Developing Concerns - March 2, 2016

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Greetings,

China is still ground zero for this burgeoning crisis, but the risks of a hard landing have not intensified recently. In fact, there have been encouraging signs that Chinese growth is stabilizing as stimulus packages buoy credit demand, home prices and infrastructure spending. However, the focus of downside risk has merely shifted to developed markets as growth data continues to weaken. The US and EU grew a mere +1% in the fourth quarter, while Japan contracted – again.

Draghi has every excuse to drop the hammer and blow out his QE program at the ECB’s gathering next week. Eurozone CPI dropped back into negative territory at -0.2% Y/Y in February, and even core inflation is back down to +0.7% Y/Y. Germany, the EU country that should be benefitting the most from a weaker EUR, is struggling mightily. The German IFO Business Climate survey saw the largest M/M drop since the Financial Crisis in February, and the Business Expectations component suggests GDP will keep slowing. And frankly, it’s hard to imagine businesses getting more optimistic anytime soon with the migrant crisis, Brexit vote and regional elections looming. Even former BoE Governor Mervyn King, a card carrying member of the central banking elite, is now predicting a collapse of the Eurozone.

The situation isn’t any prettier in Japan where the yield on 40Y JGB’s fell below 1.0% for the first time ever last week. The BoJ’s sudden shift towards negative rates has sparked a surge in demand for safes, where depositors will presumably hoard cash. At least it’s a policy that spurs demand for something, as opposed to the tax hikes that are still scheduled for next year. There’s a reasonable chance that negative rates could even backfire and become deflationary as depositors pull cash from the banking system and kill the money multiplier.

Data from the US hasn’t really done much either way. At least Fed officials are starting to talk sensibly about the economy. Governor Brainard reiterated her dovish bias, and acknowledged the tightening of financial conditions has already delivered the equivalent of three 25bps hikes. Then Governor Dudley came out and said economic risks are tilting “slightly” to the downside – better late than never. Hopefully the Beige Book, released this afternoon, will reflect those sentiments.

Investors will now turn their attention to non-farm payrolls on Friday where a strong reading could send a resurgent USD sharply higher. The DXY index is quietly back within 2% of its highest level in 13 years. Of course, an ultra-strong USD is what sparked the slowdown in China to begin with and will exacerbate China’s problems if it rallies from here. Further weakness in China would again filter down to Germany, Japan and ultimately US, where the Fed would have yet another chance to knock down USD. In the meantime, these major economies will keep passing around weakness until it ultimately culminates in a sustained global crisis.

The Cup & Handle Fund is up around +4.0% YTD, and +13.0% Y/Y. Not much activity on the trading front recently. We added a small new FX position on Friday, but it’s hard to take a big position in either direction. There haven’t been many catalysts and it seems like everyone is waiting for the ECB on 3/10. I’m almost finished writing our March letter, and it should be available soon. If you’d like to start receiving these letters click here.

With that I give you this week's letter:

March 2, 2016


As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

Until next time, tread lightly out there,

Michael Lingenheld

Managing Editor – Cup & Handle Macro

Posted to Cup & Handle Macro Research on Mar 01, 2016 — 2:03 PM
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