Crash 'Risk' Is Soaring: "This Is Where They Lost Their Minds"

Last week, the U.S. equity market climbed to the steepest valuation level in history, based on the valuation measures most highly correlated with actual subsequent S&P 500 10-12 year total returns, across a century of market cycles.

As Didier Sornette correctly observed in Why Markets Crash,

"The collapse is fundamentally due to the unstable position; the instantaneous cause of the crash is secondary."

My sense is that investors are going to learn this again the hard way.

On the accelerating slope of the current advance

Speaking of Didier Sornette, I've periodically discussed his concept of "log periodic power-law" price behavior, which has accompanied speculative episodes in numerous markets and often precedes inflection points or collapses. This structure is based on a purely mathematical fit to price behavior, and does not reflect any valuation considerations. It's not part of our own investment discipline, but we occasionally fit the log-periodic structure to price behavior when market movements are particularly extreme.

In recent years, those structures have generally identified inflection points of flat or correcting prices, but certainly not crashes in the S&P 500. Given the increasingly steep slope of the current market advance, along with the most extreme valuations in history and the most lopsided bullish sentiment in more than three decades, it's quite possible that this instance will be different. In any event, the underlying "arbitrage" considerations described by Sornette are worth reviewing here.

In 2000, as the tech bubble was peaking, Nobel laureate Franco Modigliani observed that the late stages of a bubble can be "rational" in a certain sense, provided that investors are inclined to self-reinforcing behavior.

Imagine a market that you fully believe to be overvalued and at risk of a market crash. Indeed, let's say that there is a defined probability of a crash, which increases rapidly as the pitch of the market advance becomes more extreme. Should you sell? Well, it depends. Given that an immediate crash is not certain, a speculator must, in each period, weigh the potential gain from holding a bit longer against the potential loss from overstaying. Sornette uses a similar argument to describe a speculative bubble advancing toward its peak (italics mine):

"Since the crash is not a certain deterministic outcome of the bubble, it remains rational for investors to remain in the market provided they are compensated by a higher rate of growth of the bubble for taking the risk of a crash, because there is a finite probability of 'landing smoothly,' that is, of attaining the end of the bubble without crash."

"This line of reasoning provides us with the following important result: the market return from today to tomorrow is proportional to the crash hazard rate. In essence, investors must be compensated by a higher return in order to be induced to hold an asset that might crash. As the price variation speeds up, the no-arbitrage conditions, together with rational expectations, then imply that there must be an underlying risk, not yet revealed in the price dynamics, which justifies this apparent free ride and free lunch. The fundamental logic here is that the no-arbitrage condition, together with rational expectations, automatically implies a dramatic increase of a risk looming ahead each time the price appreciates significantly, such as in a speculative frenzy or in a bubble. This is the conclusion that rational traders will reach."

The chart below shows our current best-fit parameterization of Sornette's log-periodic structure, applied to the S&P 500 Index. Notably, unless we allow for the slope of the current market advance to become quite literally infinite, it's impossible to closely fit the current price advance without setting the "finite-time singularity" – the point at which instability typically emerges – within a few days of the present date. Notably, the singularity is not the date of a crash. Rather, it's the point where the pitch of the advance reaches an extreme, which may simply be an inflection point (as has been the case for other structures in recent years) or a pre-crash peak.

The collapse is fundamentally due to the unstable position; the instantaneous cause of the crash is secondary.

– Didier Sornette

If you want my opinion (which we don't trade on and neither should you), my opinion is that this singularity will prove to be more than an inflection point.

Though nearly every morning prompts the phrase "Yup, they're actually going to do this again," the steepening pitch of this ascent – coupled with record valuation extremes, record overbought extremes, and the most lopsided bullish sentiment in over three decades – now produces the most extreme "overvalued, overbought, overbullish" moment in history. In prior cycles across history, similar syndromes were either joined or quickly followed by deterioration in market internals. In this cycle, it has been essential to wait for explicit deterioration in market internals before establishing a negative outlook. Notably, the market has lost value, even since 2009, when overvalued, overbought, overbullish conditions were joined by divergent internals.

I expect the S&P 500 to lose approximately two-thirds of its value over the completion of this cycle.

My impression is that future generations will look back on this moment and say "… and this is where they completely lost their minds."

As I've regularly noted in recent months, our immediate outlook is essentially flat neutral for practical purposes, though we're partial to a layer of tail-risk hedges, such as out-of-the-money index put options, given that a market decline on the order of even 5% would almost certainly be sufficient to send our measures of market internals into a negative condition. It's best not to rely on the ability to execute sales into a falling market, because the range-expansion we've recently seen on the upside may very well have a mirror-image on the downside. As usual, we'll respond to new evidence as it emerges.

US National Debt Will Jump by $617 Billion in 5 Months

Just as the Fed accelerates its QE Unwind. Treasuries reacted.

While everyone is trying to figure out how to twist the new tax cut to their advantage and save some money, the US Treasury Department just announced how much net new debt it will have to sell to the public through the second quarter to keep the government afloat: $617 billion.

That's what the Treasury Department estimates will be the total amount added to publicly traded Treasury securities — or "net privately-held marketable borrowing" — through the end of the second quarter. This will be the net increase in the US debt through the end of Q2. By quarter:

During Q1, the Treasury expects to increase US public debt by $441 billion. It includes estimates for "lower net cash flows."

During Q2 – peak tax seasons when revenues pour into the Treasury – it expects to increase US public debt by $176 billion.

It also "assumes" that with these increases in the debt, it will have a cash balance at the end of June of $360 billion.

So over the next five months, if all goes according to plan, the US gross national debt of $24.5 trillion currently – which includes $14.8 trillion in publicly traded Treasury securities and $5.7 trillion in internally held debt – will surge to about $25.1 trillion.

That's a 4% jump in just five months. Note the technical jargon-laced description for this (marked in green on the chart):

The flat lines in 2013, 2015, and 2017 are a result of the prior three debt-ceiling fights. Each was followed by an enormous spike when the debt ceiling was lifted or suspended, and when the "extraordinary measures" with which the Treasury keeps the government afloat were reversed. And note the current debt ceiling, the flat line that started in mid-December.

In November, Fitch Ratings said optimistically that, "under a realistic scenario of tax cuts and macro conditions," the US gross national debt would balloon to 120% of GDP by 2027. The way things are going right now, we won't have to wait that long.

Back in 2012, gross national debt amounted to 95% of GDP. Before the Financial Crisis, it was at 63% of GDP. At the end of 2017, gross national debt was 106% of GDP!

Over the next six month, the debt will grow by about 4%. Unless a miracle happens very quickly, the debt will likely grow faster over the next five years due to the tax cuts than over the past five years. But over the past five years, the gross national debt already surged nearly 25%, or by $4.1 trillion.

So that's a lot of borrowing, for an economy that is growing at a decent clip. What will happen when the full force of the tax cut hits US government receipts, or when the next recession appears out of the blue and outlays jump as receipts fall? What will happen to the government's borrowing needs?

The bond market is barely starting to do the math.

This comes at the precise time when the Fed is unwinding its QE. It's reducing its pile of Treasury Securities by up to $36 billion during Q1 and by up to $54 billion in Q2. In addition, it will also allow MBS to roll off its balance sheet.

Is the Treasury market already figuring out the answer, given this surge in supply? Will some frazzled folks start buying gold and unload Treasuries? The answer is that new investors need to be lured into the market with higher yields. Which means lower prices. And this will hurt existing investors.

So the Treasury sell-off continues. The 10-year Treasury yield rose today to 2.73%, the highest since April 22, 2014. And the average 30-year fixed-rate mortgage – which follows the benchmark 10-year Treasury yield – was quoted today with a rate for top-tier borrowers of 4.35%, also the highest since 2014.

But folks that were worried about an "inverted yield curve" can relax. It isn't going to happen. Instead, they might want to worry about the housing market.

Trader Warns: Beware The "Freaking People Out Effect"

"The trend is your friend..." as the old adage goes but as former fund manager Richard Breslow notes there is an additional 3 words that need to be added to that phrase - "...until the end," and this week's avalanche of events could be the trigger. In this case, as Breslow details below, words trump deeds and traders in love with their trends should pay special heed to the warnings from goldilocks-promising doves.

Via Bloomberg,

Can you spot the one that doesn't belong? The choices are: family, buddies and trends.

Ordinarily, you would think that family and trends go together as, in theory, you don't pick them, but are meant to embrace them nevertheless.

It seems, though, that we have somehow decided that trends are defined in the eye of the beholder.

But if you pick your market views the way you build your circle of friends, you may receive a lot of positive feedback, but little in the way of a performance bonus.

In conducting an unscientific but, perhaps, statistically significant survey of market participants I have overwhelmingly heard that the dollar has been going down all January and looks like it has more to go. Bonds have been going down all year, but this surely has to stop, or at least get a grip. Equities have been on a tear since the beginning of the year, well for the last nine years really, but every down day is described using the most salacious, end-of-world adjectives that can be conjured up.

Markets may move based on animal spirits, fear or greed, but they don't move in order to suit any particular trader's comfort zone.

Without picking a side, or pointing out that the Bloomberg Commodity Index is looking decidedly undecided at the moment, there really is no solid foundation to declare any of these moves as compromised.

The only negative thing you can say at this point is they seem to have gone too far, too fast and need to chill for a while. But real trends don't afford you that luxury. They insist on being chased.

The problem commentators have is that daily ranges have noticeably widened.

Small sample, big impact. Call it the freaking people out effect.

Don't think of it like that. In truth, what traders are being presented with is more opportunities and the chance to get some decent location, if you are willing to grab it. But that is exceedingly hard to do if you add the extra decision-making overlay of whatever traumatized you earlier in your journey.

And something we're not used to in the well remarked upon low-volatility, spread-compression world, our central bankers are desperately trying to get out of.

Keep that last fact in mind when deciding whether these trends will continue to have legs or not. There is a ton of news out this week, here, there and everywhere. What will change your mind on the market? A random beat or miss even on Class A economic releases? Probably not, data-dependence notwithstanding. At the end of the day, it will end up being just additional fodder for the various factions to use in the moment. Especially if there is the inevitable over-reaction to some small deviation.

What you should really be paying attention to, is what the policy-making movers and shakers are saying. There is a significant possibility that global markets are at a defining crossroad and, depending on the decisions, monetary or fiscal, made this year, asset prices have plenty of room to motor. What the Fed, ECB, BOJ or PBOC do will matter a lot. So do, for that matter, a long list of other central banks. None of them act in a vacuum. And, with fewer exceptions than one might think, they don't often misspeak. They do, however, dissemble.

And make sure you network with a risk-parity practitioner.

They may end up being your best friend, or the next candidate to replace your global macro pals at the bottom of the hedge fund strategy league tables.

VIX Breaks Above Crucial Technical Level; FX, Rates Vol Spikes

This could be a problem...

2018 has seen a strange phenomenon of rising VIX and rising stocks (which until the last few days was driven by a panic-buying euphoria in calls - bidding volatility up for upside enthusiasm, not downside protection)

But the last two days have seen VIX spike dramatically as downside protection is suddenly bid...

And that has smashed VIX above its two-year downtrend...

As CitiFX Technicals group warns:

"We are now closely watching the combined larger double bottom neckline (14.5-14.6%) as a break of this, if seen, would suggest the potential for extended gains towards 20%."

But it's not just Equity risk, volatility is spiking in FX and interest rates...

And most worryingly, credit has yet to react to this sudden surge in volatility... and a spike in HY to 360bps could seriously spoil the party...

As we noted Friday,"BofAML Bull & Bear indicator has given 11 sell signals since 2002; hit ratio = 11/11; "

What happens next? Well, once hit, the average equity peak-to-trough drop following 3 months = 12% (backtested, Table 1); note the last Bull & Bear indicator flashed was a buy signal of 0 on Feb 11th 2016.

Putting it all together, BofA warns that a "tactical S&P500 pullback to 2686 in Feb/Mar now very likely."

And here is what can spark it:

"The Art of Falling Apart: US dollar key catalyst; note US-Europe FX spat sparked '87 crash; higher US$ "pain trade" = risk-off coming weeks; we reiterate 2018 calls: Big Long = Vol, Big Short = Credit, Big Risk = Equity Bubble (driven by $10.3tn of negatively yielding debt), Big Rotation from Davos Man to Joe-Six Pack portfolio"

Will this time finally be the charm for BofA's recurring warnings of an imminent market plunge? The next 2 months will reveal if - this time - it was finally right...

The S&P 500 appears to be heading towards its first 1% drop in 112 trading days

As Nomura's Cross-Asset Strategy MD Charlie McElligott noted:

VOLATILITY AWAKENS AHEAD OF EARNINGS, BUT CROWDING AND 'SHORT VOL' OFF A LOW-BASE TO BLAME AS WELL: But the larger story to me yesterday was the move in SPX implied vols, ESPECIALLY focused in the CROWDED large cap Tech / Cons Disc / Healthcare spaces, with key names reporting in the next week +. An uptick in vols ahead of earnings should be expected of course…but off such a low base (too low), it felt 'thunderous.' The VIX outperformance was so large relative to the S&P move that we would have expected SPX closer to the 2805 level.

Regardless, the outsized vol move (and its impact on the VIX future) forced a rebalancing from the exchange traded notes universe to the scale of $3B of SPX futures delta for sale // equivalent of 46k VIX futs to buy. Remember: the current scale of the vol short (outright) sits near all-time highs, while the NET vol short IS at all-time highs.

Renaissance Warns Of "Significant" Correction Risk, Prepares For "Turbulence Ahead"

First it was Bank of America, then Goldman, now the world's most profitable hedge fund is warning that a severe market shock is imminent.

Renaissance Technologies, the hedge fund that two years ago we dubbed the "Puppetmaster Behind The US Presidential Election" due to its concurrent bets on both Hillary Clinton and Donald Trump to win the presidency (Jim Simons was a prominent Hillary Clinton backer while Robert Mercer has been a notorious supporter of Donald Trump), has warned that there is "significant" risk of a correction in prices and is preparing for "possible market turbulence."

In a letter to clients this month obtained by Bloomberg, Ed Hubner - RenTec's head of risk control - cautions that while accelerating global growth, corporate tax reform and a business-friendly administration in the U.S. have contributed to market gains, "it's not clear these factors justify current valuations, especially in light of sovereign debt levels."

RenTec founder and chain smoker Jim Simons

Echoing a familiar warning discussed in recent weeks, in his letter Hubner notes that while the current S&P 500 PE ratio of 18.6 (compared with about 11 in 2011) may be justified if volatility remains low and 30-year bonds hold below 3%, "with higher rates and more volatility a distinct possibility, there is a significant risk that asset prices will correct."

In addition, the downward technical pressure on the Cboe Volatility Index, orVIX, due to the growth of strategies that bet against market volatility, and lower correlations within the S&P 500, shouldn't be confused with unshakable economic calm, Hubner said.

Hubner also noted that "while the fear of missing out may not be a concern for equity investors, increasing euphoria mixed with a bit of complacency certainly is" and that "Historically low levels of volatility may well have given investors a false sense of security in the nearly two years since the last market correction."

RenTec's Institutional Equities Fund, known as RIEF, returned 15% last year, according to the letter, underperforming the S&P 500 Index which rose 19%.

While we haven't seen the memo, it does not appear to break any news ground, and appears aimed at relatively unsophisticated investors with a warning that "while equity prices have moved upward for many years, and technical and quantitative analysts say "trend is your friend," at some point trends reverse."

Well, yes... however, as Bank of America pointed out in December, every time the market has threatened to crash, the Fed always stepped in.

The question is will it do so this time. RenTec no longer appears so sure as it concludes that "while we cannot know when that will happen with the current markets, we are doing our best to prepare for what may be turbulence ahead."

30Y TSY Yield Nears 3.00% - Triggers Gundlach's "Bonds Will Damage Stocks" Threshold

While all eyes are on the 10Y, it's the 30Y bond that is bloodbath-ing today with its yield snapping above October's highs, breaking towards 3% for the first time since May 2017...

Notably, 30Y at 3% was DoubleLine's Jeff Gundlach's Second Trigger for bonds to damage stocks (after his first trigger -10Y crossing 2.63% - hit earlier in the month):

Reminding his audience of the rivalry between himself and Bill Gross, Gundlach disagreed with the former bond king, who made headlines today with his statement that the bond bull market is over, and said that "Gross is too early with his TSY bear market call."

What is the catalyst for Gundlach? As he explained, one "needs to see the 30Y at 2.99% or above for the trendline to break."

And it just did...

Crash 'Risk' Is Soaring: "This Is Where They Lost Their Minds"

Last week, the U.S. equity market climbed to the steepest valuation level in history, based on the valuation measures most highly correlated with actual subsequent S&P 500 10-12 year total returns, across a century of market cycles.

As Didier Sornette correctly observed in Why Markets Crash,

"The collapse is fundamentally due to the unstable position; the instantaneous cause of the crash is secondary."

My sense is that investors are going to learn this again the hard way.

On the accelerating slope of the current advance

Speaking of Didier Sornette, I've periodically discussed his concept of "log periodic power-law" price behavior, which has accompanied speculative episodes in numerous markets and often precedes inflection points or collapses. This structure is based on a purely mathematical fit to price behavior, and does not reflect any valuation considerations. It's not part of our own investment discipline, but we occasionally fit the log-periodic structure to price behavior when market movements are particularly extreme.

In recent years, those structures have generally identified inflection points of flat or correcting prices, but certainly not crashes in the S&P 500. Given the increasingly steep slope of the current market advance, along with the most extreme valuations in history and the most lopsided bullish sentiment in more than three decades, it's quite possible that this instance will be different. In any event, the underlying "arbitrage" considerations described by Sornette are worth reviewing here.

In 2000, as the tech bubble was peaking, Nobel laureate Franco Modigliani observed that the late stages of a bubble can be "rational" in a certain sense, provided that investors are inclined to self-reinforcing behavior.

Imagine a market that you fully believe to be overvalued and at risk of a market crash. Indeed, let's say that there is a defined probability of a crash, which increases rapidly as the pitch of the market advance becomes more extreme. Should you sell? Well, it depends. Given that an immediate crash is not certain, a speculator must, in each period, weigh the potential gain from holding a bit longer against the potential loss from overstaying. Sornette uses a similar argument to describe a speculative bubble advancing toward its peak (italics mine):

"Since the crash is not a certain deterministic outcome of the bubble, it remains rational for investors to remain in the market provided they are compensated by a higher rate of growth of the bubble for taking the risk of a crash, because there is a finite probability of 'landing smoothly,' that is, of attaining the end of the bubble without crash."

"This line of reasoning provides us with the following important result: the market return from today to tomorrow is proportional to the crash hazard rate. In essence, investors must be compensated by a higher return in order to be induced to hold an asset that might crash. As the price variation speeds up, the no-arbitrage conditions, together with rational expectations, then imply that there must be an underlying risk, not yet revealed in the price dynamics, which justifies this apparent free ride and free lunch. The fundamental logic here is that the no-arbitrage condition, together with rational expectations, automatically implies a dramatic increase of a risk looming ahead each time the price appreciates significantly, such as in a speculative frenzy or in a bubble. This is the conclusion that rational traders will reach."

The chart below shows our current best-fit parameterization of Sornette's log-periodic structure, applied to the S&P 500 Index.Notably, unless we allow for the slope of the current market advance to become quite literally infinite, it's impossible to closely fit the current price advance without setting the "finite-time singularity" – the point at which instability typically emerges – within a few days of the present date. Notably, the singularity is not the date of a crash. Rather, it's the point where the pitch of the advance reaches an extreme, which may simply be an inflection point (as has been the case for other structures in recent years) or a pre-crash peak.

The collapse is fundamentally due to the unstable position; the instantaneous cause of the crash is secondary.

– Didier Sornette

If you want my opinion (which we don't trade on and neither should you), my opinion is that this singularity will prove to be more than an inflection point.

Though nearly every morning prompts the phrase "Yup, they're actually going to do this again," the steepening pitch of this ascent – coupled with record valuation extremes, record overbought extremes, and the most lopsided bullish sentiment in over three decades – now produces the most extreme "overvalued, overbought, overbullish" moment in history. In prior cycles across history, similar syndromes were either joined or quickly followed by deterioration in market internals. In this cycle, it has been essential to wait for explicit deterioration in market internals before establishing a negative outlook. Notably, the market has lost value, even since 2009, when overvalued, overbought, overbullish conditions were joined by divergent internals.

I expect the S&P 500 to lose approximately two-thirds of its value over the completion of this cycle.

My impression is that future generations will look back on this moment and say "… and this is where they completely lost their minds."

As I've regularly noted in recent months, our immediate outlook is essentially flat neutral for practical purposes, though we're partial to a layer of tail-risk hedges, such as out-of-the-money index put options, given that a market decline on the order of even 5% would almost certainly be sufficient to send our measures of market internals into a negative condition. It's best not to rely on the ability to execute sales into a falling market, because the range-expansion we've recently seen on the upside may very well have a mirror-image on the downside. As usual, we'll respond to new evidence as it emerges.

PIMCO: "It's Time To Start Betting The Other Way"

Scott Mather, CIO U.S. Core Strategies and a managing director at Pimco, thinks that monetary policy normalization will be a game changer for financial and expects the return of volatility.

The bond market is on the move. The economy is gaining steam and interest rates are rising. This week, the yield on ten year Treasuries climbed to the highest level since the summer of 2014. Despite that, Wall Street doesn't' seem to care much. The Dow Jones chases record after record and investors take on more and more risk.

"So far, they have been rewarded. But it's dangerous," says Scott Mather. The veteran Chief Investment Officer of U.S. core strategies and managing director at the Californian bond giant Pimco expects that inflation will become a key topic this year. He cautions that the global normalization of monetary policy is going to be a game changer and volatility will finally stage a comeback.

Mr. Mather, bond yields are rising. It this a sign that the economy is getting better?

I think this year is going to be the best year in terms of growth that we have seen in a while. For the first time in a long time, there's not one major region in the world that is underperforming. The outlook for Europe looks pretty good. In the US, we are going to get fiscal spending which is going to bump up growth to probably 2,5% with risk to the upside. That's versus 2% for many years in the past. Japan's growth looks pretty good, too. Also, in the emerging markets almost all the problem cases have recovered. Putting it all together that means you have to bump up your growth forecast for the world by a quarter to half of a percentage point versus what people were thinking a year ago.

That's sounds encouraging. How sustainably it this pick up in US?

We have some concerns that the US is going to slow back down again because much of the growth this year is fiscal stimulus. There's the corporate tax cut which is structured to pull the activity forward: The incentive for corporations is to do all the spending and investment this year and then push the profits out to the future when they're taxed a lower rate. So investment spending could bump up this year because of that. You also have another $100 billion of fiscal spending from the hurricane relief and raise in defense spending. But that's just kind of a onetime shot because it won't be repeated the following year. Also, we're pretty close to full employment. At some point, if you can't put more and more people into the labor force you are going to slow down unless they become more productive and there is no reason to think that we are going to see some productivity miracle. So after the boost this year there will be some sort of a gravitation that will us pull back down.

How does filter into your outlook on inflation?

Inflation is a factor that will come into play this year. It's sort of unique that we haven't had wages rebound and inflation come back sooner. But we don't think the laws of supply and demand have been repealed. If we start to see wage inflation, that's sort of an omen for future generalized inflation and we know that the Fed pays a lot of attention to wages. So inflation will probably head closer to the Fed's 2%-target which means the Fed will have reason to move. It's not as if they want to slow the economy down. But they have reason to move to try to at least get back to a neutral Federal Funds Rate. And if we get a little bit of acceleration in terms of inflation as we head through the year they will probably even think about what they should be doing with respect to overshooting. Having inflation overshoot a little bit might be ok. But they could start to get nervous.

What does this mean with respect to monetary policy?

We are getting into an environment where monetary policy around the world starts to reverse course. I think that's one of the big themes this year which is a global movement towards normalization. In US, we will get two or three more rate hikes this year. That takes the Fed Funds Rate back in the 2% to 2,5% range and that's the level that starts to slow the economy down. At the same time, the ECB tapers and will be done with QE by the end of the year. Elsewhere, it looks like that the Bank of England will hike once this year. The Bank of Japan is likely to tweak its balance sheet expansion and yield curve control. The Bank of Canada has moved, and the Reserve Bank of Australia will probably be moving this year as well. So everybody starts moving.

Right now, everybody is focusing on the ECB. Will the European Central Bank be able to follow through with its plans to normalize monetary policy?

Growth in Europe has been good which has surprised them. I think we have seen the lows in inflation. So there is reason for the ECB to think the same way the Fed has which is to take advantage when you have the opportunity to start normalizing. The big priority would be getting away from negative rates. If that goes well, then they will make a judgment if they want to shrink the balance sheet first or hike rates. Probably they want to hike rates a bit further. So it's the same playbook as the Fed and we think that economic growth will allow for this.

It's been almost four years since the ECB became the first major central bank to push rates to negative territory. Are they at risk of falling behind the curve?

If the ECB could do it over, they probably would be tapering faster because growth has surprised them. If you're a Martian and you landed on earth you would be like: "What in the world are these central banks doing?"

Why?

This expansion has been going on for a long time and I don't see any risk really on the economic horizon that are very challenging. And yet they have zero and negative rates and huge central bank balance sheets. So central banks are being very cautious, maybe too cautious about normalizing. But this year is the big change and we think people may be underestimating it.

What does the normalization of monetary policy mean for the bond market?

One of the biggest unknowns is what this normalization does to financial markets. No one really knows. The balance sheet reduction at the Fed and the tapering of the ECB will be a big change for the bond market. We are going to get a lot more net supply. If you're looking back on the past two or three years, we had two trillion dollars in global quantitative easing by the major central banks every year. But this year that all changes: We go from a two trillion run rate to flat lining. I'm not so worried about it having a major impact on the real economy. But it will potentially slow down inflation in financial assets. It probably has an impact on risk premiums in general and will bring back a little more volatility. Basically, what we are describing is a more normal market environment. But it's been so long that people have forgotten how that feels like.

In the US, the yield on ten year treasuries climbed to the highest level since June 2014. Will this trend continue?

There are major forces at work here. Normally, when the Federal Reserve is tightening the yield curve flattens. On the other hand, you have the balance sheet reduction and you have a fiscal expansion which at this point of the cycle is very unusual. Both factors are steepening forces with respect to the yield curve and they begin to prevail. This doesn't mean that yields have to continue to go up dramatically. Ten year yields can edge up into the 2,75% range this year but they probably can't get much over 3%. The long end could be 50 to 75 basis points higher than that.

Outgoing Fed chief Janet Yellen said that the balance sheet normalization would be a very quiet and almost boring process, like watching paint dry. Is it really going to be so painless?

That's the way central banks want to frame it. But they know that can't be true. You can't go from a two trillion dollar QE run rate down to zero and not expecting an impact. But central banks also see that the costs and risks of doing nothing are growing by the day. So it's time to stop and push the responsibility back to the fiscal agents. In that sense, the Fed is kind of lucky that they have President Trump and this fiscal expansion because it will allow them to normalize without much risk. Europe needs the same sort of thing probably: There is a little bit of fiscal expansion in Europe, but it would be helpful if it was more because then the ECB could stop quicker.

At the beginning of February, Jerome Powell will take over as Chairman of the Federal Reserve. In what respect will that impact monetary policy in the US?

Normally, there are all sorts of uncertainty that comes when you get a new Fed chair. But I think the new Fed chair looks a lot like the old Fed chair – and the old Fed chair looks a lot like the previous Fed chair, Ben Bernanke, who we talk to all the time since he's an advisor to Pimco. Based on our understanding, Powell is unlikely to change the Fed's reaction function. So I wouldn't expect anything dramatic. He's a well-known entity and his thoughts and beliefs are recorded by the Fed board for a long period of time. There is no reason to expect that he's going to change the way the Fed reacts. But it will be interesting to see who the Vice Chair is going to be and who fills the other spots. The real question however, is what happens if the unexpected happens. What if they have an inflation problem? Or what if growth slows down? What if some sort of strange thing happens?

The last time the Fed got caught by an ugly surprise was when housing prices in the US were tanking. How will higher rates impact the mortgage market this time?

We think that private mortgages are pretty attractive. They have been great and they're in a lot of ways safer than corporate credit because normally you don't see the housing market that closely linked to the economy. Yes, a recession causes housing prices to slow down. But the last recession was unique because we never had this generalized price decline in the US. So people are still sort of viewing in through that lense but that's not the right way to view it. The next recession won't be caused by housing or mortgage problems, it's likely caused by something else.

So what's the biggest risk for financial markets in your view?

The biggest risk that we worry about is a geopolitical event. That could really change the economic outlook and it certainly could impact the markets. It's a higher risk than it has ever been because we have new leadership which is completely an unknown: How would the US respond? How would other countries respond to one another? It's a completely changed world from where we were ten or twenty years ago. We have a lot of friction globally, so it doesn't take much at this point. It could be a terrorist event or an accident. The US, Russia and China are always playing with each other in the skies and on the ground. And there's the one risk that everyone is focused on which is North Korea. That's bad enough in itself but when you look outside of that, there is a lot of instability.

How can investors prepare for that?

It's very hard to plan for and it's very hard to price. You can't just go and put a trade on because you don't know how it will unfold. But it's another reason to say that now is not the time for investors to be counting on asset price inflation to infinity and low volatility. It's a reason to start betting the other way.

What does this mean in terms of investment strategy?

One mistake market participants are making is they're sort of looking what the Fed has done in the past two years and they say: "Well, it didn't seem to cause any issues, there's no volatility. So why does it matter if the ECB and the Bank of Japan do the same thing?" But people are ignoring the fact that the Fed could do it with having seemingly no impact only because the other central banks were offsetting it with monetary expansion. The difference is, this year nobody is offsetting. Everybody is going into same direction. That's why investors should not underestimate the very likely scenario that volatility returns to normal. It doesn't have to be dramatic, but it will look a lot different than the past few years and people need to prepare for it. It's time to be a bit more defensive.

So what should investors do?

You should look what you are doing now and think about what your asset allocation should be. Most people take on more risk than they should, and they know that. But they feel that they have no alternative. But now is the time to just say: "I'm not going for that last 1%. I'm not going to try to play it to the end here". What you should do is to give up a little bit of carry, go up in quality, go up in liquidity and gown down in maturity. Just be safer and wait. There will be some opportunities. But there won't be opportunities if you're already in the risk. So it's a good diversifier to have bonds in your portfolio.

Where do you find such kind of safe, high-quality investments in the bond market?

One the things we are focused on is that increasingly people will look for US high quality bonds because the US is normalizing monetary policy faster than other countries. The US is about the only real bond market in the world. You are not going to get that kind of yield in Japan and you are not going to get much yield in core Europe. So investors should look at their portfolios and be comfortable holding more US high quality bonds than they would normally because they can't get that anywhere else until other countries get further along on the path of normalization.

And what about high yield bonds? How will they react when the Fed is normalizing rates?

It means probably some pressure. We've seen a little more of that in the pasts months and it does worry us a bit. Also, the underwriting standards have declined. You have all sorts of companies issuing at relatively tight spreads which should be sending off alarm bells because this is always sowing the seeds for the next big problem. In addition to that, you've had a record push from retail investors into the high yield space. You've had an explosion of things like ETFs and untested sorts of structures. You've had an explosion in low quality loan issuance which is another warning sign. People buy just tons of bank loans and this market has been getting riskier every day for the past several years. So it won't take much to set off the next bit of high yield spread widening which will spill over. At these yield levels it's not going to take much at all.

So how risky are junk bonds?

There is sort of a mirage of liquidity out there. No one really knows what happens if you get a big shift of a lot of people trying to get out at the same time because we haven't had a major widening in the credit market when we've had so much money in daily liquidity mutual funds and second by second by liquidity in ETFs. But behind the scene there is not that liquidity, we know that. That means that spreads can widen pretty fast and prices can decline a lot faster than people think.

Markets In Turmoil: Bonds Bloodbath, Stocks Slammed, VIX Vertical

For the first time since Dec 20th, The Dow dared to lose investors' money for two days straight.

This is the biggest two-day drop since September 2016.

The culprits...?

And what they said afterwards...

Bear in mind that stocks are still on the path to their best monthly gain in 2 years (and the 15th monthly gain in a row).

The Dow kicked off Tues regular trading session with a gap down that amounted to 241 pts, or 0.91 pct loss on the open. As a percentage of prior day's close, that's the worst opening gap since Sept 11, 2002, when the blue-chip average started with a 0.96 pct loss (Thomson Reuters data).

That said, today's sharp Dow opening slide skewed by one stock, UnitedHealth; UNH responsible for ~100 pts of DJI opening drop, roughly 40% of the decline. The S&P 500 gap-opened today 0.73% lower - the worst initial print since May 17 of last year.

Friday's meltup seems like a long time ago now...

China was ugly overnight again...

Healthcare-related stocks tumbled...

VIX spiked back above 15...

For the first time since August...

It wasn't just Equity risk that is spiking...

And Credit markets started to stir with HY CDX back above 300bps...

Bonds bloodbath'd even more with 10Y at new cycle highs and 30Y ramping up near 3.00%...

30Y up 26bps year-to-date...

Testing key technical levels...

Today was the worst day for bond and equity holders since the Election...

Which along with a spike in vol has crushed Risk Parity fund performance in the last couple of days...

Risk Parity funds are near their deleveraging limits...

Lots of talk about End of Month rebalancing but it appears more like bonds spooked stocks...

The Dollar Index ended the day modestly lower once again despite Mnuchin's best efforts...

As Bloomberg notes, the dollar pared losses after Treasury Secretary Steven Mnuchin reiterated his support for a strong greenback in the long term, while investors awaited U.S. President Donald Trump's first State of the Union address. The Bloomberg dollar index was down ~0.1% after swinging from gains of 0.3% in Asian trading to losses of 0.4% early in the New York morning; the dollar briefly erased its decline after Mnuchin told a Senate committee that he "absolutely" supports a strong dollar and in no way "intended to talk down" the greenback last week in Davos.

Cryptocurrencies took another dive today (on Bitfinex subpoenas) with Bitcoin down 10% and testing back below $10,000...

Commodities were mixed with crude down hard but copper, gold, and silver down very modestly...

WTI/RBOB tumbled today ahead of tonight's API data...

And finally, don't forget, Americans have never been more sure that stocks are going higher...

Greatest Moments In Profit Taking History... You Were Warned

Even in a central bank driven world, some things probably still matter. 

Given the US economy is nearly three quarters premised on consumption; the income, spending, and savings of those consumers probably still matters. Just two of the most important variables shown in the chart below: 

Household net worth (value of all assets held) as a percentage of disposable personal income (all sources of income minus the tax paid on that income). 

Personal savings rate (the amount remaining from disposable personal income, after all expenditures, that is available to be saved in a bank and/or 401k / IRA, etc.). 

The chart below, from 1960 through Q3 of 2017, shows that accelerating significant dives in the personal savings rate have preceded each crash in asset prices.

Below I narrow in from 1985 through Q4 of 2017. The personal savings rate is on the verge of making an all time low while my best estimation for household net worth has asset prices setting new highs versus far slower growing disposable personal income. 

I'm not a money manager, not an economist, I have nothing for you to buy, and give this advice freely...but historically speaking, now is the time to sell.

If the current surge in equities and home prices is maintained through Q1, Q1 2018 data is likely to put the HHNW as a % of DPI north of 700%...while the savings rate moves to an all time low.

No one can say for sure what comes next, but historically speaking, this scenario has been unequivocally bad for asset prices. Bad like the tide receding beyond the horizon before the impending tsunami while you are encouraged by "experts" to go gathering the exposed sea shells. Plus, the magnitude and damage of each "tsunami" has been significantly more severe than the last.

The Date of the “Big Credit-quake”: a lost chance.

The old signposts can no longer be trusted, we noted in Friday's reckoning.

Like Nazi saboteurs redirecting road signs during the Battle of the Bulge, the Fed sent investors off in the wrong direction…

After the crash of 2008, interest rates would have soared.

Marginal companies dependent on low interest rates and cheap credit would have gone the way of all flesh.

The pain of bankruptcy would have been acute… but the pain of bankruptcy would have likely been brief.

From the wreckage of the old a new, healthier economy would have emerged on sounder footings.

But instead of letting markets take the hard but necessary road to Reality…

The Fed twisted the road signs… and pointed investors toward Shangri-La, the mythical land of perpetual boom.

It conjured trillions of dollars in phony money since 2009. And for years kept interest rates nailed to the floor.

Thus did the Fed destroy all honesty in markets, all price discovery.

As we claimed:

"The old road signs that used to point south… now point north. Or east. Or west. No one really knows."

The Fed has taken markets so far down the false road, Shangri-La now hovers into view…

Stocks are "melting up."

The Dow went from 24,000 to 25,000 in record time.

It required even less time to pass from 25,000 to 26,000.

Meantime, the market hasn't suffered a 5% drop in some 400 trading days — another record.

Retail investors are now rushing into stocks at a gait unseen since just prior to the 2008 wreck.

But will they soon discover they're chasing a central bank-spun fantasy?

The Fed has begun to "normalize" interest rates.

And it's begun cutting into its $4.5 trillion balance sheet — if only slightly.

The European Central Bank has also pledged to withdraw stimulus.

Yet records continuing falling by the day.

How?

We suggested recently that large asset purchases by the People's Bank of China may be the hidden source of credit fueling the "melt-up."

So has Z.H.:

This "intervention"... which has seen retail investors unleashed across stock markets, buying at a pace not seen since just before both the 1987 and 2008 crashes, helps explain why stocks have — for now — de-correlated from central bank balance sheets.

But analysts at Citi have spotted a pothole on the road to paradise…

Despite China's recent spree, the decline in central bank assets is beginning to tell in the credit markets...

Longer-term interest rates are beginning to rise.

The yield on the bellwether 10-year U.S. Treasury, for example, has risen to 2.7% — its highest rate since 2014.

As bond yields rise, bond prices fall (as a seesaw, they move in opposite directions).

High-yield bonds are especially sensitive to rate changes.

And the "smart money" is now rushing out of these high-yield bonds.

Z.H.:

Positioning among institutional investors has turned markedly more bearish recently… There has been a surprisingly sharp and persistent outflow from U.S. high-yield funds in recent weeks… it is becoming increasingly apparent that a big credit-quake is imminent, and Wall Street is already positioning to take advantage of it when it hits.

If true, Shangri-La may soon be proven as illusory as ignis fatuus — swamp fire.

Given today's hyper-connected markets, a quake in the bond market could reverberate throughout the stock market.

But when does Citi expect the "big credit-quake" to strike?

And what awaits the stock market once it does?

Z.H.:

If the Citi [market timing indicator] is accurate, and historically it has been, it would imply that by mid-2019, equities are facing a nearly 50% drop to keep up with central bank asset shrinkage.

Stocks could plummet 50% by mid-2019?

We've maintained that current melt-up could potentially last two years, based on previous episodes.

Citi's analysis — if true — knocks six months off it.

But stocks could still race toward Shangri-La for the next year and a half.

The stock market nearly doubled in the 18 months prior to the Crash of '29, for example.

And the Nasdaq soared 200% over the 18 months before its 2000 high.

It could therefore be a very lucrative year and half for investors.

But then, just when it appears Shangri-La is upon us… we fear the mirage will vanish into the vapory mists.

And disoriented investors will have to find the long, hard road back to Reality.

How Long Before The Bond Selloff Slams Stocks? Wall Street Answers

Back in November 2016, when bond yields were surging in the aftermath of Donald Trump's election, Goldman, together with SocGen, JPM, RBC and various other banks, answered the question that has once again become especially relevant: how high can 10Y bond yields go before they start to hurt equities?

Over a year ago, Goldman answered that "the equity market is still at a level that can cope with moderately rising bond yields. We estimate that a rise in US bond yields above 2.75% or probably between 0.75-1% in Germany would create a more serious problem for equity markets: at that point we would expect the correlation between bonds and equities to be more positive - i.e., any further rises in yields from there would be a negative for stock returns."

2.75% is also the level above which JPM's head quant Marko Kolanovic said the 10 Year would begin to cause problems for stocks: "should bond yields continue increasing (e.g. 10Y beyond 2.75%) this will risk an equity sell-off that usually triggers a broader deleveraging of var-based strategies."

More recently, Jeff Gundlach warned that "if the 10Year goes to 2.63%, stocks will be negative impacted." As of this morning, the 10Y yield rose as high as 2.7216% - a level not seen since early 2014 - before fading some of latest surge.

So fast forward to today when overnight SocGen's strategist Kit Juckes rekindles the conversation of how long before the bond selloff morphs into an equity selloff - one which both Bank of America and now Goldman expect will hit over the next three months - by comparing equity investors to frogs who are about to be caught in boiling water.

"The frog analogy (it doesn't realise it's getting boiled until it's too late to escape) is likely to be popular in 2018" - Socgen

In his note "How long before the bond sell-off heats up markets?", Juckes points out he may "as well get an early vote in for 'boiling frogs in rising yields' as the next market theme." Still, contrary to November 2016, the Socgen strategist doesn't see a critical resistance level beyond which stocks tumble, at least not yet.

A slow-motion rise in bond yields is not, yet, threatening risk sentiment in equities, credit or EM. As long as it doesn't, yields can rise on a tide of decent economic data and expectations of higher inflation thanks in no small part to rising oil prices. The frog analogy (it doesn't realise it's getting boiled until it's too late to escape) is likely to be popular in 2018. For now, we're basking in synchronised growth and thinking happy thoughts......

Those thoughts may be far less happy if the market takes a long, hard look at the crashing US savings rate and realizes its broad, deflationary implications for the broader economy, and the fact that the recent, GDP -boosting spending surge is coming to an abrupt end.

And while we were disappointed by Juckes' lack of a concrete target for a level in the 10-Year which would slam stocks, conveniently his employer put out a table back in November 2016 which answered the question on everyone's lips: when will bond yields start to hurt equities. Or, as SocGen would say: "we are already there."

Treasury Yields Are Blowing Out, Slowing Dollar Plunge

The recent frantic moves in Treasurys and the dollar continued on Monday as we enter what is set to be a juggernaut of a "rollercoaster week", and while the dollar collapse seems to have slowed for now, this is as a result of an acceleration in the Treasury selloff, with 10Y yields blowing out to 2.72% for the first time since early 2014, and now deep into what Jeff Gundlach called the "danger zone" for equities.

The TSY weakness is also hitting German Bunds, where the 10Y yield rose to 0.682%, the highest since 2015 and rapidly threatening another VaR shock should the selloff accelerate from here.

Also of notable: the German 5-year bond yield rose as much as 4bps from the open to turn positive for the first time since Dec. 2015, rising as high as 0.012% after ECB Governing Council member Klaas Knot over the weekend said there isn't a single reason to continue with the QE program.

For once, the Greenback is a broad winner, if very modestly, as high/rising US Treasury yields, now at levels last seen in early 2014, are finally offering the USD some support after 7 weeks of losses, while month-end rebalancing is also prompting short covering given buy signals and latest weekly CTFC spec positioning showing another increase in shorts. The DXY looks firmer above the 89.000 level, but really needs to extend recovery gains beyond 89.500 for a more sustained retracement and to prevent bears from further attacks on key supports below 88.500.

"The higher Treasury 10-year yield is spurring dollar-buying," said Ko Haruki, head of the financial solutions group at CIBC World Markets (Japan) in Tokyo. "The dollar is consolidating with major currencies failing to break Thursday's highs."

Meanwhile, the yen fell after Kuroda's comments on stronger inflation. GBP/USD slid as much as 0.5% to 1.4094 amid media reports that the Conservatives are poised to trigger a vote of no confidence in U.K. PM May.

The Swiss franc fell versus all G-10 peers amid speculation of possible Swiss National Bank intervention first spurred leveraged buying of USD/CHF, before sellers responded and pulled the pair back down; SNB declined to comment on the matter.

The euro weakened as German bonds retreated for a fourth day, while the Stoxx Europe 600 Index turned lower after benchmarks were mixed in the Asian session.

After trading mixed early in the session, European tech stocks retraced much of their earlier gains on Monday, as traders cited the previously noted report that Apple has cut production as much as 50% for the iPhone X. Nikkei Asian Review says Apple has alerted suppliers it has cut its production target for the flagship phone to 20 million units in Q1, from a previous estimate of 40 million envisaged in November. Apple suppliers Dialog Semiconductor DLGS.DE, STMicroelectronics STM.BN, Infineon IFXGn.DE, IQE IQE.L and AMS AMS.S all fade gains shortly after the report, though all five stocks remain up on the day after AMS reported results well ahead of expectations

In terms of sector specifics, material names outperform following price action in the metals complex with Rio Tinto, Anglo American, Glencore, Antofagasta and BHP all near the top of the FSTE 100. Elsewhere, focus has also been on the IT sector with AMS (+20%) and Wirecard (+1.7%) soaring in the wake of earnings. Other notable equity specific newsflow includes Sanofi acquiring Ablynx (+3.5%) for EUR 3.9bln and a double upgrade at BAML for Volkswagen (+1.5%) with BAML commenting on whether the Co. could be a potential break-up candidate.

Earlier, Asia-Pac bourses traded mixed: the ASX 200 (+0.4%) and Nikkei 225 (Unch.) opened positive with Australia buoyed by M&A activity including AWE shares which rose 16% on reports of a bid from Mitsui & Co., while Japan stocks were less decisive with price action dictated by currency moves and the stronger yen killed early upside equity momentum.

Notably, Chinese stocks slumped the most in 2 months as large caps retreated. Equities in Hong Kong also fell, while the big-cap CSI 300 Index loses 2% as of 2:49pm local time. Shanghai Composite Index closed down 1.3% while the Shenzhen Composite Index fell -1.7%. Some Chinese investors are closing their books before Chinese New Year, which means inflows to the stock markets will slow, said Frank Lee, acting chief investment officer for North Asia at DBS Bank (HK) Ltd.

Elsewhere, U.S. oil fell, though it's at about its strongest level in five months relative to Brent as a weaker dollar and falling stockpiles boosted the American marker. Metals advanced amid optimism over global growth and the impact of the softer greenback, with zinc soaring to the highest level in more than a decade.

Bitcoin climbed, holding its value above $11,000 even after a heist of nearly $500 million in a different digital token spurred calls for more cryptocurrency regulation

Janet Yellen's final policy meeting as Federal Reserve chair will be the main focus of investor attention in what's shaping up to be another active week for markets still finding their feet after the recent dollar selloff. There's a string of fresh economic data due, as well as a State of the Union address from President Donald Trump and earnings releases from the world's biggest tech companies.

Bulletin Headline Summary from RanSquawk 

The USD regains some ground against its major counterparts as US 10yr yields break above 2.7% 

European equities have kicked the week off with little in the way of sustained direction 

Looking ahead, highlights include US personal consumption and PCE data, NZ trade, ECB's Coeure 

Market Snapshot 

S&P 500 futures down 0.3% to 2,868.75 

STOXX Europe 600 down 0.01% to 400.53 

MSCI Asia Pacific down 0.08% to 187.07 

MSCI Asia Pacific ex Japan up 0.02% to 613.88 

Nikkei down 0.01% to 23,629.34 

Topix up 0.06% to 1,880.45 

Hang Seng Index down 0.6% to 32,966.89 

Shanghai Composite down 1% to 3,523.00 

Sensex up 0.8% to 36,332.10 

Australia S&P/ASX 200 up 0.4% to 6,075.41 

Kospi up 0.9% to 2,598.19 

German 10Y yield rose 5.1 bps to 0.682% 

Euro down 0.2% to $1.2406 

Italian 10Y yield rose 4.3 bps to 1.738% 

Spanish 10Y yield fell 0.7 bps to 1.402% 

Brent futures down 0.6% to $70.11/bbl 

Gold spot down 0.1% to $1,348.48 

U.S. Dollar Index up 0.2% to 89.23 

Top Overnight News 

Donald Trump's presidency would "end" if he followed through on efforts to fire Robert Mueller, the special counsel leading the investigation into Russian interference in the 2016 U.S. election, said Senator Lindsey Graham 

Trump's Infrastructure Plan Hits Early Roadblock Over Funding 

Massive Cryptocurrency Heist Spurs Calls for More Regulation 

The European Central Bank has to end its quantitative easing as soon as possible, according to ECB Governing Council member Klaas Knot, who said there's not a single reason anymore to continue with the program 

Sanofi Leapfrogs Novo With $4.8 Billion Cash Bid for Ablynx 

U.S. Is Said to Consider Building 5G Network Amid China Concerns 

The bumpy journey toward Brexit reaches another fork in the road this week as the upper chamber of the British parliament plans to rewrite a key piece of Prime Minister Theresa May's legislation 

Billionaire Singh Brothers Accused in Suit of Siphoning Cash 

Germany's Social Democratic leader said he needs concessions from Chancellor Angela Merkel to sell party members on staying in her government 

Noble Group Said to Reach In-Principle Deal to Restructure Debt 

Ingvar Kamprad, Ikea's Swedish Billionaire Founder, Dies at 91 

Brexit Woes Mount for May, Fox Says 'Foolish' to Challenge Her 

Europe Closes In on Fresh Trade Deal as Trump Puts Up Barriers 

Sentiment among London's Brexit-hit bankers sank to its gloomiest depths since the 2008 financial crisis, a survey showed - a stark contrast to the bullish tone of finance executives gathered last week in Davos, Switzerland 

Japan's Vice Minister for International Affairs and currency chief Masatsugu Asakawa says officials are watching foreign-exchange markets closely as volatility has increased 

Asia-Pac bourses traded somewhat mixed, as the region failed to maintain the early broad momentum from last Friday's gains on Wall St. where sentiment was underpinned by earnings and in which all major indices closed at their all-time highs. ASX 200 (+0.4%) and Nikkei 225 (Unch.) opened positive with Australia buoyed by M&A activity including AWE shares which rose 16% on reports of a bid from Mitsui & Co., while Japan stocks were less decisive with price action dictated by currency moves. Both the Hang Seng (-0.6%) and Shanghai Comp. (-1.0%) initially conformed to the gains in which the former continued to post fresh record levels, although the tone later deteriorated amid increases in money market rates after the PBoC skipped open market operations, coupled with underperformance in Shenzhen where Leshi fell limit down for a 4th consecutive day. In addition, Wynn Macau was a notable underperformer in Hong Kong and slumped around 5% due to allegations of sexual misconduct by Wynn Resorts Chairman, CEO and founder Steve Wynn. Finally, 10yr JGBs are mildly lower as prices fell amid an initial positive risk tone in the region and alongside spill-over selling from their US counterparts, while the BoJ's Rinban operation was relatively light with the central bank in the market for only JPY 435bln of JGBs. PBoC skipped open market operations for a net daily drain of CNY 140bln.

Top Asian News

• Moody's Cautions Vietnam Against Further Monetary Easing

• Fitch Sells Stake in China Rating Firm Amid Market Opening

• Alibaba, Foxconn Invest $350 Million in Chinese Car Startup

• India Does Not Rule Out Fiscal Consolidation Pause This Year

• China H Share Euphoria Enters New Stage as Laggards Surge

European equities have kicked the week off with little in the way of sustained direction (Eurostoxx 50 flat) after a relatively mixed session during Asia-Pac trade. In terms of sector specifics, material names outperform following price action in the metals complex with Rio Tinto, Anglo American, Glencore, Antofagasta and BHP all near the top of the FSTE 100. Elsewhere, focus has also been on the IT sector with AMS (+20%) and Wirecard (+1.7%) soaring in the wake of earnings. Other notable equity specific newsflow includes Sanofi acquiring Ablynx (+3.5%) for EUR 3.9bln and a double upgrade at BAML for Volkswagen (+1.5%) with BAML commenting on whether the Co. could be a potential break-up candidate.

Top European News 

Offshore Cash Spike Rattles World's Biggest Covered-Bond Market 

Le Pen's National Front Slips in First Votes of the Macron Era 

In currencies, the Greenback is a broad winner (for once), as high/rising US Treasury yields are finally offering the USD some support, while month end rebalancing could also prompt short covering given buy signals and latest weekly CTFC spec positioning showing another increase in shorts. The DXY looks firmer above the 89.000 level, but really needs to extend recovery gains beyond 89.500 for a more sustained retracement and to prevent bears from further attacks on key supports below 88.500. 

USD/JPY has bounced off 108.50 again, but remains top heavy around 109.00 amidst offers at the big figure and a fib just above (109.07). 

EUR/USD is straddling 1.2400, but firmly supported above a 1.2344 Fib and via hawkish comments from ECB's Knot, while Cable has retreated sharply from post-Brexit vote highs (1.4345) to 1.4100 or a few pips under amidst more UK political and EU divorce agreement uncertainty. 

USD/CAD is back up near 1.2350 after mixed NAFTA noises as some reports suggest progress and others big sticking points. 

USD/CHF around the middle of a 0.9335-0.9385 range with the SNB declining comment on any intervention 

AUD/USD and NZD/USD have both backed off from recent 0.8100+ and 0.7400+ peaks on the back of softer metals/commodity prices and cross currency flows (clear rebound over 1.1000 in AUD/NZD). 

Very busy week ahead, with US President Trump's State of the Union address, January's FOMC meeting and the first NFP release of 2018.

In the commodities complex, WTI crude futures marginally extended above the USD 66.00/bbl level while Brent remains above USD 70bbl. Notable energy newsflow has included comments from the Iranian oil minister who stated that output declined in some oil fields due to lack of resources and added that Iran will seek lower production in coming years if it cannot be fixed. In metals markets, gold trades modestly lower as prices are hampered by the reprieve seen thus far for the USD. Elsewhere, focus has been on Zinc with prices surging to their highest levels in over 10 years amid speculation of contracting global supply. Iranian Oil Minister Zanganeh stated that output declined in some oil fields due to lack of resources and added that Iran will seek lower production in coming years if it cannot be fixed. JP Morgan raised their 2018 WTI forecast by USD 10.70/bbl to USD 65.63/bbl, and Brent forecast by USD 10/bbl to USD 70/bbl citing OPEC's efforts to rebalance the market.

Kicking the week off the big focus today should be in the US with the December PCE core and deflator data due, alongside the personal income and spending data. Also due to be released is the Dallas Fed manufacturing activity index for January while late in the evening we'll get the December jobless and retail sales data in Japan. Away from this, China's NPC Standing Committee is due to kick off a two-day meeting in Beijing in which it's expected that a revision to the constitution will be discussed. EU ministers will also meet in Brussels where they may decide on a new set of directives for Brexit negotiations. Elsewhere, the sixth round of NAFA talks are expected to conclude in Montreal and the ECB's Coeure and Lautenschlaeger will also speak.

US Event Calendar 

8:30am: Personal Income, est. 0.3%, prior 0.3% 

8:30am: Personal Spending, est. 0.4%, prior 0.6%; Real Personal Spending, est. 0.4%, prior 0.4% 

8:30am: PCE Deflator MoM, est. 0.1%, prior 0.2%; YoY, est. 1.7%, prior 1.8% 

8:30am: PCE Core MoM, est. 0.2%, prior 0.1%; PCE Core YoY, est. 1.5%, prior 1.5% 

10:30am: Dallas Fed Manf. Activity, est. 25.4, prior 29.7 

DB's Jim Reid concludes the overnight wrap

It's a potentially electrifying week ahead with a number of the big rolling themes at the moment having fresh data points for us all to pore over. It's fair to say that inflation is absolute key to macro at the moment and therefore the most watched print of the week will likely be average hourly earnings in Friday's payroll report. With regards to inflation and wages we also have the US PCE core and the deflator readings today, the US ECI index on Wednesday, the flash January CPI report for the Euro area also on Wednesday with country level reports out in Germany (Tuesday) and France (Wednesday) and US unit labour costs and productivity on Thursday.

In today's pdf we copy a chart from DB's Marcus Heider's inflation weekly from Friday night where he showed that periods of US$ weakness have typically been associated with higher inflation in developed markets over the past twenty years. He also discusses how Oil prices have benefited from news of another (counter-seasonal) weekly decline in US crude inventories and that recent news imply upside risks to oil price forecasts.

Regular readers will know we think that a number of variables are stacking up at the moment towards higher inflation and a combination of these two factors above potentially adds to the story.

Outside of inflation and labour costs, Friday's payroll report will be a focus (consensus 180k, DB at 210k) as will tomorrow's first State of the Union address by Mr Trump. It's not entirely clear yet what he will talk about but expect the recently passed Republican tax reform bill, trade, the state of the US economy and markets, infrastructure proposals and immigration to all potentially play a part. We also have the latest Fed meeting on Wednesday which Mrs Yellen will chair for the last time with Jerome Powell taking over next week. This meeting could be a bit of a non-event with the next rate hike pencilled in for the March meeting (market pricing currently around 95%). DB continue to expect four rate hikes in 2018 (one above that implied by the Fed dot plots). Away from this, Thursday will be a busy day for manufacturing sector data with the final global PMIs due along with the ISM manufacturing in the US. Finally, earnings season will really ramp up this week with 120 S&P 500 companies due to report, including the turn of some of the big tech heavy hitters including Facebook, Microsoft and eBay on Wednesday, and Alphabet, Amazon and Apple on Thursday. Pfizer, McDonald's (both Tuesday), AT&T, Boeing (both Wednesday), Shell, Alibaba (both Thursday), ExxonMobil and Chevron (both Friday) are amongst other notable companies scheduled to release results. The full week ahead is published at the end.

The week is off to a mixed start in Asia, with the Kospi 0.74% up, the Nikkei is broadly flat while the Hang Seng (-0.16%) and China's CSI 300 (-1.05%) are down as we type. The YEN jumped 0.76% back on Friday after Governor Kuroda noted that on inflation "…I think we're finally close to the target", but over the weekend, the BOJ clarified the Governor did not revise the inflation outlook and his view is in fact no different to the bank's Outlook for Economy Activities that was released earlier last week. This morning, the YEN is c0.2% weaker. Elsewhere, Bloomberg reported that hackers have stolen $500m of digital tokens from Japanese crytocurrency exchange Coincoin Inc. back on Friday.

In other news over the weekend, the ECB's Knot noted QE should end as soon as possible as "the program has done what could realistically be expected of it" and there is not a single reason to continue with it. Further, he added there there's enough proof for the ECB to end the program, which is also the current sentiment in the governing council.

Ahead of tomorrow's state of the union address, Friday's Davos speech by Mr Trump gave us some clues as to his current mood. Initially he noted the US would "no longer turn a blind eye" to what he described as unfair trade practices and will "enforce our trade laws and restore integrity to the trading system". That said, his other remarks seemed a bit less protectionist. He noted the US is "open for business" and that "now is the best time to bring your money....jobs…businesses to America". Further, he noted that he would always promote "America First", but he added "America first does not mean America alone. When the US grows so does the world". Elsewhere, he said "I may terminate NAFTA, I may not". So lots bubbling along until his big speech.

Now recapping other markets performance from Friday. US equities rose to fresh highs following strong corporate results, including Intel (shares +11%) and Abbvie (+14%). The S&P (+1.18%), Dow (+0.85%) and Nasdaq (+1.28%) were all higher as all sectors within the S&P advanced. European markets were all higher too, with key bourses up 0.3%-0.7% (DAX +0.31%; Stoxx 600 +0.50%; FTSE +0.65%). The VIX fell for the first time in four days to 11.08 (-4.3%).

Over in government bonds, core 10y bond yields were 2-4bp higher with UST up 4.3bp to a fresh 3.5 year high (2.661%), while Bunds and Gilts rose 1.7bp and 3.2bp respectively. In currencies, the US dollar index extended its three year low (-0.36%), while the Euro and Sterling gained 0.25% and 0.13% respectively. WTI oil strengthened further, up 0.96% to $66.14/bbl (+4.5% for the week). Elsewhere, precious metals were slightly higher (Gold +0.06%; Silver +0.63%) and other base metals were mixed but little changed (Copper -0.60%; Aluminium -0.24%; Zinc +0.29%).

Away from the markets and onto some of the Brexit headlines. In Davos, President Trump said he would have taken a "different attitude" to Brexit talks and that "….I'd have taken a tougher stand in getting out". Back home, the UK opposition Labour Party leader Corbyn reiterated "we're not asking for a second referendum" on Brexit and that the UK should have a regulatory environment that is "commensurate with the EU, but must also have power to influence EU rules after Brexit. Elsewhere, a Guardian/ICM poll showed 47% of respondents would favour another referendum once the terms of UK's departure are clear. If excluding those without a view, 58% of respondents would support a second vote on Brexit. There is also lots of press (incl. Bloomberg) here in the U.K. suggesting that PM May is under increasing pressure within her party to exercise control with rival factions repeatedly speaking out with competing Brexit visions. A vote of no confidence and leadership battle is increasingly being discussed, as per Bloomberg.

Over in Germany, Ms Merkel seemed a bit more open to compromise in order to further progress in the coalition talks with the SPD. The CDU state premier KrampKarrenbauer noted that "our scope (to negotiate with the SPD) is very narrow", but Ms Merkel noted the preliminary agreement with the SPD is an "outline", which suggests some room for negotiations in order to finalise talks by 4th February.

We wrap up with other data releases from Friday. In the US, the 4Q GDP was below consensus at 2.6% annualised (vs. 3%).Our US economists noted that despite strength in consumer spending, growth in the quarter was impacted by an outsized increase in imports and materially less inventory accumulation than expected. Net exports subtracted -113bp from headline growth while inventories were an additional -67bp drag. They expect the latter will likely reverse, hence they have raised their Q1 real GDP growth forecast to 3.1% (from 2.3% previously).

The 4Q core PCE was in line at 1.9% qoq while personal consumption was slightly above market at 3.8% (vs. 3.7% expected). The December durable goods orders (ex-transportation) was in line at 0.6% mom but the prior month was upwardly revised by 0.4ppt, while core capital goods beat at 0.6% mom (vs. 0.4% expected). Finally, the December advance goods trade balance deficit widened to -$71.6bln (vs. -$68.9bln) and wholesale inventories grew 0.2% mom (vs. 0.4% expected). In the UK, 4Q GDP was above market at 0.5% qoq (vs. 0.4%) and 1.5% yoy (vs. 1.4%). Elsewhere, France's January consumer confidence was slightly below expectations 104 (vs. 106) but manufacturing confidence was above at 113 (vs. 112 expected), which is back to November levels that was a c11 year high.

What to look out for on Monday: Kicking the week off the big focus today should be in the US with the December PCE core and deflator data due, alongside the personal income and spending data. Also due to be released is the Dallas Fed manufacturing activity index for January while late in the evening we'll get the December jobless and retail sales data in Japan. Away from this, China's NPC Standing Committee is due to kick off a two-day meeting in Beijing in which it's expected that a revision to the constitution will be discussed. EU ministers will also meet in Brussels where they may decide on a new set of directives for Brexit negotiations. Elsewhere, the sixth round of NAFA talks are expected to conclude in Montreal and the ECB's Coeure and Lautenschlaeger will also speak.