July 08

Global Risks Swarm Janet Yellen

Yesterday’s morning plunge in the S&P 500 was quickly erased in a late day rally, but the reasons to be nervous for Janet Yellen are only growing day by day. China’s stock market continued it’s jaw dropping losses overnight as the Shanghai Composite fell 5.7%. The index has now lost nearly 35% of its value since the early June highs. Chinese stocks have wiped over $3tn in wealth away from Chinese retail investors in less than a month. On the other side of the world Angela Merkel and the European Commission have given Greece a Sunday deadline to submit a real proposal to obtain bailout funding. Ironically this proposal in all likelihood would require pension cuts that the Greek people just voted against. Alexis Tsipras can either cave in and walk back on everything he’s done up to this point, or be forced out of the Eurozone next week when the ECB withdraws its ELA support for Greek banks.At the same time, commodity prices are plunging with oil posting an 8% loss on Monday and Iron ore plunging 10% yesterday. In the context of a year long USD rally, deflation concerns could be back on the table.
In this midst of all this, U.S. stocks have moved back and forth in a relatively small range since the ruckus started about a month ago. Each time risk flares up in China or Greece the S&P 500 falls but always manages to come back again. The US Dollar has been relatively resilient, but fell sharply versus the Japanese Yen today with USDJPY currently down 1.22% as of 10:34am. I wrote last month about the connection between US stocks and the Dollar, and I believe this trade could be coming to a head in the next couple of weeks. The Australian Dollar has taken the brunt of the selling so far, but in the coming days I plan to rotate into USD selling as there is a real possibly for a global shock to confidence on the way.

On July 15th Janet Yellen will go before the US congress to give her semiannual testimony on the US economy and monetary policy. A few weeks ago, many saw this moment as her chance to signal intentions for rate hikes. If risk sentiment continues to be hammered from all sides, it is hard to see how she can confidently pivot towards a hawkish tone. The Chinese equity market story seems to have gone mainstream this a week after yesterday’s massive amounts of stock suspensions and continued declines in the face of stabilization measures. The bet against rate hikes and the US Dollar (vs EUR & JPY) will swirl into an all out rush if Greece exits the Eurozone next week.

CFTC positioning showed that EUR shorts edged back above 100k last week, there were also a notable amount of JPY shorts that may have been stopped out in the last 48 hours. In order for EURUSD to move to 1.1500 we would need a disorderly collapse of Greece‘s banks that sends European bourses down hard, forcing currency hedges to be unwound which should set of a big squeeze in short EUR positions. Then on July 15th if Yellen makes any noises about external risks affecting the US economy, expect more pain in the long in the tooth USD trade.