Global Inflection Points: China, Oil, And Plunging Bond Yields

|
Includes: BBSA, BIL, BNO, CHN, CLTL, CN, CXSE, DBO, DFVL, DFVS, DLBL-OLD, DLBS, DTO, DTUL, DTUS, DTYL, DTYS, DWT, EDV, EGF, FCA, FIBR, FLCH, FXP, GBIL, GOVT, GSY, GXC, HYDD, IEF, IEI, ITE, KGRN, NRGD, NRGO, NRGU, NRGZ, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, OPER, PGJ, PLW, PST, RISE, SCHO, SCHR, SCO, SHV, SHY, SPTL, SPTS, SZO, TAPR, TBF, TBT, TBX, TDF, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBT, UCO, USAI, USL, USO, USOD, USOI, USOU, UST, USTB, UWT, VGIT, VGLT, VGSH, VUSTX, WCHN, WTID, WTIU, XPP, YANG, YGRN, YINN, YXI, ZROZ
by: Chris Puplava
Summary

Several areas of the market are at make-or-break inflection points.

We are watching closely for signs of a bottom in the overall market or for a further break from current levels.

They are oil, the Chinese renminbi, the yen-carry trade, copper, and global bond yields.

As a follow-up to my warnings last month prior to the recent correction ("US Stock Market Showing Tech-Bubble Divergence" and "Is a Bad Moon Rising for the Stock Market?"), several areas are at make-or-break inflection points that we are watching closely for signs of a bottom in the overall market or for a further break from current levels. They are oil, the Chinese renminbi, the yen-carry trade, copper, and global bond yields. Here's where each of these stand today and why they're so important.

Oil

West Texas Crude's uptrend from the 2016 lows was decisively broken in Q4 2018. We rallied to the underside of it and failed. We currently have a 1-year triangle formation and just broke below support (green line below).


Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

If oil breaks lower, this will lead to lower EPS estimates for the energy sector, which will continue to weigh on overall market earnings. Secondly, while lower oil prices are good for the consumer, given the increased production and activities related to the energy sector, declines in oil prices lead to significant hits to the economies of energy states as seen in 2014-2016.

Chinese Renminbi

There was a massive shot across the bow when China let their currency weaken beyond the key 7:1 level to the USD. This was a 11-year breakout, and the further their currency weakens, the more deflationary pressures build for financial markets and economies as Chinese goods decrease in cost to global importers. This will be a large force driving down global inflation and, thus, global bond yields.crude oil breakdown

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

China's currency and its importance can't be overstated to the global economy. The 50% devaluation of the renminbi back in 1994 sowed the seeds of the Asian currency crisis as it ushered in a global currency war.china renminbi 1994

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

In response, Japan devalued their currency to the USD by nearly 50% over the ensuing years.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Global capital flows were highly in flux after China's move, which led to imbalance in Asian countries. The poster child was Thailand, which saw its balance of payments (BOP) deficit widen as it imported more goods than it exported, requiring it to have a financial account surplus through borrowing to cover its current account deficit. When Thailand's borrowings moved to levels perceived as unsustainable, foreigners began to move capital out of the currency and, in order to stabilize the situation, Thailand was forced to use their foreign exchange reserves. Eventually, as their foreign currency reserves were significantly depleted, they gave up defending their currency and, as foreign capital took flight, the USD appreciated by more than 150% relative to the Thai baht over the next six months.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

The above example highlights why paying close attention to the Chinese currency cannot be overstated and why the major decade-plus breakout in the renminbi is concerning.

Yen-Carry Trade

The yen broke its own triangle pattern, as it is strengthening to the dollar, which is saying something, since the USD has been one of the world's strongest currencies. A further decline below the $105 level could usher in a wave of global selling as the yen-carry trade unwinds. This is of particular concern given non-bank developing Asian economy borrowers are holding record levels of yen debt.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

A lot of speculation in the yen is conducted by European borrowers, and so, watching the Yen/Euro exchange rate is also important. It was when the yen began to appreciate strongly to the euro in H2 2008 that the euro-yen carry trade really began to unwind and took selling of global financial assets to extreme levels.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Similarly, the breakdown of the yen to the euro in 2012 ushered in a wave of global liquidity that led to a massive rally in global risk assets in 2013.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Looking at the present case, the yen has broken out to the euro from its multi-year triangle formation, and while it has been strengthening slowly, we need to watch for signs of acceleration to imply the euro-yen carry trade is being unwound.

Dr. Copper

Copper has not been acting well of late, as it has broken an uptrend since 2016, though it is currently holding support at the 2018 lows. A breakdown from here, specifically given low inventories for copper, would not be a bullish sign for the global economy.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Free Fall in Global Bond Yields

The lower bond yields go, the more they will pull US rates along with them. German yields are now at historical lows, with the 10-year at -0.536% as of Tuesday, August 6th, which is causing US 10-year and 30-year rates to fall strongly in suit. Given there is no technical support for German yields as they are hitting record lows, US long-term yields could breach 2016 levels.

This is effectively undoing the Fed rate cut last month in trying to normalize the US yield curve, as long-term US rates are falling faster than short-term rates. Nearly the entire UST yield curve relative to 1-month T-bills has inverted, except for the 30-year.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Comparing the current yield curve to a week ago, just prior to the Fed meeting, shows how rates 5 years and out dropped significantly more than rates 2 years and under, as the yield curve has worsened, not improved, since the Fed cut rates.

Source: Bloomberg, Financial Sense Wealth Management. Note: Past performance is no guarantee of future results. You cannot invest directly into an index.

Again, the more foreign yields fall, the more our yields fall, and tightness in the credit system will continue to worsen, as banks will not have any interest to lend for lower than their borrowing rates.

This argument is made crystal clear when looking at US rates relative to developed countries. As of Tuesday, August 6th, the entire curve for Switzerland, Germany, and the Netherlands are effectively in negative territory!

Source: @charliebilello, Bianco Research

Comparing US yields to those of other developing nations makes clear the attractiveness of US yields and why there should be continued buying of US Treasuries, pushing yields lower the further foreign yields drop.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.