A new Deutsche Bank prime brokerage study suggests some unusual negative catalysts that have been moving markets, while hedge fund asset flows are considered. The report considered both the implications of Argentina and a recent Spanish bank failure along with the withdrawal of US Fed stimulus on the market, and it didn’t paint a pretty picture.
Fed Stimulus: Currency spreads have widened
The study, published in the bank’s monthly global hedge fund trends publication, points to Argentina and the unwinding of the Banco Espirito Santo SA (ELI:BES), as cause for insider concern. The insight is these two events seemingly isolated events have caused certain currency spreads to have widened, pointing to a larger issue in the debt market.
One of the report’s more tame primary conclusions was that asset flows correlate with performance, which might not come as much of a surprise to those involved in marketing hedge funds to both institutional and retail investors as, oddly, both groups can be performance chasers.
But that wasn’t the headline to this observer, as the real insight came in choosing the performance drivers of the divergence in the spread between the Euro currency and high yield debt in that region. The spread widening had a few performance drivers that included an elite member of the European ruling class associated in fraud case and a Latin American country, Argentina, going rogue and defying the western-dominated financial system.
Fed stimulus reduction and SWAPs interconnected
Of course this blunt talk was not that of the establishment-backed Deutsche Bank. After all, noting the behind the scenes maneuvers that impact the hedge fund trader is what interpretation is all about. Never speak bluntly, always allow for the real story to be interpreted between the lines without giving away the core concepts that underlie the issue is typically the general mantra in financial services. If the issues were simple to decode it tends to erode profit margins, as is the case in the big bank SWAPs derivatives that are currently a time bomb waiting to implode the world economy.
Although the reduction of Fed stimulus and the big bank SWAPs could be interconnected, I digress.
Decoding the Deutsche Bank report, Banco Espirito Santo and Argentine’s default were noted to weigh on market sentiment, which was particularly true in the EUR / HY currency / debt spread. Documenting these key points as “geopolitical concerns,” the report said the differential between the European currency and that of the corresponding high yield bonds.
What the article, “European HY Strategy: A focus on Flows,” didn’t say was that with European interest rates at never before witnessed levels – risk in a Spanish ten year government note, for instance is priced lower than that of the US ten year note. This has been an inside topic of concern for bond traders, one that is generally glossed over in mainstream reports – often the sign of an important story underneath.
After tackling the relative value disparity between European debt and currency, the report moved into another fascinating area. In exploring the relative value in the rise and fall in value between the S&P 500 and the Fed’s balance sheet delivered particularly interesting insight.
Fed stimulus correlation with the stock market
As QE rose, the stock market correlation was uncanny. Now as QE is projected to flatten, and ultimately turn lower, the asset bubble that is the US stock market might find difficulty in the reduction that is the drug of artificial Fed stimulus. The published report didn’t show the projection of the market when Fed stimulus just didn’t flat-line, but started to turn negative.
The report did review the US Federal Reserve balance sheet relative to the S&P 500 (INDEXSP:.INX). Such analysis of quantitative easing, done in an “on the record” publication commonly reviewed, is unusual. The report speculated that times could become more challenging for the market as quantitative easing is unwound, an inside topic of discussion that is now increasingly making its way into the on the record level.