To understand what’s happening in global credit markets right now, it may help to think of a kid playing with a toy boat in the bathtub.
By Vikram Rangala
Wednesday, May 13, 2015
You might have done this yourself (maybe still do, we won’t judge). You push the water to make a wave and the boat moves. Then the wave hits the end of the tub and comes back towards you. And with it comes the boat.
We all know markets move in waves even when they are trending up or down overall. However, sometimes a market’s overall movement for months on end can be sideways and wide: a lot of very large waves back and forth. Those were the kind that flooded the bathroom floor and got you in trouble.
Not long ago, overexcited investors made bets that the ECB’s quantitative easing program would make Eurozone bonds an attractive play. And for those who shorted the German bund this week, it certainly was. The difference between the relative uncertainty in the US and the apparent sure thing that Mario Draghi’s zero rate policy offered was compelling. The buzzword for many was “Sell the US, buy Europe” not only in bonds but also in stocks. Remember when the DAX hit new highs?
Here’s a better question: do you remember why the DAX hit new highs? Or why it sold off so sharply in the week that followed? Oh, there were reasons we gave ourselves about consumer confidence in Germany and manufacturing output and even how their feelings about China might have influenced some euro currency traders. But the logical relationships between the price action and the reasons given (and accepted) were tenuous at best.
Now, some of the money that was put into European debt markets on optimism about the ECB’s quantitative-easing plan is coming back out. The new buzz is "Sell Europe, buy US." Most of that money is flowing across the Atlantic to the now-comparatively attractive US Treasury bonds. Goldman Sachs Group reported Monday:
Overblown expectations for the European Central Bank’s quantitative-easing plan helped push global debt valuations to extreme levels, triggering a “large and vicious” selloff in European bonds that’s infected other markets.
Two unusual events will coincide this summer and fall. First of all, the ECB will continue and expand its quantitative easing and zero borrowing cost policy. Second, the US Federal Reserve will raise interest rates for the first time since before a near-Depression. Those two events are unprecedented by themselves. For Europe and the US to go through them together is doubly unusual. We haven’t seen this particular movie before, which means we can expect a good amount of volatility and uncertainty as Europe and the US get through this together.
To some extent, what happened in the German bund’s sharp selloff this week was just water in the bathtub. Only the bathtub is the whole Atlantic ocean, with Europe and the US pushing the money back and forth. It’s no wonder we’re seeing some big waves. We may see quite a bit more of this transatlantic flow back and forth through the rest of the year.
The larger context is actually quite large. A host of era-defining issues are testing the global economy, from the rise of China and India (by two very different political and fiscal paths) to the resolution of the crisis in Greece to the challenge of war in Yemen, Syria, Iraq, and elsewhere in a Middle East that may well see the redrawing of old postcolonial borders and the end of oil’s supremacy. The fluctuations in the credit markets reflect the roots of the word “credit”: credo, the Latin for “I trust.” We’re not sure who or what to trust.
In that case, it may help to go even further back in etymology to the Sanskrit counterpart ofcredo, which is sraddha. The word roughly means faith, but more precisely, it means cultivating awareness of the truth. The way to do that is by paying attention to what is and putting aside preconceived notions of what should be.
Unlike pundits, experienced traders don’t try to guess what the market should do. They don’t try to explain the market’s motives for a selloff or rally. They pay attention to what is. You see money flowing from one place to another, so you pay attention. The only verifiable truth in the markets is price and the flow of buying and selling. Smart traders follow the money.
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