The Case for Deflation

The market is in a curious state with some sectors such as oil and oil serivces hinting at bullish breakouts and bonds hinting at bearish breakdowns. How about the contrary? The charts say the market isn't far from deflation either. If crude reverses, the outlook for inflation dims fairly quickly. I'm not going into monetary data in this post, only looking at some assets that should be doing well if inflation, specifically commodities prices, move higher.

Crude oil is about $10 away from a clear bullish breakout, but it is battling at a resistance area. It is $20+ away from a major bearish breakdown.

Rio Tinto has a potential measued move to $100 or its done and topping.

Freeport-McMoRan has what looks like a diamond pattern to me. Moves out of diamonds are often huge, powerful moves.

Emerging markets, of which China is the main component, are less than 10 percent from major support.

Copper is already well into a rollover and it leads oil.

Not enough to call it a serious break yet, but EURUSD went through support on Friday. The euro is keeping the U.S. Dollar Index in a bearish pattern.

East Asian currencies are rolling over. It won't take much of a push open a retest of the dollar's 2022 highs. An extension of the current dollar rally into Monday might be enough, as it would be enough to carry EURUSD below support...

Of Australia, Brazil and South Africa's stock markets and currencies, only Brazil's currency looks strong. You'd think it would be more than 1 out of 6 if a commodities bull run is coming.

Gold has a bullish look to it, but it often falls in the first part of deflationary waves. A pullback towards ther $1550 to $1600 area might be the buy of a generation if secular disinflation and the 40-year bond bull market have ended.

I've been focused on rising home prices and affordability, but I didn't pay close enough attention to the 2006 top. The Case-Schiller Index spent about 13 months topping (the low between the two tops broke in April 2007, after the initial March 2006 peak) with a double-top pattern. A precisely similar top in time would see home prices implode this month because Black Knight has said, and the trend in Case-Schiller, points to a new high in July. Case-Schiller will report August data in October. Analogs need not be precise though. As long as prices sink in the autumn, it'll be a very similar top. The prior top was followed by a 50 percent decline.

Something Brewing in South Korea?

The won looks weak, with a possible major bearish breakdown in play. It only looks good versus the yen.

China Cuts RRR Again

Yikes.

CNY Down

USDCNY 8 is the chart and fundamental target in the near-term. If CNYJPY 21 is a ceiling, and the target for USDJY is 175, that is 8.33.

Chinese Intervention Hits DXY

I wouldn't be shocked if the moved in DXY is entirely the sterling bounceback and Chinese intervention. USDJPY hasn't joined yet. If it turns, there's a dollar pullback. If not, there's still a risk of East Asian currency meltdown.

Who's Ready for Yuan Devaluation?

I hate having to call it yuan devaluation, but that's what the mainstream idiots will call it when China gives up and lets the currency drop to a more natural level. What's been going on for the past decade is yuan stabilization and yuan overvaluation.

Reuters: China's state banks seen acquiring dollars in swaps market to stabilise yuan

China's state banks stepped up their intervention to defend a weakening yuan on Monday, with banking sources telling Reuters these banks sold a high volume of U.S. dollars and used a combination of swaps and spot trades.

I say it every time and I will say it again: if the dollar drops then no worries, the pressure will be alleviated. If the dollar continues rising...blatant intervention is the last step before letting the yuan reprice.

Crash or Rally Day 2

I have missed out on substantial downside profits the past couple of days by moving to cash. I can't complain though. I tenex'd my Apple position by buying puts in mid-August, sidestepping that big rally in early September, and then re-entering. My smaller trading account, an old Roth IRA that I converted to YOLO status this year, also increased nearly 10 times in the past six weeks. I sold the bulk of my remaining Apple puts yesterday. I also sold my EEM puts which were an 8x. I lightened up on XLP, which had been YOLO sized. I plan on getting back in after what I suspect will be a rally, along with a few new and old positions such as my Canadian bank puts.

I come into the day with some small positions on DOW, FCX, ASHR and XLP, along with a small OTM runner call position on SPY which I may daytrade into size today, along with a substantial long position in TLT including what are now 0 DTE calls. I bought 20ish delta calls for October and November which could remain.

The market has developed a diamondy pattern this week. Diamonds are rarely clean, but the form is there. The moves out of diamonds are typically powerful. There's a case either way because a move down will bring many many put positions into the money negative gamma effect will kick in as market makers have to hedge. There's also a case for rally because the market is overdue for one. Since the market failed at 3750 two days ago and has struggled around 3700, bears have been emboldened. Almost every rally was sold yesterday. Yet from around 10:30 AM and 3:10 PM, there were two powerful rallies of about 40 points on the ES.

What I was watching most of the day was the up minus down volume. Both of those rallies came on brief interruptions in the selling. Not net buying. You can barely see the 10 AM rally on the volume and you can see a small shift into up volume buying late in the day, but on net it was a small move. My sense of the market here is that it will take something like a panic to shake more sellers out, but there is a high risk of panic in these conditions. I'm not downplaying the possibility. On the other side, all it will take is some positive net buying to unleash a ripping rally for as long as the buying lasts. I suspect something like 100 points would come quickly if they buyers finally step in, if 40 points came when buying and selling volume were merely in balance. My bias here is to buy a dip, but it is not strongly held.

Bonds will rally if stocks rally. There is a rather sizable inverse H&S pattern formed on ZB and it has a target at the former mid-June low. That is about a 3 percent move. I could see that being traversed today if the market rallies. Conversely, it won't take much weakness to invalidate this pattern. The core PCE was higher than expected in August and increased the overall inflation rate, not bullish for bonds, although perhaps it wasn't bearish enough with home prices and rents now falling in September...

I like ZB and TLT as longs as the calendar turns to Q4. Not because I expect the Fed to follow the BoE with a new round of QE, but rather I see a combination of inflation coming down, potential stock panic fueling some safe haven buying and less room for losses. As long as inflation doesn't reaccelerate, it's at a level where there isn't substantial downside on the long-bond in late 2022. On balance, that can fuel a rally for a time even if it heads lower later this year or next.

BTC still hasn't cracked.

The Dollar Index looks similar to March 2015, but as I've been saying, "it ends when it ends." Assuming the stock market goes lower in October, there's still risk of massive depreciation in export currencies including the Chinese yuan.

The market will be easier to trade if it rallies, but the market doesn't have to make it easy to trade. The trend is down because this is a bear market. Tesla broke support on Thursday. The market has shown Apple is not safe. Both stocks are overloaded with bulls who still think this isn't a bear market. Yesterday, both stock showed they can wreck the market if they lead on the downside. I think both will fall hard in the next month or so, though maybe not today. If you've held puts/shorts until now and you have enough time, the coming rally shouldn't develop into a profit-crushing move. I use much shorter-term options and therefore have sold out. I would see my profits collapse if the market rallies. If it turns out I am wrong and the next move is a larger rally, I would have seen my profits completely wiped out.

Ignore the Yuan at Your Peril

Bloomberg: China Warns Yuan Speculators They Will Lose Money in Long Term

“Do not bet on one-way appreciation or depreciation of the yuan, as losses will definitely be incurred in the long term,” the People’s Bank of China said in the statement released Wednesday. Key market participants need to “voluntarily safeguard the stability of the market, and be firm when they need to iron out big rallies or declines in the exchange rate.”

The central bank added that it has “plenty of experience” to fend off external shocks and effectively guide market expectations. The statement referred to corporates making speculative bets on the exchange rates and financial institutions that were violating policies.

They're bluffing. They don't have enough dollars to defend the yuan and moreover, they don't want to defend the yuan if the dollar continues rising.

The onshore yuan has fallen more than 4% against the dollar this month and is on track for the worst annual loss since 1994. Earlier Wednesday the onshore yuan fell to the weakest level since early 2008 and the offshore unit to a record low in data going back to 2010.

They devalued in 1994.

Chinese version with some additional all-is-well context: 央行警告：莫赌“单边市”，久赌必输！人民币瞬间拉升

It's a situation with binary outcomes. Either it happens or it doesn't. If the dollar moves higher, odds of a revaluation surge. If the dollar peaks, there is no need for revaluation because CNY will depreciate along with the U.S. dollar (the peg may suddenly become tighter as well if they want to close the gap with EUR,JPY and KRW).

USDCNY Breakout

If the breakout holds, next target is above 8, my hunch is around the old peg of 8.28.

Lows Beget Lows; Yuan Deval to 8.28 on Deck

I talked about what could be next for markets this weekend. I posted charts on transportation companies, an airline, high yield and chemicals. There is a clear case for a bounce on these charts because they're at major support. If I have to condense the market into one chart, I pick BTC. My long-term support line breaks around $17,800.

The other charts to watch are currencies as I laid out in the "what's next" post. Almost all currency charts are either in "free fall" territory or coming up on major support and resistance. USDCNY is one day (at current volatility) away from breaking out. The target is around 8.10, but I'd wager the market tests the old peg area of 8.28 on a break. A 15 percent rally for USD from here, about 14 percent deval for yuan.

If this sounds crazy to you, consider this: yuan has mostly risen with the USD durign the bull market. Here's the returns for USD vs EUR,JPY, KRW and CNY since September 2018:

A yuan "deval" is not so much a devaluation as catching up with the decline in export currencies. I'm not predicting this will happen now, though I think it is highly likely for this cycle. If the dollar keeps running though, that is where the yuan is headed.

Finally, long-term government bonds continue their slide.

The 10-year bond futures contract has reversed all gains since 2008.

In conclusion, the market is poised for a bounce or a collapse and that's it. Until there are concerted reversals in currencies, bonds and stocks, then do not expect a sustained rally. Rallies will terminate within hours or days until this happens.

Yuan

China Starts Floating Yuan Deval Balloon

How many economic and financial commentators have you heard call for the death of the dollar and also say that China or its currency is strong? They are all clueless. The death of the dollar part is likely because all fiat currencies head toward the same terminal value, but what I have been saying here for a decade or more is what is actually happening: dedollarization happens via U.S. dollar strength and deflation because the rest of the world's central banks and fiat currencies are even worse. The dollar is popular when it inflates.

China is building the infrastructure for an international currency, and eventually a reserve currency, but it's actions today are the exact opposite. Meanwhile, the dollar system dies a slow death with every instance of depegging and/or hyperinflation in foreign currencies. Credit, then fiat, burns from the periphery to the core.

Back in 2015: Doomsayers: This Is the Domino You Have Been Waiting For

Doomsayers have been predicting the collapse of the global financial system and the dethroning of the U.S. dollar as reserve currency (or at least a severe real devaluation of the dollar versus gold and other other hard assets) for years. They have been wrong to date because the thesis was predicated on pre-2008 trends continuing. There was a significant change in 2008. First, a regular cyclical shift from inflation to deflation. In addition, demographics across the developed world and China likely are part of an order of magnitude larger cyclical shift. We are in the deflationary downturn of a larger deflationary shift, almost the mirror opposite of the 1970s cyclical inflationary boom amid the 1945 to 2008 larger inflationary boom. Central bankers have tried, in vain, to push the global economy back to the pre-2008 inflationary trend. Those predicting collapse for the greenback also argued China was the strongest economy, instead of one of the worst serial money printers in the entire world running up a credit bubble that looks to be the largest, and one of the most poorly invested, in history.

My position has been and remains that the fiat currency system will burn from the periphery to the core. China's currency has been artificially propped up since 2011, arguably since 2008 since the Chinese stimulus debt binge was the main driver of a rebound in commodities and emerging markets. The deflationary downturn was aborted globally by concerted central bank action in 2008 (and since). Imbalances have only grown since. China printed money at a rate that falls in the same category as Argentina, Russia, Brazil and Turkey. Those four currencies have all collapsed to varying degrees. China's currency is not immune to the laws of economics.

When the yuan devalues, it will start a fire that will consume the world's monetary system. It is the first big domino because when it falls, it will cause torschlusspanik.

Well here we are again...

Global Times: The strong dollar should not become a sharp blade to cut the world

The US Federal Reserve will hold a new policy meeting on Tuesday and Wednesday, with the decision on interest rate growth being the limelight. It is widely anticipated that the Fed will deliver at least another 75-basis-point interest rate hike to tame inflation. This might further increase the value of the US dollar against other currencies, which is at its 20-year high. Driven by the Fed's aggressive rate hikes, the US dollar is viewed as "experiencing a once-in-a-generation rally." For many countries in the world, this might be the beginning of another nightmare.

Controlling inflation is a nightmare.

The meeting will witness the fifth time that the Fed will raise interest rates. The direct reason is to ease the high pressure of inflation in the US. But if people dig the root cause, this is an inevitable consequence of US' blind and unlimited money printing to temporarily maintain "prosperity." In other words, in the face of the deep-seated problems exposed by the 2008 financial crisis, Washington has been powerless, and unwilling as well, to solve them. Instead, it was extremely short-sighted to cover up the crisis and curry favor with the Wall Street, while taking advantage of the hegemony of the US dollar to quietly treat the crisis like dumping wastewater - draining it to the world.

Talk about a beam in your eye.

This has not only worsened the already weak economies of Europe and Japan, but also forced a large number of developing countries to swallow the bitter pills of the economic recession caused by imported inflation. Countless families were impoverished overnight. This is a very abnormal situation that is not supposed to occur, but it is the cruel truth behind the US "containment of inflation."

All of this talk of imported inflation...countries can only import inflation or deflation if they use the currency that's inflating or deflating. If China devalues the yuan, prices adjust for it. If China does a massive infrastructure stimulus, it causes price increases for raw materials such as copper and iron, and it could be forced to raise prices for wages, but that only translates abroad if other countries are willing to pay for it. If Vietnamese factories don't require wage hikes, they can take away market share, and Chinese businesses can move there over time. What actually happened the past decade as China increasingly relied on its real estate bubble for growth.

Each round of dollar appreciation in the past decades has been accompanied by extremely bad memories: The Latin American debt crisis broke out in the first round, Japan suffered from the "lost two decades" during the second round and the Asian financial crisis took place during the third. Particularly in the Asian crisis, which is still fresh in many people's memories, more than 100 million middle-class people in Asia fell into poverty, according to the World Bank estimation. The strengthened dollar, time and again, cuts the world like a sharp blade.

Why do foreign countries keep making the same mistake over and over? Why does the USA for that matter? It's always someone else's fault with communists though.

Poor financial decisions result in poor financial results. The U.S. is as stupid as many of these countries, but still far less stupid because it remains more capitalist and more open. As bad as the Federal Reserve is with monetary policy, foreign countries are worse.

The best way to restrain the rampaging hegemony is to practice true multilateralism. Whether it was the Asian financial crisis in 1997 or the global financial crisis in 2008, the world seemed to have stumbled more than once by the same stone, which, however, is not that firm anymore. The instability and fragility of international financial markets have once again become prominent. It is precisely at such times that the international community should be more determined to cooperate and build a reliable, systemic and long-term multilateral international financial system. This cannot wait.

The U.S. would be terminally stupid if it ever agrees to join a world system, but terminal stupidity is abundantly supplied by the Baizuo ruling class these days. The U.S. should abandon hegemony though, and let the rest of the world collapse to its natural socialist level. The U.S. was meant to be a "Shining City on the Hill," an example to the world. Not a hegemon, but a teacher. It was seduced by power after WWII and gone far away from its capitalist, Christian roots. Time to return.

As for China, they're floating a devaluation of the yuan. This editorial is out because they're finally screaming out loud from the dollar pain. 

Asian Crisis 2.0

2015: China Reserves vs M2 Worse Than 1997 Asian Crisis

China's ratio of reserves to M2 fell to about 8.25 percent in August. They don't have much in the way of free cash to defend the currency because most of those reserves are needed for the economy and financial system. Maybe they have 1 to 2 percent. As the chart above shows, Thailiand was above 20 percent when the Asian Crisis kicked off. To get back to a 10 percent reserve to M2 ratio, the yuan has to devalue to USDCNY 8.5, a drop of about 18 percent.

Not predicting, only letting you know that if a ball gets rolling in the FX markets it can roll very far. If it happens, there will be a small window for nimble traders to put on trades that could make a fortune. Even if no trade, the idea that there is some currency defense coming...they're locking down cities but leaving export factories open for a reason.

US China Yield Spread Points to New Highs for USDCNY

If bonds break lower in the U.S., the dollar is going to be hitting new highs versus foreign currencies again. CNY is already on deck.

ECB Hikes, Powell the Matador Up Next

The ECB hiked 75 basis points today. There were spikes in equities, the euro and bonds, and then it faded. The question for today is whether this pullback hints at continuation of the prior three week trend or if this is a buying dip in a developing countertrend rally. I'm long TLT coming into the day, with a tight stop. Possible double bottom in play.

The spread between US and China govt bonds broke lower this week, but not Japan. The 2s10s has been rallying, but that is not a long-term positive sign because it's coming via the long-end rising faster than the short-end. Prior recessions (after 1982) saw a soaring spread because short-term rates fell in recessions. For now, the spread isn't as interesting as what bonds themselves are doing.

ZeroHedge was talking about a snap reversal in yen yesterday. It's not very actionable, but that's ok. Sometimes it's good to be reminded of potential trades even when the setup is not quite baked through. Looking at CNYJPY, one of two things is coming: a pullback in the dollar and reversal in charts like CNYJPY or something like July 1997 and Setpember 2008.

Bear markets are strange because it pays to have a very long-term macro focus, but the news feed is wild because years can be compressed into days. Rallies that take months to unfold in bull markets can happen in hours. Right now I'm lightly positioned waiting for reentry on shorts, and maybe go long if the rally has legs. Zooming out though, the Federal Reserve is still trapped. Prematurely declaring victory over inflation is a very expensive mistake. They must err on the side of overtightening. A recesssion is already underway and it will probably get worse. The Fed is going to take flak for that. They have an excuse though: we were fighting inflation. Everyone told us to fight the inflation. Failure is both inflation and a recession. That's why I expect stocks will tank around the time ZB starts moving higher, but the current moment might fool a lot of bulls who misinterpret what the bond market is saying.