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Korean businessman yawning and stretching in office

Many roving Fed-heads have been giving very hawkish speeches in the recent days, which have attracted no attention from Wall Street.  For example, Philly Fed Pres Harker just said on Tuesday: “I would not take March off the table.”  And earlier this month Dallas Fed-head Kaplan said that he would raise rates “sooner rather than later.”

It seemed as if they were trying to tell us that the FOMC Minutes might be a surprise, and were trying to soften the blow.  Alas, Wednesday’s data were pathetic and elicited another collective YAWN on the Street.  Volatility was NON-existent; the market didn’t budge.

The Fed is always saying, “On the one hand we have this, on the other we have that.”  There is nothing definitive at all in it, which can be read here in its entirety, if you’re that much of a nerd.  https://www.federalreserve.gov/monetarypolicy/fomcminutes20170201.htm

The main statement of FOMC gibberish was: “In discussing the outlook for monetary policy over the period ahead, many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the Committee’s maximum-employment and inflation objectives increased.” 

Yeah, whatever – this means nothing.  We have been hearing the same nonsense for years.  There were a few comments , however, that were interesting and new and deserve mention.

The Trump statementA few participants commented that the recent increase in equity prices might in part reflect investors’ anticipation of a boost to earnings from a cut in corporate taxes or more expansionary fiscal policy, which might not materialize.

The overvalued warningThe staff’s assessment took into account the increase in asset valuation pressures since the November elections… Overall, valuation pressures appeared to have risen for some types of assets.

And the “we’re too stupid to understand why this is happening” statement:”  They also expressed concern that the low level of implied volatility in equity markets appeared inconsistent with the considerable uncertainty attending the outlook for such policy initiatives.

The last two statements are particularly amusing to me, because the FOMC members are too dim-witted to realize that THEY ARE THE CAUSE of their own concerns!


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A picture illustration shows Euro and U.S. dollar banknotes in Sarajevo March 9, 2015. REUTERS/Dado Ruvic (BOSNIA AND HERZEGOVINA - Tags: BUSINESS) - RTR4SMQ2

In minutes released by the FOMC on Wednesday, it was noted that the one of the concerns of the central bank in raising interest rates is that the US dollar is too strong and will ultimately hurt US exports. The continuing weakness of the euro currency has created a situation where demand for US exports may decrease substantially. However, the FOMC also mentioned that it was confident in the continued strengthening of the US economy and therefore felt that raising rates would be appropriate as long as the US economy stays on track. Therefore, it seems clear that the US dollar should continue to strengthen versus the euro.


The strengthening of the US dollar has been a major trend for the financial markets since 2014. Since then, the US dollar Index (DXY) has risen from below 80.00 to over 100.00. DXY is a measure of the relative strength of the US dollar in comparison to a basket of other currencies, and thus the current dollar is able to buy more than it was back in 2014. The two main factors in the strength of the dollar are the ending of quantitative easing by the Federal Reserve and the continuing weakness of the European economy. Both of these factors have led investors to prefer investment into US assets.
This trend seems likely to continue as the European Central Bank shows no signs of being able to raise interest rates given the persistently subpar growth of the European economy and the continued pressures of political and social upheaval amongst EU member countries such as Italy and France. With elections upcoming for Holland and France over the next two months, we can expect strong volatility in the event that an anti-EU administration is elected into office in either country, much more so if this happens for both. We’ll touch base on this topic again soon.

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President Barack Obama's nominee for Federal Reserve Chair Janet Yellen, currently vice chair of the Board of Governors of the Federal Reserve System, stands in the State Dining Room of the White House in Washington, Wednesday, Oct. 9, 2013, where the president announced he is nominating Yellen to be chair of the Federal Reserve, succeeding Ben Bernanke. (AP Photo/Charles Dharapak)

Minutes may hold clues on timing of next interest-rate hike.  Federal Reserve Chairwoman Janet Yellen most likely won applause from her predecessor Alan Greenspan for her deliciously vague testimony to Congress last week about the timing of the next interest-rate hike.

“At our upcoming meetings,” was all Yellen said about it in her brief prepared remarks about when the U.S. central bank might move.

Asked to elaborate, the Fed chief replied: “Precisely when we take an action —March, May or June — I can’t tell you.”

As a result, Fed watchers said they are going to scour the minutes of the Jan. 31-Feb. 1 policy meeting for any more clues about the timing of the move. The minutes will be released at 2 p.m. Eastern Wednesday.  Fed watchers were split over how hawkish Yellen’s terse comments actually were.  But markets have been slowing this year raising the probability of rate hikes.

The timing of the next move is not an academic exercise.

A hike at the next meeting on March 14-15 “would be markedly hawkish as it would drive markets to price in up to four hikes this year from two-and-change today,” said Krishna Guha, the vice chairman of Evercore ISI who previously worked at the New York Fed.

This was a topic that we briefly touched on in our weekly Mastermind call.

All in all this is exciting for the markets.  It should provide some volatility on in the interest-rate plays, which is something we haven’t seen in a very long time.  Three rate hikes this year would be outside of what we’re used to, but not necessarily wrong.  The economy is pumping along at a healthy rate, and that’s why we have a Fed, and an interest rate policy to accompany it.  The Fed Minutes today should give us some good context, but it will only get more interesting from here on.

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Perhaps the title of this article is a bit dramatic, but I cannot help but notice that the perpetual rise of the US equities markets has drawn out the fears and hopes of many. It’s been awhile since I’ve seen the minds of investors so sharply divided in their beliefs about the future prospects of the equities markets, and this appears to be partly responsible for the observed behavior of equity index futures and etfs lately. In particular, we’ve seen these products often gap overnight, and then make more gains during the day before trading sideways for the remainder of the session. In other words, we are not seeing any substantial volatility intraday, which suggests that sellers at best are only able to impede the progress of the prevailing uptrend rather than to aggressively take control of the market. The greatest evidence of this is the fact that the S&P 500 has yet to experience a down day of 1% or more over the last 3 months. Clearly, optimism is winning.

But what about fear? How is this being manifest? Well, in my observation, fear is most evident in the fact that some are refusing to participate in the current rally, and have been since the election in November. While a clearly strong contingent of bullish investors have continued to bid the major equity indexes higher, we still hear a persistent chant of “buyers beware” coming from those who are still awaiting the 10% correction that has been expected for several years. Although we did essentially have such a correct between May 2015 and Feb 2016, it seems many in the market are still convinced that a stronger and faster correction is still overdue. Whether or not that ends up being the case will of course remain to be seen, but without a sharp increase in volatility it seems clear that the optimists will continue to move the indexes higher. As always, we can only follow the trend. Look for potential strong corrections only if volatility increases. Otherwise, expect the markets to continue to trend higher.

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Yesterday we talked about “forced liquidation” in several forms but focused on, of course, financial liquidation. It was my contention, as well as many others, that the markets were being driven in part by a highly-leveraged company being forced to cover it’s wrong-way bets.

As it turns out – it was all TRUE! The owner of the hedge fund called CNBC on Thursday to confirm that his company was indeed a partial reason why the S&P500 was rallying in a nonsensical and relentless fashion.

The CEO of Catalyst said the following to CNBC:

… we no longer have that type of short position at this time. Consistent with our overall risk management strategy we have some draw-downs where we decided to take action and we are pretty neutral with our positions at this point.  

We finished adjusting the portfolio.

I’ve seen some things in the press about the fund and short term forced-buying, we’ve had no margin issues.

The fund is under no duress or anything like that. We weren’t forced to sell.”

Ok, that sounds great, right?  What else would he say to calm his investors down?  Of course he’s going to say that.  What’s interesting, however, is HOW he chose to say “we weren’t forced to sell.”

Not being forced to sell would lead the average Joe to believe that he wasn’t doing anything; but we’re not average Joe’s here.  “IF” the early reports were true (and we couldn’t possibly know that) then Catalyst Hedge Fund is mostly short calls, which is causing the stress during a rapidly rising market.  Oh sure, the owner Ed Walczak, says he “hedged perfectly” like Amaranth Advisors had done in the natural gas market – until it all came unraveled.

Although the positions of Catalyst were more sophisticated than the following, I would like to try to explain WHY/HOW the market moved with its wrong-way bets, without using $billions to describe every transaction. If a company like Catalyst sells massive amounts of call options because it doesn’t believe the market can trade above 2,300.00, for example, there will be a problem when the market skyrockets!  The volatility of the move will overtake any premium collected.

When this happens, what does Catalyst do?  Good question – let’s use number form to decide…

  1. It can do one thing, buy back its short call position; but that would be a loss.
  2. But he says they weren’t “forced to sell” so what’s the problem?
  3. When Catalyst is forced to buy back its prior loser call positions, it also forces them to “hedge” forward…because they couldn’t be wrong – right?
  4. Now that it has covered some bad positions, Catalyst must re-hedge (for the overall portfolio) with more options as the markets continues higher.
  5. And that means selling more premium. But who buys from Catalyst?
  6. Right – market makers do!  So if the market makers take the risk by selling Catalyst higher and higher call premium levels yet the market continues to go against the market makers – how will they HEDGE their risk?
  7. And that’s the answer!  Those who sold the risky premium as the markets screamed higher MUST hedge…and everyone that I know hedges by BUYING S&P500 .. FUTURES!
  8. Therefore the option trading of Catalyst, in part, helped the markets go higher as OTHER options traders hedged their own bets by buying futures to cover their own behinds.

The market’s melt-up, or down whenever it happens, will always be due to more than one company.  As it turns out, it’s usually a house of cards with one card removed…poof, it’s gone.  

But don’t worry– Buy all the things!

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When someone is forced to do something, it is almost always a bad thing.  In fact, many times what is being “forced” is flat-out illegal and reprehensible.  There may be a few times, however, when forcing someone to do something may be for their own good; like making your children eat their vegetables.  In fact, Pink Floyd wrote about it when they sang, “How can you have any pudding, if you don’t eat your…vegetables!”  Lol, yeah I know it was a little different than that, but you get the point.

Today we will talk about perhaps a third category, where it’s neither illegal, nor for someone’s own good: forced liquidation in the financial markets.  At the end of the day today I was thinking how the current equity non-stop rally felt like the natural gas rally of 2005.  

In 2005 a hedge fund, Amaranth Advisors, ultimately went broke when a massive trade in natural gas futures went the wrong way.  Although the main trader, Brian Hunter, thought that he was spreading out his risk exposure by simultaneously being short the nearby futures contracts and long the back months, it didn’t quite work out that way.  Once the market started rallying in all months, word got out on the Street that a hedge fund was mostly short and the position was huge.  Other sharks (traders) smelled blood in the water and bought the heck out of nat gas futures to drive the price up on Amaranth, thus causing the “forced liquidation.” And it worked.  Mr. Hunter and Amaranth lost nearly $5 billion in one week.

That forced liquidation and many others over the years made me think this afternoon: “Hey, I wonder if this crazy rally, that is completely unhinged from fundamental reality, is being driven by a forced liquidation somehow?”  Well imagine my surprise when I read about exactly that in ZeroHedge earlier this evening!  http://www.zerohedge.com/news/2017-02-15/multi-billion-trade-meltdown-here-reason-markets-inexplicable-surge

After today’s price action (and more color from trading desks) we are starting to see the ‘fingerprints’ of what appears to be a multi-billion dollar forced short cover, reportedly by Catalyst Funds’ Hedged Futures Strategy Fund (HFXAX), that has almost perfectly correlated with the linear surge in US stocks.

As RBC’s Charlie McElligott, who dug deeper into the details behind this move, notes the melt-up in the S&P is the result of “a purported / murky melt-down over the past week in a large trade by a multi-billion Dollar (open-ended) futures fund which sells vol on S&P.  Without going into specifics, there is market speculation that the entity is effectively short upwards of ~$17B of SPX (deltas to buy) through selling February expiry upside 1×5 (or 1×4) call spreads.”

The trade was going well, until the S&P rose above 2,300. At that point the “convexity seemingly ‘kicked-in’ as witnessed by market participants, the short-gamma ‘take’ since has been nothing short of astonishing.”

And what do you think could happen when the forced liquidation is over?  Well, after Amaranth was forced out of it’s natural gas positions, nat gas futures plummeted about 68%.  That won’t happen in equities of course, because there are no central planners in commodities – just the stock and bond markets.  

Yes sir, the central planners will surely halt any decline at -0.99%.  We can’t ever have even a 1% decline again!

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Janet Yellen, of California, President Barack Obama's nominee to become Federal Reserve Board chair, testifies on Capitol Hill in Washington, Thursday Nov. 14, 2013, before the Senate Banking Committee hearing on her nomination to succeed Ben Bernanke. (AP Photo/Jacquelyn Martin)

It is no secret that the equities markets began to surge sharply upon the election of a Republican administration. Focus has sharpened on the the prospects of relaxing regulations on business and deregulation of the financial industry. The prospects of higher spending on infrastructure has also bolstered speculation on increased inflation. While there are some who have expressed doubt as to why the equities markets have suddenly rallied, especially against the backdrop of a more hawkish FOMC, it seems quite clear to me that the financial markets are anticipating a business environment that is more robust, flexible and much less constrained by government regulation.
But the prospect of deregulation is raising concerns amongst regulators, as would be expected. During her conference with Congress yesterday, FOMC Chairperson Janet Yellen was repeatedly pressed to detail how she expected deregulation would affect the economy, and in particular what she believes will be the impact on risk of another financial crisis. For the most part, Yellen dismissed the notion that the current state of financial regulation was impeding economic growth. This seems to me an odd assertion, given that the financial markets are sending a clear signal that they expect greater growth if regulation is relaxed. In fact, it would be quite illogical to think that increasing regulation would not impede growth, since it would naturally increase the difficulty of doing business. This is not to say that regulation is necessarily bad, but it must be understood that significant reductions in regulations will tend to increase business activity and growth, with the only purpose of regulation being to prevent economic turmoil or abuse of workers or the environment.

In the end, the new administration will have to seek its own balance of regulations. If they strike the right balance, then it seems clear that stronger economic growth should be the result. Let’s keep an eye on the policy changes to come so that we can get a better sense of the likely outcomes.

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Production cuts are now underway for both OPEC and non-OPEC oil producers, setting into motion a potential recovery of oil prices to stabilize above $50 per barrel. As I’ve noted previously, oil prices suffered severe declines after Saudi Arabia and other oil producers engaged in sustained production surpluses, apparently for the purpose of driving oil prices down to levels low enough to drive out competitors who could only remain profitable as long as oil prices remained above certain price levels, generally above $80 per barrel. However, the impact of oil prices remaining well below $50 per barrel took its toll on all OPEC members, as well as major non-OPEC producers such as Russia. These producers were forced to spend large portions of their capital reserves and sometime borrow money in order to cover their nation’s financial obligations. It is for this reason that I believed that oil producing nations would reach an agreement to cut global production, since the only likely alternative was bankruptcy.

As of January 1st, 2017, the latest oil production agreement has begun implementation. OPEC members recently confirmed their commitment to honoring the production cut agreement reached in December of last year. The current agreement is to cut oil production a combined 1.8 million barrels per day. With financial needs being such a strong issue at this point, it seems that this agreement has a greater chance of sticking than many others. Nevertheless, it is possible that higher oil prices may be met with decreased demand, particularly from China. Also, the United States has consistently run an oil surplus over the last few months. According to some analysts, if oil prices were to rise significantly, this would make China less likely to make strategic oil purchases. China is noted to have a strong track record of buying oil in larger quantities than usual when oil prices are low in order to stockpile oil for later use. With this in mind, the only likely scenario to sustain or increase Chinese purchases is if the price of oil would seem likely to increase despite a reduction in Chinese bargain hunting.

Whatever the case, oil prices are set for substantial volatility this month. If the oil production cuts are honored, then oil prices should move significantly higher, provided that US consumption begins to match production. I remain bullish long term for oil, but cautious in the short term due to the US supply glut.

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Janet Yellen will probably be the talk of the market this week.  On Tuesday and Wednesday she will be giving here Humphrey Hawkins testimony to the Senate, and the then the House regarding the financial state of the economy.  This 2-day long testimony will give the lawmakers ample time to question her on many issues, most importantly being just how close is the Fed to raising rates again?

Another important data point will the CPI on Wednesday.  If inflation is picking up, then Janet Yellen and the rest at the FOMC will have to hike rates sooner than she may want.  The CPI headline number has grown to the point where it will be very difficult for the Fed to ignore.  In late 2015 this stood at just 0.5%, whereas a recent estimate put it at 2.4%!

It will be very interesting if the CPI data are too hot!

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There was much excitement again today on all of the bubble financial shows exalting the new highs in the Dow, Nasdaq, and the S&P500.  It was magical; or so they reported.  In the market, this is getting to be so routine that it may be worrisome. Can easy money last forever? (Pro tip- NO)  Nevertheless, I’ll let the market tell me when to get truly worried – but that doesn’t seem to be yet.

Could Greece cause a conflagration?  The Financial Times has an idea in the following article.  https://www.ft.com/content/d78e9173-8821-3529-89e1-5cb92a90f2c2

Greece’s finance minister has lashed out at the International Monetary Fund’s “misleading” analysis of the country’s economic health and debt trajectory, intensifying a rift between Athens and the Fund over its involvement in the country’s three-year bailout programme.

Responding to the IMF’s 91-page health check of the Greek economy, Syriza’s Euclid Tsakalotos said the analysis gave an unfair and “insufficient” account of reform efforts undertaken by the left-wing government since the summer of 2015.

Mr Tsakalotos said the “overly pessimistic” account led the Fund to a wrong-headed assessment of the country’s debt dynamics, which the report says could reach “explosive” proportions above 200 per cent of GDP without major debt relief or bolder spending cuts and reforms.

Well, as we can read from a portion of the article above, there is no agreement coming along soon.

We certainly do NOT wish any ill-feelings or worse, lost cash, because of our readiness for heightened volatility, and wish everyone and every country (Greece) the best.