ECB Emergency Meeting, FOMC and Japan's Crisis

ECB calls surprise meeting as borrowing costs rise

European Central Bank policymakers called an emergency meeting on Wednesday, as more indebted eurozone states have come under pressure from rising borrowing costs. A week after a regular gathering, the governing council will hold an "ad-hoc meeting"...

...The switch in the central bank's policy has raised the spectre of "fragmentation" in the eurozone, where the borrowing costs for some, more indebted members rise faster than for others.

My guess: Powell told the ECB a 75 basis point hike is coming. Spreads have been widening in Europe and the market action makes an emergency meeting warranted, but why not Monday or this Friday? The day of the FOMC announcement makes me think they want to project stability ahead of a surprise. Even if I am wrong, I view the emergency meeting as a sign a culmination move is underway or possibly even over. 

There hasn't been a highlight-reel blow-up like Bear Stearns yet, but the market fell about 20 percent into January 2008 and then retested that level in March 2008. It then rallied on the Bear Stearns bailout.

My view of the current situation: the economy is in worse shape than in 2000 and 2008. The Fed really screwed up leading into 2000 and set the course for everything that followed. The 2008 crisis was one where everything happened very rapidly. There was a slow buildup with housing topping around 2006-2006, the Bear Stearns hedge funds failing in August 2007 and an emergency rate cut by the Fed, auction securities failed in February 2008, Bear Stearns in March...and then everything collapsed at once. 

I do not expect everything will collapse at once this time, at least not until there is actual deflation in the economy. Instead, I expect something a longer period of decline similar to the 1970s. "Authorities," such as the ECB today, will step in and try arresting the decline. There is a case to be made for slowing the process of rate hikes, drawing out the pain to lessen the risk of a catastrophic collapse. 

There is one exception for a crisis. A sovereign debt blow-up and currency crisis in a major nation. Candidate number one is Japan: Japanese Bond Futures Suffer Biggest Rout Since 2013, Trigger Circuit-Breakers After 'Soros'-Style Bets Build

I will kick myself if this crisis kicks off now because I closed out my JPY shorts, but I do not think this is coming right now. Like the housing crisis though, a JGB-yen crisis can be seen from miles away, in fact it was seen at least a decade away. This phase from John Mauldin was seared into my mind 12 years ago: Japan Is a Bug Searching for a Windshield

Maybe we'll do it like Japan? Japan is a disease. They're like a bug searching for a windshield. It's a dying country. Nominal GDP is where it was 17 years ago. Plus, the population is very old. When they stop funding their own debt [as a result of retirees ceasing to save], it's going to get ugly. You're going to see the yen valued against the dollar go to 100, and then 120, and then 250, 300. They won't care how low it goes. They can sell more Hondas and Toyotas to us. They're just going to print money. 40% of their budget right now is borrowed. Think about that. They're in deep dire trouble with a government that has no clue. I think Japan will implode within the next two to three years. It will not be good for the world.

This event didn't happen in two or three years, but most people thought QE1, QE2 and QE3 would lead to the inflation seen now, in 2022. It took catastrophically bad policy in response to a novel respiratory virus, along with years of stupid energy policy, to get us to this point. Long Nikkei/short yen will be one of the trades of the decade if events continue playing out on the current trajectory. 

Short-term: I expect a bounce in stocks, a pullback in the dollar. After that, the deluge.

Long Japan, Short Yen Update

Back in March I posted: Trade of the Decade: Long Nikkei, Short Yen

I neglected to mention in that post that there is an ETF that does exactly this trade: DXJ. It made a new all-time high intraday today.

Shorter-term of years makes the Nikkei look like it will bounce versus the S&P 500 Index, note that currency depreciation massive enough to push the stock index higher would boost NK over ES. Longer-term, Japanese stocks looks like an abandoned asset class relative to the S&P 500 Index.

I'm only short the yen for now. DXJ is a decent vehicle becauase WisdomTree tilts the porfolio into export companies. It is at least a great starting point for people who want to maybe construct their own Japanese-stock portfolio. Speaking of myself, I seldom look at Japanese stocks and almost no one speaks of them outside of a few major exceptions that trade in overseas markets or are extremely high-profile companies.

Markets Do Not Believe Trade War Coming

Here's a look at China, South Korea, Japan and Germany, four export powerhouses. China is of course most likely to suffer in a trade dispute with the United States, but if China deals with the U.S. and imports more U.S. cars (one possibility) it will likely import less from somewhere else. Global trade isn't growing rapidly, rebalacing trade at this moment means redistributing trade.

Whatever one's opinion on the matter, there is no sign of investor concern in any of these charts. That could change at any time and markets are notoriously wrong at key turning points, but there is bearish signal from these charts with the exception of DXJ, but that's mainly due to the strengthening yen. A stronger yen is a bearish signal, but not because of trade.

The lack of concern might be because many of the people screaming loudest about tariffs also screamed loudly about Brexit and Trump's election, and were shown to be wrong. It may be that investment managers support tariffs, but don't want to go on record publicly because they either dislike Trump or don't want to get into a debate with economists. It may be that people complaining about tariffs don't really believe their rhetoric or lack investment capital (no skin in the game). It may be that the sudden thaw in North Korea relations (assuming North Korea isn't simply buying time, a good assumption given their track record) finally taught investors to watch Trump's actions more than his rhetoric, that negotiations with China are the most likely outcome. It may be investors think Trump is all bluster and will back down when the global push back hits. Whatever the reason, if you expect a negative market reaction, the market is priced right for going short.

I don't think a tariff dispute will be a single event like Brexit and the U.S. presidential election. Instead, it will likely drag on as the North Korea situation did. If China fires back with fiery rhetoric or a strong retaliation, even if it is also a set up to negotiations, I suspect markets will react poorly. It will be remarkable if they don't. Several charts including China, Germany and Japan Hedged (DXJ) aren't far from support. South Korea (EWY) would need to fall 20 percent to hit support. China (FXI) needs to slid a little more than 7 percent to fall below support.