five year real yield have finally completed its drop, weak-ass bounce, then drop again pattern. (USDMXN looks good too, but it has already had a big run and positioning is not as favorable.)

Obviously, for the EM currency bucket to work, risk appetite will almost for sure need to comply. This is less true for the funding currencies and precious metals, which have looked good for a couple of weeks now.

Roll tape:

USDBRL on the one year
USDBRL on the five year
USDTRY on the one year
USDTRY on the five year
USDZAR on the one year
BBDXY on the one year
BBDXY on the five year
US five year TIPS real yield on the five year

Good luck.

Misunderstanding Liquidity, Misunderstanding QT

Liquidity. It’s one of the most frequently used words in finance. It gets invoked to explain virtually everything and anything. But it’s often clear that those invoking it are just parroting things they learned somewhere along the way and don’t truly grasp the mechanics of it. Most don’t even make the basic distinctions among its various forms.

Here’s a rough TL;DR of what you need to know.

There are three basic types of liquidity: Systemic, Credit, and Transactional.

Systemic liquidity can be loosely thought of as the unencumbered resources in the banking system that can be used to settle intra-bank payments. Think Fed funds. And if Fed funds breaks down, payroll doesn’t get made and ATMs run dry. This is what we were on the cusp of in 2008.

But, importantly, Fed funds is a closed system. A bank can draw on its reserves to meet payments to other banks in the system, or, when necessary, get physical cash, but it can’t ‘lend them out’ to clients. Nor can it flood the equity or currency markets with them–contrary to the popular trope. They are not fungible in that way. Only the Federal Reserve can add or withdrawal from the system (with that small exception of physical cash). So, while the composition of reserves across banks can change, the aggregate level in the system cannot unless the Fed wants it to. This type of liquidity is exogenous; it’s all about the Fed.

Credit liquidity is the ability of borrowers to access credit–either to increase debt or roll over existing liabilities. Bank loans, bond issuance, trade finance, whatever. Credit availability is a function of risk appetite, not bank reserves.

It is really hard to disabuse people of the belief in the loanable funds model of credit availability we were all taught in school. This will surprise a lot of people, but the level of Fed fund reserves and credit extension are–even over the long run–uncorrelated.

Don’t believe me? Consider this:

From 1981 to 2006 total credit assets held by US financial institutions grew by $32.3 trillion (744%). How much do you think bank reserves at the Federal Reserve grew by over that same period? They fell by $6.5 billion.

Think about what that means. Bank reserves declined over the 25 year span of a generational credit boom of massive proportions. There’s no way this could happen if banks couldn’t, on their own, without regard to reserves, create money ‘out of thin air’.

Skeptical? Go over to FRED and verify these numbers for yourself.

Yes, in theory banks have capitalization ratios that at some point could constrain lending, but, as we’ve seen time and time again, banks find ways to get around regulations when their risk appetite runs hot. Moreover, cap ratios are about sufficient ‘asset coverage’; reserve levels are about sufficient ‘liability coverage’ and have nothing to do with lending.

Think about it this way: If I give my brother an IOU for $100, and he accepts it, we have created credit out of thin air. No cash needed, no reserves liquidated, no assets pledged. He can then sell it to my sister, if he so decides and she trusts my creditworthiness. She then has the claim on me, and we have just created money. If my reputation in her town is sufficiently creditworthy, she could then sell the claim to others, and so forth and so on. No one has to even think about systemic liquidity or the Federal Reserve’s balance sheet, much less be constrained by it. It all comes down to risk appetite, in this case specifically others’ perception of my creditworthiness and their perceived vulnerability should I not make good on it. This is what is called endogenous credit creation.

Transactional, or market-making liquidity is the ease with which market participants can buy and sell financial assets. This is often proxied by bid-ask spreads, volatilities, and market depth. Old hands know how pro-cyclical this type of liquidity is. It is driven by risk appetite, regulatory environment and market structure. This is where things like the Volcker Rule bite. It has virtually nothing to do with the size of the Fed’s balance sheet, either.

The bottom line: Only one of the three fundamental types of liquidity are directly in the hands of the Fed. The other two are pretty much entirely up to our risk appetite.

This is an extremely un-nuanced explainer of the basic types of liquidity and their drivers. Importantly, it abstracts completely from the psychological dimension of what people think the actual drivers are–something that genuinely matters, if only in a transitory way. And it also abstracts from the Fed’s signaling and other indirect effects, which can be significant. But, as a first cut at looking at the mechanistic links between the size of the Fed balance sheet and ‘liquidity’, this should be a good place to start. So, next time when someone comes on TV conflating different types of liquidity, you’ll know what time it is.

P.S. If you want to understand the mechanism through which banks lend, I recommend the Money and Banking chapter of L. Randall Wray’s “Why Minsky Matters“. Some of the concepts are counterintuitive, so keep reading it until it make sense.

Improving Krugman – A Story About Brazil

Paul Krugman tells a story about the Brazilian economic crisis of 2015-2016. I am usually a fan of his large economic brain. You can disagree with his politics, and even quibble with his economics, but any objective reading of the outturn since the GFC makes it clear that he got the big things right when very few others did.

His story about Brazil, however, while not outright wrong, could be substantially improved. He argues that the trifecta of a commodity shock, large domestic debt burden, and application of expansionary austerity (contractionary fiscal and monetary policies) did them in.

First, Brazil is not a big commodity exporter as a share of GDP. The pervasiveness and persistence of this misconception goaded me into posting this a few years back.

The TL;DR is that Brazil’s exports are not only about 11 percent of GDP (very low by EM standards), but the ratio actually declined over the course of the boom years (from 15% of GDP to 11%). Hardly what you’d expect to see in an export-led boom—even if you account for currency appreciation on the export share of GDP.

This doesn’t mean that the terms-of-trade shock didn’t matter. It certainly had a negative effect on output, especially when you consider the negative signaling effect to foreign investors who deeply bought into that narrative, and had, by that point, already become a material part of Brazil’s domestic debt financing. But at 11% of GDP, this part of the story was not nearly as nasty as it was made out to be.

Second, he lays a lot of blame at the feet of the Brazilian policy response. And in a very strict sense, he’s right. Raising rates in an economy that just built up a lot of domestic debt (more on that in a sec) while contracting the fiscal position will hit an economy like Brazil’s hard. Government outlays there are a large share of GDP (IIRC just under 40%).

The important omission here though is “how risky would simulative policies have been”? In most developed economies—and certainly in the US–policy credibility allows for expansionary fiscal and accommodative monetary when there’s a downturn. This is not the case in emerging market countries. In fact, many would argue that this is the defining distinction between EM and DM countries.

To the point, the legacy of liquidity and solvency crises in emerging markets results in running the risk that expansionary countercyclical policies scare investors—rightly or wrongly—and induce more aggressive retrenchment by foreign portfolio investors and further capital flight by locals. The muscle memory in Latina America on this runs particularly deep.

As a rule of thumb, the greater the perception that a country is or could easily be faced with a liquidity-cum-solvency crisis, the greater the risk that expansionary countercyclical policies prove counterproductively tragic. At some point along the credibility spectrum countries decide, understandably, that it’s not a policy risk worth running.

The real culprit in the Brazilian crisis was the sudden stop. Not the classic sudden stop à la Calvo, but the sudden stop of domestic credit. And this is the part where Krugman gets the emphasis right, citing Atif Mian et al.

From 2003 to 2014, domestic credit to the private sector in Brazil went from 23% of GDP to 70%. This, not exports, is what fueled the economic boom (and in many other EM countries in the same period). It left Brazil with a credit overhang it had to digest and a lot of debt that needed to be rolled over at higher rates, as Brazil jacked up the SELIC (Brazil’s policy rate) from 7% to 14%.

Maybe this all seems like one big quibble, but to me there are two important take-aways: (1) It’s a myth that Brazil’s s a country driven by commodity exports, and (2) the role of policy credibly needs to be a larger part of the discussion of optimal policy responses to adverse shocks. This may be obvious to someone who has spent a career toggling between EM and DM sovereign analysis, but is regularly absent when DM economists–even great ones like Krugman–go tourist.  (Side note: This is particularly important in all the current chatter surrounding MMT, but that’s a post for another day.)

Charts and Thoughts

There’s a lot going on right now. Tons of cross-currents. Lots of risk, but lots of good risk/reward set ups as well.

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Here are the charts and thoughts that to me matter most.

First, and most importantly, we are very, very oversold by historical standards.

The above is the McCellan advance-decline summation index. If you line up all the other times since the GFC that the indicator has been at this level with the SPX, you will see that either contemporaneous to or within a few days of the local low, stocks started a meaningful bounce. The three times this did not hold true were in the July 2008-March 2009 window. There is also a pronounced divergence in the NYSE cumulative AD line and its RSI.

(NB: For an aggressive trading style, there is a big difference in sizing a position in anticipation of an immediate bounce, and sizing it for a bounce that you think is likely to happen after the next couple/few days.)

Second, shorter-term, many of the major and sector indices are running into natural resistance spots–either popular moving averages or overhead supply points. Most investors right now are some combination of skittish, wounded, and underperforming; Can’t afford to lose more, can afford even less to be left out of a year-end rally. This creates the exaggerated buy the rip, sell the dip dynamic that is often referred to as a ‘short gamma mindset’.

Here are the SPX, IWM, and QQQ:


You can also see overhead/natural resistance in the SMH and the XLF, among others. However, on a more constructive note, if you look closely at the above charts you will see that when they made lower lows in price, their RSIs (relative strength indices) made higher lows; in other words, positive divergences.

Third,  EMFX, metals, and some EM names bottomed in early September, and platinum, gold, and some gold miners have really promising patterns. It is true whatever safe-haven bid that may have crept into gold and gold minors would unwind in a meaningful equity bounce, but the fact that EMFX bottomed at the same time, and platinum is leading gold, is encouraging.

Here are: FXJPEMCS (JPM’s EMFX spot index), AU, ABX, GLD and BFR (one of the Argentine banks)

Fourth, and at odds with the last point, real and nominal yield patterns have shown no sign of stopping their rise.

Below are the 5-year real yield and the 10-year futures contract:

The bottom line on rates is that despite whispers of global slowdown, the data–in the US at least–are still running on the hot side and yield patterns still look higher. This could turn quickly, on even the smallest of comments from the Fed, but it is important to underscore that until it shows signs of doing so, it’s little more than wishful thinking.

Fifth, there are a lot of names that have asymmetric entry points. Stop outs are fairly close by, and if global markets do rebound, there would be a lot of room to run. Some, like Deutsche Bank, Argentine banks (BFR, BMA, GGAL), homebuilders (PHM, MTH, NVR, , are knife-catches–and in the cases of European banks and US homebuilders, they are bets that the US and global cycles haven’t ended. Others are strong secular growers–thinking about names like AMZN, Tencent, BIDU, SQ–that only give us entry points when we are least inclined to want to buy them.

It should also be pointed out that many of the charts that have bumped up into resistance of one type or another could easily pull back for a day or three and turn into a ‘W’ or an inverted Head-and-Shoulders–two common bottoming patterns–so the timing over the next couple few days could be tricky even if a meaningful bounce is upon us. But the signs, on balance, are quite constructive.

How you risk-manage (how to size, where to set stops, how much correlation across positions/risk concentration) is a function of your ‘mandate’, your personal style, your current level of ‘mental capital’, etc. But it is worth underscoring the importance of managing your risk in a way where you aren’t likely to get ‘chopped out’ because positions are too large, or the portfolio is too concentrated.

Good luck.


This is the time when we look for divergences. There are many ways to look at divergences and the approach should always be a weight-of-the-evidence kind of thing. It’s not binary. You simply want to see if there are enough indications that the odds have been tweaked in favor of a reversal.

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The classic divergence is when, in the re-test of a hard decline, price undercuts the previous low but other indicators don’t exceed the levels reached on the day of the first decline. If there are enough such divergences, the odds of a rebound improve significantly.

More often than not, though, the picture is somewhat muddied. And that’s the case here. A few indicators do show divergence, but one important one doesn’t.

Here they are:

First, I’m posting a chart of the SPY. I’m using SPY instead of futures so we can also get a clean read on volume.

You can see that today the October 11th low in price was undercut. But you can also see that it did so on lower volume. That’s one divergence.

Another common divergence go-to is the 52-week new low list. You want to see the new lows contract relative to the first low.

Here, you can clearly see that new lows expanded a fair amount today relative to October 11th, so no divergence.

Another common indicator is, of course, the VIX. You want to see it make a lower high.

You can see that here, the VIX did make a lower high, so we have another indicator suggesting the selling pressure today was less intense.

I also like to look at the number of declining names in the NYSE (common stocks only), which you also want to see contract.

And here we have another divergence. Today’s 2,574 is lower than last week’s 3,209.

Lastly, even though I don’t place too much emphasis on relative strength indices, the RSI on the SPY did make a higher low today, which constitutes another divergence.

Bottom line: We do have a number of divergences. The odds of a rebound are decent. It would be a lot better if new 52-week lows also contracted, but still, decent.

Argentine Banks

Catching falling knives is a dangerous game. It might be a little bit easier in an emerging market economy that has just gone through a crisis, but figuring out when there’s the right amount of blood on the streets, when others are sufficiently fearful, is always a dicey task.

But it is also, potentially, a very lucrative one. There are no guarantees, but there are a couple things in situations like this you can do to tweak the odds in your favor.

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First, the currency leads. EM blowups are synonymous with big, uncontrolled currency depreciations. The local monetary authorities are usually forced to raise policy rates aggressively to short-circuit capital flight. They also often avail themselves of an IMF program to bolster reserves and confidence. Eventually, these policies start to work and when they do we tend to see it first in the currency.

This appears to be happening now in the Argentine peso.

The break of 37 last week signaled that currency stabilization/appreciation is, with a high probability, on. It helps when short term market rates are just over 70 percent.

The second tweaker is pattern analysis. Ideally, one would want to see a day or two of high volume bottom selling, followed by a period of solid bounce on high volume as well. Then you would want to see a drift down from that bounce to a higher low on light volume, and then a move out off of that higher low on a pick up in volume. This would constitute a classic double bottom retest. High quality pattern.

This is now what we are seeing in the Argentine banks. The four charts posted below all more or less show it.






Of these four, the first two show the best patterns. And the first three are probably “systemically important”. The last one, $SUPV, probably has the the diciest book of business (most consumer credit, least government credit) of the four. Of course, qualitative distinctions might not matter (at least for a while) if this indeed is the beginning of a recovery.

But in investing there are many ways to be wrong. There are plenty of headwinds. One, we’re in the midst of a bout of global risk aversion. Two, EM sentiment is terrible and investors have shown little interest so far in returning. Three, the peso might not be done depreciating. It’s not clear to me that the peso has overshot fair value as dramatically as is often the case in EM crises. There were many years in which high inflation far exceeded peso depreciation. If the peso is only ‘cheap’ and not ‘ridiculously cheap’, this would limit the scope for appreciation and probably dampen the amplitude of any rebound in the banks (I doubt with 70% rates we’ll see significantly more depreciation, but this too is possible). Four, the banks are black boxes at this stage. It’s hard to know how much damage there will be. In these kinds of plays if you wait for there to be more visibility onto the banks’ books you will have missed the opportunity. Some leap of faith in these circumstances is required. But not knowing exactly what’s on the books and how it will interact with high rates and a big currency move is obviously a big risk.

To mitigate the consequences of these risks, there are two things you can do. One, set stops below the recent higher low. How far below those lows will depend on your confidence in the thesis and how you size the overall position, but there are many points that will give you highly asymmetric payoffs. Two, you can set a stop based on USDARS staying below a level. 37 would probably be too aggressive. 38 would probably be more reasonable. If USDARS doesn’t stay down–and ideally continue lower–this investment thesis is much less likely to play out.

Good luck.

Currency swap basis vs Currency swap rate

I’ve run into some confusion lately on FinTwit with respect to ‘currency swap basis’ and ‘currency swap rate’. The discussion was about changes in currency hedging costs for euro and yen-denominated investors buying US fixed income assets. Admittedly, it’s easy for people who aren’t deep global fixed income practitioners to confuse them. I thought this simple description might help.

A currency swap is supposed to reflect the interest rate differentials between two countries. But it never works out to exactly that. There’s usually a small difference. And that difference is called the ‘basis’. ‘Deviation from theoretical’ is how I think about it. So, the basis is not the cost of the hedge, but it is one component of the overall swap rate, which is the cost of the hedge.

The original market point I was making is that the costs of hedging out the currency exposure in dollar-denominated assets has increased more than the yields on those assets have, and this has been an underappreciated force that has been weighing on the US bond market.

Shortest Market Take Ever

I thought this email captured my views pretty succinctly, so I decided I’d share it. Please ask questions if you have them in the @BehavioralMacro stream and I will answer them as best I can during jury breaks. Good luck.

“Hey X. Sorry again about the slow response. Still terrible with email and on top of that have been (and still am) on jury duty. I posted this on my blog back in April.

I still think, amid all the tape bombs and geopolitical noise, that this is the operating environment until roughly end of summer. If we get into a full blown trade war, it will of course get uglier, but whether we do is still too path dependent for us to know. I have been in ‘keeping P&L mode’ more than ‘making P&L mode’ since I posted that piece. I had a ridiculously good Q1 in my Trading style and don’t want to mess it up. In my Investment style I have been waiting for us to finish the consolidation pattern to deploy more cash. Not too worried about the Fed, about overheating, or about a recession for the foreseeable future. I think EM continues to underperform until the market begins to think it has some clarity on where the Fed’s terminal rate will be and when we are likely to get there. At least this is my working hypothesis. Hope all is well out there in the Hamptons.




Currency View. Right here. Right now.

Surfacing from pup training to share two words on currencies. I was prompted by a DM this morning from a sub who follows EM ccys very closely, and by the price action this morning/late last week, which to me has evolved in favor of seeing some USD softness soon. (Just look at today’s intra-day reversal in silver.)

I have posted below his question (pretty sure my assumption that the sub is a ‘he’ is correct) and my brief answer. Please feel free to follow up with questions in the stream or in DMs.


“Hi Mark, what is your best estimate of when a short USD / Long EM position is tradable? I take that this is to some extend data dependant and we probably need to see a bit more softer US data to conclude that the top is in for rates and the USD, but given the sharp corrections we have already seen in certain EMs, I am starting to getting increasingly tempted. Do you have any thoughts in terms of the timing here? Cheers!”


Hi. So, first one has to specify if we’re talking about a trade or a position. And if you are looking to position EM ccys, you have to start with what your current weighting relative to your benchmark/mandate/risk tolerance is. I would want to be modestly overweight here from a strategic POV. So, if you are underweight EM ccy, it makes sense to add here IMO. Need to leave room in case the EM unwind goes further (easily could), but I think the levels and the dynamic warrant adding. If you are flat, you can still start here to get overweight, but, again, make sure you leave room to add. On the tactical side, makes sense IMO to take a shot here at being more aggressively short USD, but with stops in mind/in place. Yes, for a short USD position to really run the data would have to cooperate somewhat, but the positioning and psychology is at least now somewhat favorable to try short USDEM here.”

Trump Will Come for the Fed

Monday morning, Trump tweeted the following, ostensibly about currency manipulation:

But it wasn’t about currency manipulation. It was about the Fed. He was laying down a marker for later blame while at the same time preparing the ground for stepping up political pressure when and if the interest rate hikes start to bite. It also serves as a subtle first trial balloon, to see what kind of pushback/reaction he gets—with the ambiguity in phrasing serving as plausible deniability if not well received.

This is obviously conjecture, and it’s hard to get into Trump’s head. But when it comes to tweeting, there is usually a propagandistic method to his madness.

So, let’s take a look at what we do know.

We know Russia is not a major economy by any metric. And what exports it does have (commodities) are not exchange rate sensitive. And Russia doesn’t have a history of competitive FX manipulation. So, it wasn’t about Russia, which was likely thrown in to create the impression of a broader issue.

We know the Chinese exchange rate had been a real issue, but not so much any more. It is one Trump repeatedly mischaracterized/misunderstood during the campaign, but the Big De-peg of 2005 and the massive ULC-adjusted CNY appreciation thru 2013 pretty much took that issue off the front burner.

USDCNY, last 15 years

It’s true that Trump often tries to put lesser or bogus issues on the table in the hopes of getting something for negotiating them away later, and the US is in some sense in trade negotiations with China, but it’s a weak play, the issue wasn’t top-of-mind, and there was no need to reference Russia or the Fed if trumping up a negotiating point with China was the objective.

And we know that the timing makes more sense with respect to the Fed. Rates have been hiked now a half-dozen times, the growth optimism felt back in January has cooled/is cooling. The prospect of a slowing—or even moderating—economy has to terrify Trump, since he has pinned his political hopes on delivering outsized growth. It’s the only play he has. He both needs the Fed to blame if growth falls short and for the Fed to “cooperate” as much as possible. Moreover, his administration announced two new Fed Board governors the day of the tweet, so this issue was top-of-mind. And he has shown zero compunction in trampling on the integrity of any person or any institution that gets in the way of what he wants, whatever the systemic implications.

If you believe, as I do, that growth will soon settle back in with a two-handle and not a three-handle, the temptation for Trump to increase political pressure on the Fed will be too great to resist—unless the GOP and his base revolt in consequence, a bet that recent history suggests is not a good one.