The Synthetic Matrix?

by: The Nattering Naybob


Discussion of the potential effects on equity, bond, commodity, capital and asset markets regarding:

Atlanta GDP Redux; Subject Matter Expertise; World "Money".

Broad Dollars; Synthetic Flows; Interest Rate Swaps vs DXY.

CNY; CNH; Eurodollar; China's Forward Dollar Swaps; Nuances.

The Matrix

The Matrix is a 1999 American-Australian neo-noir science fiction action film written and directed by the Wachowski Brothers. It depicts a dystopian future in which reality as perceived by most humans is actually a simulated reality called "the Matrix", created by sentient machines to subdue the human population, while their bodies' heat and electrical activity are used as an energy source. A computer hacker learns from mysterious rebels about the true nature of his reality and his role in the war against its controllers. Matrix poster art courtesy of Robert Bruno

GDP Redux

On April 5th, we posted Dollar Hell? (or Road to Perdition?) and used April 2nd Atlanta Fed Now GDP at +0.7%. Rechecking later that very day.. cut to +0.4%

Above note, checking on Friday 8th, another cut down to +0.1% Do I hear negative by next week? Confirmation of our Aug - Oct GDP call for weak Q4 and negative Q1. At +0.1% it might as well be.


A well intended friend and I often differ on certain subject matter. He once commented, "the Dollar is a VERY complex instrument...There's a reason I stay away from currencies - for me, there's a limit to how many things I can pay attention to and understand well enough to make good decisions.. there's just no room in my limited and aging databanks."

As with most things in life, that is a choice which is founded in your self knowledge and heeding the golden rule. Bandwidth can get narrower as we get older, especially if you are lucky enough to be like Abe and make it to 94. What was the subject at hand?

Back on the right track... given the above noted limitations, that's why I try to stick to the things I somewhat know; banking, monetary policy and the "dollar". I leave the options, futures portfolio hedging, straddles, collars, spreads and capital preservation to my friend. Why? Because that subject matter is in his wheelhouse and thus, he is the SME (subject matter expert) in that field. Long ago in a defensive posture, my friend recommended "go to cash", we concurred and still do, because he is the SME and "Doctor" as it were.

Speaking of which, if one who felt perfectly fine and is not a heart surgeon, yet had a heart surgeon show them evidence their mitral valve was in prolapse (leaking), in need of repair, and explain as to why this condition could be life threatening, would one argue that the surgeon was completely wrong? I'm no heart surgeon, but like my friend, I am what I am, I know what I know, and on occasion when debating with my friend about things that are in my wheelhouse and clearly not in his, I feel like Walter Sobchak. Moving West...

World Money and Derivative Synthetic Matrix

Last week our good friend sent "The Money Matrix" below and commented, "Derivatives never do get settled, they just slosh around on balance sheets for the most part. If they ever DO get settled and there's even a 1% imbalance, the whole World could end in a microsecond! So, like any good global citizen, we should ignore it and pretend it doesn't exist but, even if they did - they certainly wouldn't have any effect on the Dollar."

This is my reaction, and now if you wish, you can take the blue pill and stay at home, or the red pill and come on a entertaining journey, its all a matter of choice, taking the time and clicking (not your heels) on the links... Matrix Art courtesy of Shana Gourmet.

Courtesy of: The Money Project

Broad Dollars

Interesting graphic indeed, somewhere between $630T and $1.2Q in synthetics; $199T in global debt - paper; $70T in stock markets; $52T in non liquid broad money

One small problem, when any of these $1.5Q in accounts get settled, it usually requires USD, either legal tender, bank credit or usually unregulated credit based version ED. According to the graphic above, there is only $28T in narrow money; $20T in US debt and $1.4T in actual physical dollars underpinning a $1.5Q global system. Like I say, the point is, there is no shortage of dollars, unless you need them.

A credit based eurodollar, CP or UST has an obligation attached and cannot always be converted at face value, hence the term "hair cut", while a federal reserve note has no such encumbrance or hindrance. Only the US Treasury can print dollars and they aren't printing much of any "new" money, despite what many uninformed people assert. That is why greenbacks are being hoarded globally and the method of "printing" them, not quite out of thin air or ex nihilo, is at an extreme premium, witnessed by increasingly negative sovereign bond yields and cross currency swap spreads. How far will that go? TBD.

Above note, The broad trade weighted dollar is off only 5 points or 4% from its peak of 125 on Jan 20th. What to worry? Is there any better currency or money out there? Draghi-queen euro, Abe Kuroda yen or General Zhou's "Spicy" Xiaochuan RMB backed by economies that make our enfeebled one look good?

We catch cold, they get the flu and its flu season baby. Is the currency in which 70 - 80% of the global financial system is denominated and transacts going to be replaced? Homie don't think so, at least not in our lifetime and even then, over the Rothschild's dead bodies, King Dollar is still the 800 pound gorilla.

FYI - Last year the BEP printed around $580M for the Fed and 90% of that was to retire old notes. So YES, they do print money last I checked and in 2015 the US Treasury printed up $50M in new notes for the Fed.

Synthetic Flows

[Derivatives] "they just slosh around on balance sheets" Our friend and many others might be surprised at how leveraged synthetics can work. Yes, those synthetics do "slosh around like water in a tank", but most often off balance sheet. Making a more accurate estimation of "what is in the tank", problematic. If if you want to estimate the level in that tank, one must set a "deadband" to eliminate the "noise" coming from the slosh. That's why we posted this on Dollar Hell?:

What forecast? I saw nothing resembling a forecast. And now a commercial from our sponsor, a new panacea boutique drug for day traders called Moniflo...

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Combining short term trends (which can turn on a dime as they are much more subject to credit or liquidity fluctuations, water slosh in the tank) with known seasonal fluctuations in an attempt to "time the market" is a completely different animal, and can be likened to playing with matches or trying to bottle lightning. Many moths drawn to that flame, have been burned in the extreme.

Ask your doctor if Moniflo is right for you.

And now back to tonight's program...

Yes it is true that some of the "synthetic" water is sloshing around on balance sheets, of which banks have had precious little to give since pre crisis. When synthetics mature, they are either rolled forward, abandoned and/or replaced. In the latter two cases they must be settled and in all cases, there are interim payment streams involved and additional costs to roll which constitute synthetic monetary or "on and off" balance sheet flows.

IR vs. DXY

Gross Total Notional IR (Interest Rate Swap) Derivatives

May 2014 IR 340T; DXY 78.9

Dec 2014 IR 320T; DXY 89

Jan 2015 IR 300T; DXY 92.5

Feb 2015 IR 285T; DXY 94.1

Mar 2015 IR 274T; DXY 100

Above note, between May 2014 and March 2015; interest rate swap notional value contracts contract 20% from $340T to $274T, while the DXY ramps up 27%. X marks the spot, coincidence? Data from CFTC.

"Derivatives never do get settled... they certainly wouldn't have any effect on the Dollar." Said contraction in IR synthetics was the result of 20% of outstanding contracts being settled. Resulting in a corresponding contraction in the Eurodollar market, forcing the dollar premium up. When ED contracts, dollars contract and vice versa. Why?

"If they ever DO get settled and there's even a 1% imbalance, the whole World could end." In the ED market, banks with net fund inflow or surplus, can accumulate dollar balances as private bank liabilities, and can lend the excess. To who? Banks with net fund outflow or deficit borrow those surplus "dollars" to meet their present obligations through forward swaps.

The "price" of this wholesale market is set in LIBOR+ and thus, the Eurodollar market is the global "liquidity" system through which the global banking system matches its book (on and off balance sheet), liabilities to assets, in dollars. Our friend is correct as those synthetics, whether on or off balance sheet, have to be balanced when they settle out, lest there be problems.

"Over the course of an average month at the NYMEX, 5 billion barrels of oil will be traded, with a fee collected on every single transaction. That is ultimately passed down to US consumers, yet less than 40M barrels will actually be delivered. That is just 8 tenths of 1 percent of actual demand for the product that is being traded." - Philip Davis - The Global Oil Scam

Above an astute observation by one of our favorites, Mr. Davis. The price of physical barrels of oil based upon actual production is being influenced and manipulated, by the sheer open interest and speculation in synthetic options and futures. In the case of ED, even worse, as those forward swaps or IR swaps control a credit based "currency", created with the click of a button.

The eurodollar market is larger than RRP and considerably larger than the federal funds market. According to FR 2420 data, on average in the last two months of 2015 there was $233B of overnight borrowing in the Eurodollar market; in contrast, over that same period, there was $70B overnight borrowing in the federal funds market. Over that same period, Fed Reverse Repo with foreign official and international accounts averaged $203B.

Obviously the banks have been making "wholesale" changes (pun intended) in their "balance sheets" as witnessed above by the huge contraction in IR synthetics. Even a casual observer cannot deny that the synthetic "water sloshing around in the tank" can have more than just a causal affect on the dollar, or any other underlying asset or commodity. Think like Mr. Davis above.

Rolling Chinese Swaps

Another example of synthetic affect or effect, if China were to settle and close their open and ever growing forward dollar swaps position est. $150 - 300B. The PBOC would have to fork over that amount of dollars to settle. How could a quarter of a trillion dollars, in this case in credit based form of ED, exiting circulation in one day, affect the dollar? Immensely.

Above note, the USD spikes vs CNY and CNH Aug and Jan, note the spike concomitant with the SP500 and global markets tanking. Coincidence? No, clearly a dollar liquidity issue. A fly on the wall at the Fed is one thing, if I had a calendar showing the day when China was going to roll their forward dollar swaps, that would be nice.

Next best thing to the fly on the wall, watch the RMB - onshore CNY/USD when the RMB slowly drifts up, they are making small interim dollar payments on those swaps. When they actually roll, a large devaluation in the RMB occurs because of all the "dollars" they have to pay to roll forward, which drains market liquidity. My sense is just ever so slightly before this, the offshore CNH/USD pair spikes, its like the tide going out before a tsunami. Another thing to watch closely, the eurodollar...

Above note, weekly, an inverse relationship between the bars (Eurodollar June) vs. SP500. Note the ED spikes taking the SP500 down in particular note the Aug and Jan gaps. Also note the steady increase in ED between May 2014 - March 2015, the period where King Dollar, literally went ape (pun intended).

Those interim or rolling synthetic position money flows also have effect and affect, albeit much smaller than if the position was closed. The whole point of these "kick the can" synthetic positions, is delaying paying the piper what is due. Those costs are built into the interim or rolling flows, so instead of death by bludgeoning, it can be death by several hundred billion "dollar" paper cuts.

Imagine the student who racks up $30K in credit card debt living beyond their means. When the bill comes, thank goodness its 18 months at zero on that balance and the minimum payment is only $25. All is well, until the 18 months runs out and 22% interest rates kick in. As we have pointed out before... you can pay me now, or pay me later.

Nuances and Perspective

Our friend, who really is a brother from another mother, once commented: "BUT I still reserve the right to make fun of you and poke holes in your "natterings"... especially when I believe you are completely wrong."

Again, I am an idiot, albeit a useful one at times, and what we know is next to nothing. As I have demonstrated on occasion, I am here to share my knowledge and have no problem attempting to educate or direct to reference material, if asked properly and time permitting. Meanwhile, ad hominem, inflammatory innuendo or self entitlement shall always receive this kind of treatment.

"What we know is not much. What we do not know is immense "- Pierre Simon Laplace

In closing, my friend and I are both strong willed, opinionated and occasionally butt heads. You want the truth? Just ask me. Like the Dutch, I speak my mind, even if people don't like it. It's not in my nature to professionally or personally, suck up, brown nose, kiss ass, candy coat or perform like a trained sycophant or yes man, never have, never will.

Unless in immediate harm's way, when confronted with mis/dis-information, commonly held beliefs based in false doctrine, when the truth is found to be lies, or wrongdoing, you can be assured, I will always do this.

Like differing perceptions and a posterior, we all have opines (beliefs) and are entitled to them, replete with their benefits and detriments. Go ahead my friends, keep trying to poke holes for I am out to expand my knowledge as well.

The ensuing discourse can be healthy, challenging and stimulating and unlike the economy, our knowledge base would expand. In that manner, we make each other better, and isn't that what it's all about, In the end?

With regard to the above, we examined the FX and macro concepts involved in: In The Toilet?, Rally Dance?, Need For Speed?, In Time?, The Balance? and Dollar Chaos?

Would like to thank you folks fer kindly droppin in. You're all invited back again to this locality. To have a heapin helpin of Nattering hospitality. Naybob that is. Set a spell, take your shoes off. Y'all come back now, y'hear!

This is the 27th in a series of thematically related missives which will attempt to identify the macroeconomic forces with potential to adversely effect capital, commodity, equity, bond and asset markets.

I wish to dedicate this missive to one of my mentors, Salmo Trutta, who is a prolific commenter on SA. Without Salmo's tutelage, and insistence in not masticating and spoon feeding the baby ducks, as in learning the hard way by doing the leg work and earning it, this missive would not have been possible. To you "Proximo"... "win the crowd and win your freedom" - Spaniard


Investing is an inherently risky activity, and investors must always be prepared to potentially lose some or all of an investment's value. Past performance is, of course, no guarantee of future results.

Before investing, investors should consider carefully the investment objectives, risks, charges and expenses of an investment vehicle. This and other important information is contained in the prospectus and summary prospectus, which can be obtained from the principal or a financial advisor. Prospective investors should read the prospectus carefully before investing.

Market Plays

As for how all of the above ties into the potential and partial list of market plays below... the market as a whole could be influenced, and this could tie into any list of investments or assets. Those listed below happen to influence the indices more than most.

There are many macroeconomic cross sector and market asset correlations involved that affect your investments. Economic conditions, the eurodollar, global dollar debt and monetary policy all influence the valuation of the above and market plays below, via King Dollar's value, credit spreads, swap spread pricing, market making, liquidity, monetary supply and velocity, just to name a few. For a complete missive series listing covering those subject and more,click here.

The potential global economic developments discussed in this missive could affect numerous capital and asset markets, sectors, indexes, commodities, forex, bonds, mutual funds, ETFs and stocks.

A List of 17 Potential Market Plays (Long or Short?): Apple Computer (NASDAQ:AAPL); Google (NASDAQ:GOOG); Facebook (NASDAQ:FB); Microsoft (NASDAQ:MSFT); Citigroup (NYSE:C); General Electric (NYSE:GE); Cisco (NASDAQ:CSCO); Bank of America (NYSE:BAC); Amazon (NASDAQ:AMZN); Tesla (NASDAQ:TSLA); SP 500 Trust ETF (NYSEARCA:SPY); Ford (NYSE:F); Starbucks (NASDAQ:SBUX); Intel (NASDAQ:INTC); ATT (NYSE:T); IBM (NYSE:IBM); Exxon/Mobil (NYSE:XOM)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.