Update: on the close of December 22's trading session in New York, US stocks ended at their record highs with the S&P 500 up 0.4%. Astounding!
As we turn yet another page into Christmas week, and the soon following New Year's Eve, trading volumes have lightened and markets have taken a breather from their hoop and hoopla the previous few weeks. There is a lot that has happened, many lines in the sand have been crossed, things are moving in the geopolitical scene, a mass terror attack in Pakistan that is of the most grotesque of crime against humanity, 3 cops have been murdered "execution style" in broad daylight in New York and Florida in what might just be America's own genesis of its racial wars, and then there is of course the satirical Soap Oprah that is the data hack on Sony and the stoppage of the much anticipated film from Hollywood. A flurry of developments, a lot which are quite frankly rubbish, but some that have gone a little undercover like hyperinflation in the tiny nation of Belarus have caught my eye after having almost slipped them.
Minsk imposes 2-year ban on all OTC FX transactions as currency implodes
- Online stores blocked by government;
- All news sites and online outlets with alternative or independent opinion have IP addresses taken down by Government;
- Moratorium imposed on local retailers to keep prices steady, shelves emptied in days as barter trade and hoarding ensues;
- Run on all BYR bank deposits as any liquidity in local currency is dumped for goods;
- 30% levy on BYR sales and FX purchases;
- Outright ban on all OTC (dark market) FX transactions for 2 years till 2017;
- National bank increased 1 year BYR interbank swap rate to 50%, making it extremely expensive to swap BYR for FX;
- Capital controls also imposed, advice given to banks not to lend BYR for 3 months till February 2015
You probably didn't read this in your mainstream news wire or Sunday tabloid but there is an even bigger looser following the fallout from Oil's crash than Russia. Meet the tiny country of Belarus, a nation with close ties with motherland Russia and shares the Ruble; not Russia's Ruble, but its very own Belarusian Ruble. Harkening back to the olden days, Belarus formed part of the USSR, shared almost the same language and operated on the same economic system of communism. Post the dissolution of the Russian communist empire, Belarus had always been in a tightly knotted duet with Russia.
Both Belarus and Nigeria are showing the world how hyperinflation through the dumping of one's local currency looks and feels like. There is barter trade and hoarding on the streets of these 2 countries in particular. And the common tangent? Oil and the Russian kaput.
Everyone should have know by now that the implications of negative contagion is not a matter to joke around. The fallout from the incredible decline in global oil prices has set many countries ablaze with the respective currencies crashing through their rattan roofs. Countries heavily dependent on the black gold for their output, like Venezuela, Nigeria, Mexico, the Arab states, Russia, Norway have all seen the ire of falling revenues and concerns over their economic soundness.
When Russia was hit hard by financial and economic sanctions placed upon it by Europe and America, its demise had started. Being heavily dependent on Russia for economic production, this small nation start stumbling, with the USDBRY (US dollar against Belarusian ruble) sky rocketing more than 50% year to date.
The national bank on 19 December started imposing a 30% tax on all purchases of foreign currency either by individuals or corporations. However with the outright ban on OTC FX trading, this tax would not be fully utilized. What a waste!
The overnight night unsecured deposit rate on BYR has exploded north of 30% as the national bank has made it too expensive to lend BYR even amongst banks. As we learned from the bank's press release, it wants to halt sales of BYR by as much as possible though pseudo and conventional capital controls. The interest on commercial and retail deposits at local banks has also spiked to encourage individuals and businesses to leave their currency in their banks. Apparently enough, we know this is not working one bit and the run on banks continues and will probably extend all the way to Christmas Eve before there is any easing of tensions.
Indeed, just a few hours after AFP broke this news, the overnight interbank BYR deposit rate has surged past 50% as the fire intensifies.
Interestingly enough, the fact that the Belarusian Government proceeded to ban online shopping sites and take down the IPs of news sites with an independent or alternative view has itself sparked panic. Quite the contrary to what were the intended purposes of those measures; to stem the run on the ruble and to stave off widespread panic. Instead of dousing extinguishing foam on fire, it seems like the government has instead emptied a barrel of petrol on it. There are lessons to be learned here.
As an analog, the day the CBR (Russian central bank) started to halt trading of the RUB, we saw very similar actions by other fringe countries either with direct exposure to the federation or to crude oil prices. This is another type of contagion: Policy Contagion.
And of course pictures speak a thousand words. In the case of hidden panic on the streets, maybe a million words.
Exuberant markets see strong rebound
Sticking to market related news, global equities saw one of their best rallies in a long time on Thursday and Friday. European markets up over 3%, Dubai's stock exchange up a massive 13%, US stocks were up over 2% (the biggest two day rally since December 2011). North Sea Brent oil rallied from $58.16 on 16 December to $63.32 on 18 December, an 8.8% low to high swing in 2 days. Pretty impressive. The VIX index (or fear index) on American equities fell from over 25 on Thursday to today's lows of 15.47, a 41.4% decline on implied volatility as US stocks staged their largest 2 day gain in more than 2 years, even surpassing the up thrust from the lows of September which itself was bonkers.
The chart below will give readers an idea on the extent of the sell off we have seen, and the rebound since the latest and last FOMC meeting of 2014. For why it was a crucial meeting, please read my post following up to last Wednesday's meeting. The chart below depicts how global markets have performed over the last half of 2014. Pretty stellar moves.
Collectively, global markets have seen their inflection points at or slightly after 16 December when the CBR introduced FX controls and its 7 drastic measures to reign in on the wildly careening ruble and collapsing asset prices. Immediately after the CBR's draconian measures, it was time for the proverbial FOMC to write another set of put options underneath risk assets, and sure enough markets were catapulted much higher following the 17 December FOMC event.
Market participants understand that there was nothing materially different in the last week's statement other than a slight alteration in language. However, whatever prompted the take off in risk still leaves many scratching their heads. Whatever prompted the rotation out of safety and into risk must have been pretty significant that it occurred in a global level. One thing I've learned after more than half a decade in the markets, is that one should never every doubt the ability the convening powers of the world hold. The extreme measures taken by the CBR, and the favorable jawboning by the Fed was a very current example of convening power.
For us to understand the reasons for the abruptness and strength of this rally, we first need to know what caused the sell of in the first place. A lot of forces get intertwined in the maelstrom of a crisis that it becomes blurry. Everyone rushes to the exits, and the market turns hard leaving many half naked in the dust.
What broke the markets?
Without going down this rabbit hole, I think the following linkage might be able to explain the rout we saw:
- Declining oil prices were initially seen as a side effect of weakening global growth, no one really thought much about it until the decline became more protracted and significant than normal;
- When the OPEC summit failed to yield any supply cut from the Middle East, traders and money managers started to panic - the market had then priced in a slight production cut by OPEC;
- As oil continued to decline, now accelerating in velocity, concerns started spreading - concerns about lower oil prices and more importantly the shift in OPEC's strategy to counter the rise of small and medium shale oil producers in America;
- At this moment, markets are already crashing in the Middle East - markets there are more tied up to oil prices and hence national revenues from energy exports than anything else, hence Middle-Eastern markets were very highly geared to oil prices;
- As oil continued to tank, an increasing number of smaller scale producers that leveraged on the shale revolution started to loose money for every marginal barrel of oil they produced. However, if they stopped production, this would mean the Arabs had won via their new strategy to crowd out smaller US producers using low prices - on the basis of them having a much lower per barrel breakeven price than their American competitors;
- When Brent and Texas Intermediate oil fell below $70, Russian assets and the ruble started collapsing in earnest as the new oil paradigm coupled with financial sanctions took too much of a toll;
- At the same instance, spreads of HY credit in the oil and gas sector started to explode wider as concerns of bankruptcies due to weakening top lines and consensus that oil prices would remain low for a considerable time into 2015 weighed on confidence. Energy HY credit formed more than 20% of the entire HY credit market in America, and this fact alone meant that the entire HY market started selling off hard way before equities started to even flinch;
- Russia's CBR hiked its main interest rate by 150bp to 10.5%. This has little to no positive effect on the ruble's performance. USDRUB and the Russian stock market continued on their accelerated trends;
- By now, Middle-Eastern markets were in their free fall on an entirely different league. Anything that had a sizable exposure to those markets were also brought down;
- Besides the Arabs, Russia was also on fire by the time Brent printed $67 when the next week opened for trading. Several large European banks had sizable exposures to Russian credit and equity names of large state-owned energy firms and banks (Rosneft, Gazprombank, SMP Bank et al), even a few of PIMCO's funds had roughly 21% exposure to Russia, and in the first week of November (long after Gross had departed), PIMCO saw more than $200mn in withdrawals from funds that had significant exposure to Russia. This gives a good impression of how mass liquidations occurred as things when off in a flurry;
- European corporate credit, especially financials were one of the first to be hit through the Russian transmission, this sparked selling in the broader equity markets;
- By now, when Brent was just over $65, US HY spreads had already diverged so far under where US equites were still trading. A few disappointing macro data prints later and equites started selling off, and placed catch up to where HY credit had been traversing all along;
- Up till now, more insulated markets such as those in the US, Singapore, and UK were still taking their cues from oil. Fast forward less than 36 hours and they were behaving as if they had minds of their own. By then, markets were truly a rout;
- As Brent touched $60 and Texas $55, the CBR raised rates by 650bp to 17% in an unprecedented move. For about 15 minutes this had an positive impact on the ruble (USDRUB slipped lower a couple of hundred pips), only to erase all its gains moments later. When Europe opened for trading a few hours later, there was mass selling across the board and USDRUB proceeded to test 80, all time lows against the dollar;
- Trading session after trading session only saw a sea of red as risk was either hedged or unwound entirely. By now, the rotation from risk into safety was more apparent than daylight;
- The day after the worst day in Russian markets since the 1998 LTCM-Russian default, the CBR announced that it was suspending the trading of the ruble on international FX markets. The CBR also announced 7 measures in response to the mass flight of capital. Multiple FX brokerages stopped offering their retail clients USDRUB for trading the day before;
- It was at the end of this trading day, the 16 December that global markets bottomed and found their respective inflection points. The FOMC concluded their 2-day meeting on this day and the ensuing statement seemed to propel markets magically higher;
- The rest, as they say, is history
In other news...
Shenanigans aplenty. Lots of rubbish but there are some noteworthy ones. Here is a brief.
Pakistan moans 141 dead, Taliban prisoners executed
The gruesome terror attack (allegedly by the Taliban) on a school in Peshwar, Pakistan, leaving 141 dead among them 132 children who were executed by gunmen who stormed the school with assault weapons, massacring all in their path, leaving only 24 survivors. This was the worst attack on the country in at least 2 years, and had the most number of children killed in a single event. The attack is widely believed to be carried out by Taliban militants. The terror group has itself claimed responsibility for the attack. The world has condemned this attack and paid its respect to the dead.
US-North Korea relations atrophy, war or words
There is a real time drama between personalities and nations that probably out does the "cancelled but soon to be released" film about executing the boss of the DPRK. It is perhaps of the greatest irony that the debacle of canceling a widely anticipated film and all associated acts of lying and bluffing one's lips dry, has turned out to be satirical and comical than the comedic film itself.
It turns out that this is precisely the case. For the whole of last week, not one day has passed without somebody pointing a finger at the DPRK for engaging in an epic hack in Sony's servers, siphoning a good deal of privy data of the company's customers. I must admit though that I have never actually followed this story because it was and is just filled with too much chicanery and unprovable allegations. War of words indeed.
US officially blamed Kim Jong Un's cyber army for the hack without providing substantiated proof that it was so. Then the FBI chipped in and unequivocally confirmed the White House's claim. Obama even held a televised press conference for this matter. Oh for crying out loud, things were that ridiculous. No one was hurt, no one died directly as a consequence of the hack...
Washington's stand remains that the hack is a threat to peace and stability of America, and that North Korea would pay the price for its act of terrorism. North Korea promptly refuted all of America's claims saying it had proof that it wasn't behind the attack, and that America should work together with it to resolve this matter. All of that never happened as expected.
Obama also expressed regret over Sony's decision to cancel the scheduled release of the film, saying that it meant that the terrorists had won; implying that it was pathetic that America could succumb to the wimps of one of the world's most isolated countries. Drama queen indeed.
It doesn't stop there. North Korea retaliated to the Pentagon's threats of consequences with the following:
One can logically see why North Korean hackers might want to deal cyber damage to Sony for the production of a film that essentially spits on its leader's face. However, one should also consider the multiple times America raised false (and very much unproven and probably unprovable) flags surrounding controversial events such as the use of chemical weapons by the Assad Regime, or that Russia was behind the downing of MH17 over East Ukraine.
From my experience, it seems as though American policy orbiting strange events such as this latest hack, would be to "shoot first, think later". It always wants to be the first to make a bold claim; but always withholds information and evidence to back those bold claims (assuming said evidence exists in the first place). America seem to be using the confidence the world places in its namesake as a nightly leverage to exert its global geopolitical fortitude. That has been working up till now, across multiple spans of raising false flags, and having those snafus pass stealthily without much fanfare. This is of course just my opinion. It is an opinion, not a fact. Not fiction nor truth. Just an opinion from an observer.
But moving on, we have some developments. It seems that North Korea has been facing intense outages in its access to the net. This comes hours after the US warned of consequences.
Hopefully the story decides to stage an interlude sometime soon. Because I have a feeling things might get uglier with real tangible damages to either side, or collateral damage if China or some other ally or foe is dragged into this satirical play. In the meantime, Sony can continue licking its wounds from the many million dollars of sunk costs, it might also enjoy some free PR airtime as a bonus to its loss. And lastly, for readers who don't already know how unprofitable Sony is, one only needs to turn to Shinzo Abe and the BoJ for an answer to that question.