Article / 12 September 2016 at 10:24 GMT

Steen’s Chronicle: Bubbles, regulation and credibility

Chief Economist & CIO / Saxo Bank
By Steen Jakobsen


Underweight: Fixed Income (government bonds and credit)
Underweight: Gold and silver
Overweight: USD (vs JPY, AUD and NZD) 
Overweight:  Cash

I did some extensive sharing of charts on both and this Sunday (click on the links to see them) – also below a piece I wrote earlier this month on some of the main issues.

Why Bubbles, regulation and credibility?

I think it explains the sea change in markets perception of quantitative easing and what is to come and most importantly it explains why Fed will hike rates despite having zero economic grounds to do so.

Bubbles – Fixed income is clearly in a massive bubble – anyone willing to argue -40 basis points or even -60 bps makes sense is short of experience in this market and it's even worse if a highly educated and brilliant economist like the Fed’s vice-chairman Stanley Fischer can state that “negative rates are working more than I expected” when he only needs to call a Danish or Swiss Bank to get the “real story” it is simply scary – and by the way: the Bank of Japan's NIRP has worked brilliantly, right?

Furthermore the massive cross-asset-correlation, Xcross, has made it impossible to hedge or run for cover:

Lower for longer is no longer a clear future path, maybe this chart explains why?
Clearly the one thing central banks wants to raise: inflation is not working – and by the way QE3 did the same damage to the US!

With the European Central Bank failing to “deliver” more of same – the yield curves in Germany and Japan have steepened and surprise, surprise we are suddenly back to ZERO interest rates from deeply negative!)

Japan 2-year vs 10-year yield curve
 Source: Bloomberg

Japanese and German 10-year yields:
 Source: Bloomberg 

Regulations – In my opinion the October change to Money Market funds in the US is one of the biggest events in 2016, and the reason for this is that it dries out the funding for foreign banks in the US and Commercial Papers programmes: 

For those of you not yet familiar with these changes click here for a Vanguard customer briefing:
Basically due to Lehman, Prime Funds can no longer guarantee the “buck” – or NAV of $1 - instead they need to trade at actual NAV – this has made Prime Funds less “safe” and since October 2015, $500 billion has left Prime Funds.

Prime Fund vs Government Money Funds have one main difference: The ability to buy Commercial Papers issued in the US (foreign banks being bigger users of this facility) .

Total Asset in Prime Funds (USD) :
 Source: Bloomberg 
SO….. $500 billion is missing in “funding”…which has mean....:
Higher LIBOR, TED spreads and Cross Currency Funding costs.

Three month LIBOR (ICE):
 Source: Bloomberg 
TED spread :
 Source: Bloomberg 
JPY cross currency swaps(1 yr) :
 Source: Bloomberg 

Credibility – Fed and central banks overall have little credibility left – The Fed promised – even guaranteed – us three to four hikes in 2016 – now they are desperate for “normalisation” despite the economic data remaining dodgy, but… they are now privately and publicly addressing the fact that “too low for too long…creates misallocation of capital and social injustice…”  This is a remarkable admission, although above charts on inflation or the lack of it must be a huge disappointment for them!

This is their solution to the inequality – not to continue feeding it….and more important I think the Fed wants/needs/understands that not delivering a hike marks the end of their communication policy, fortunately for them there is good news from overseas as China PPI this week marches further and is closer to being positive again.

China Producer Prices has led world into deflation now it looks like it's coming back again..

China PPI (YoY) :
  Source: Bloomberg

The Fed is almost forced to move to show market we can actually count on them…..of course this is my private estimation but why not use a stock market at all time high, combined with fixed income yields at all time low to take some credibility back – historically the Fed would have hiked margins several times on the bank, but in today’s world of never crisis management this is a non-starter.

The Fed always cut rates on selloffs in the market, I think the market is starting to add two and two together and finding out that: Yes, the Fed needs to hike, the market needs higher rates, the world can’t continue to b sit around and wait for next Fed, BoJ or ECB meeting.

Too high a correlation between assets kills – always – and complacency rules supreme.


The above is summary of factors in play – of course there are a lot of things I left out, but throughout this crisis only one rule stood its test: The price of money dictates everything – for the first time in eight years market is now all of sudden in doubt, and policy makers more so. This may not be the last pretend-and-extend but now  two way trading has started, the best sign I have seen in years!

Safe travels,

Steen Jakobsen


Saxo Bank hosts a daily morning call where our traders and strategists from the #SaxoStrats team review the key overnight developments and give their views on trading ideas as well as current themes and drivers across the major asset classes. The call starts at 0740 GMT and lasts no more than 15 minutes, with a recording posted as a squawk in the SaxoTrader later in the morning. To join us each morning, click on this link –  http://MorningCall.Saxo – just before 0740 GMT and log in as a guest. You can also follow on your mobile.

My links :

– Edited by Clare MacCarthy


Steen Jakobsen is chief economist and CIO at Saxo Bank

12 September
fxtime fxtime
Great article Steen.
I wonder if the fed are simply scared of moving before an election as they aren't allowed/mandated to influence the electorate immediately before a presidential election also Greenspan once raised rates at market highs with devestating results and perhaps Yellen is cautious of historical outcomes too.
12 September
Market Predator Market Predator


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