The 10, 5 and 2 year yields in the US are aligned in a risk ‘ON’ way and the market is showing no sign of stress from the Iraq situation. That is good, in that Iraq is not screwing things up. Also good is that gold is down today as the yield spreads indicate it would be (again, if one day can be taken in a vacuum). Again, Iraq seems to be out of the picture today.
I’ve also included the Spanish 10 year vs. the German 30, which is a sort of junk/quality spread to apply to Europe. It indicates they are feeling a little risk averse over there in Europe today.
An inherent level of systemic risk? Most people intuitively feel Karl Popper’s observation that: “In an economic system, if the goal of the authorities is to reduce some particular risks, then the sum of all these suppressed risks will reappear one day through a massive increase in the systemic risk and this will happen because the future is unknowable”. In other words, suppress risk somewhere and it comes back with a vengeance to bite you on the derriere at some later date. Look at 2008 as an example: we cut up credit-issuing risk into tiny parcels and distributed it across the system through securitization, only to see the banks take on a lot more leverage and ultimately sink their balance sheets on instruments they failed to understand. Hyman Minsky summed up this inherent contradiction well when he stated that “stability breeds instability”. In other words, the more stable a thing is, the temptation rises to pile on leverage, which makes that “something” more unstable on the back end.
This is the whole point, that it is permissive policy that instigates bad financial behavior (encourages ever riskier speculative activity), not that the policy itself is the culprit where the inevitable unwinding (the bust side of the boom-bust equation) of speculation is concerned.
The notion of Anti-Fragile: the above brings us to the Nassim Taleb notion of “anti-fragile”: just as a parent who overly cocoons a child prepares that offspring poorly to function in the wider world, so policy-makers intent on cushioning the private sector from every shock in the economic cycle are doing the overall system a massive disservice. By preventing the build-up of immunity, or the ability to thrive in crises (i.e., anti-fragility), policymakers sow the seed for a greater crisis down the road (hence the repeated cycle of crises).
Safe in Daddy’s arms since 2008 and now coddled and nurtured by Mommy. There are supposedly serious commentators out there loudly lauding the idea that Ben Bernanke saved the financial system. Well, he and now she are doing it again. But the root elements are the same as what Greenspan did early last decade. They have simply offloaded risk from speculators to a bond market (in this case Treasuries vs. various commercial credit vehicles in the last cycle). Either way, the goal is risk ‘ON’ (and it is).
Lay the blame on zero interest-rate policy (ZIRP): following on the above, not only does ZIRP allow the survival of zombie companies (which drags down the returns for everyone) but it most certainly affects investors’ behavior. Firstly, by encouraging banks to play the yield curve and buy long bonds, rather than go out and lend. Secondly, because almost all investors hold part of their assets in equities and part in cash or fixed incomes. And in a world in which fixed income instruments yield close to nothing, the tolerance for pain in other asset classes probably diminishes all the more.
In other words, get out of savings and into assets. But when the inevitable corrections come in asset markets there is little income to be found in fixed income. If Grandma gets chewed up and spit out in the process? So be it I guess.
With all the ‘taper’ and now, compliments of Janet Yellen’s rambling jawbone, rate hike hysterics, the 30 year ‘long bond’ has held its ground. It could drop a little here and possibly form a bottoming pattern (right side shoulder), but the big picture view does not yet indicate we are in for a hard phase of rising long term interest rates.
Of course the situation is more complex for gold bugs, because it is the relationship between long and short term bond yields that they should be focused on (instead of Crimea and the whacky ‘China demand drop’ stuff).
As the big, hype filled shadow of next week’s FOMC meeting looms over markets, we calmly review the ‘Continuum’ and note that if there is going to be a bond market reversal, the time is now. I look forward to moving beyond this infantile and cartoonish ‘will they or won’t they taper?’ drama.
The Continuum is at a point where it has reversed every damned time previously. If it does so again, the trends that have been in place for the duration of the Long Bond’s bottoming process and upturn are likely to reverse as well. So, will another red arrow be inserted above?
This chart was shown last week, noting the resistance that a then fledgling bounce would run into before it could be declared a rally. Today’s ‘jobs’ report put a definitive break above resistance and the 50 day moving averages in play.
Cue Huey, Dooey and Louie in the media this weekend or next week. ‘Taper’ blah blah blah. Rising interest rates are not a friend of the Fed since the Fed’s current operation is to try to keep them contained. It could be argued that the operation needs some bad economic news or worse, something to fall apart out there in the financial system. Otherwise the Fed would be forced to stand aside or look really silly holding ZIRP and merely tapering their bond purchases in the face of rising interest rates.
Please Ben… Please Janet… just declare that due to the stellar economic performance first seen in ISM and manufacturing in general, and now jobs… that your job is done. Stand aside and let the natural markets take over. Pretty please? Everything’s going great. Let’s let Grandma and my kids get a little return with their savings accounts at the local bank! Thank you Dear Monetary Leaders. Thank you so much.
Well for one thing, gold has often experienced strength during periods when long-term yields have risen. The yellow bars on the 2 lower panels of the chart below show that. Yet on this cycle, gold has gone down as long-term yields have risen.
It appears to be time to not be on the RATES ARE RISING!!! hysteria. Of course, this time may be different. But the risk vs. reward on the rising rates view is out the window now. Here’s the big picture on the 30-year again…
Boy this is a macro market newsletter that dug and dug until it came up with a lot of possibilities for various markets going into Q4 and beyond. It also highlighted something significant going on in T bond yields that I don’t think is being considered by most people.
This as 10-year yields have just about hit the 3% target we established back in May in NFTRH 239. The 30-year is closing in on its target of 4.2%. But there is something going on in yield relationships that I really need to think more about and get on top of. Anyway, even the little promo blurb for this letter is getting too involved.
Got to love the markets; never an easy answer nor a dull moment. NFTRH 255 out now.
Once again we present the Treasury ‘TICs’ data for China and Japan, most recently available through June. It can be argued that these two countries are the T bond market, when considering the volume in which they deal and their strategic status as heretofore T bond consumers.
And now our long-running and most important macro chart, the ‘Continuum’ in long-term T bond yields; a monthly view of the 30 year yield and its ‘limiter’ AKA the 100 month exponential moving average (red line).
We note that China and Japan had started net selling of T bonds in June just as a ‘would-be’ bottoming pattern became an actual bottoming pattern with a breakout through the neckline. The 3 post-breakout months shown on the chart have featured a heavy rotation of Huey, Dooey and Louie in the media jawboning ‘QE Taper’ ever since.
This all started after June, and as the TYX was bottoming, so can we please stop the cartoonish talk about decisions the Fed may or may not decide to make? The chart above told our heroes that it is time to talk ‘Taper’ and that is what they are doing, despite the backdrop of seemingly non-existent inflation; non-existent that is unless you count the already embedded inflation effects of the past (charts courtesy of SlopeCharts).
What we actually have is inflation working overtime, but fortuitously manifesting in the ‘right’ assets rising in response this time around. Once again, here is the S&P 500 doing what it was supposed to do and making heroes of policy makers as it rises in lockstep with the expanding Monetary BASE.
We again take this opportunity to note that the S&P 500 is not out of line valuation-wise, with the previous cyclical bull market. In fact, it has not yet reached the valuation per Corporate Profits that it did in the previous cycle. But then, these data points are only valid to people who consider inflation a valid tool to be used in effectively managing an economy.
Government debt (T bonds) has been used to manipulate and engineer the economy. Corporate profits have responded as T bonds were bought and monetized.
But when we review the TICs data and the nearly 4 month trend in T bond yields, we are left with the question of whether or not an ‘organic’ economy and a healthy stock market are in play or something utterly dependent on more debt and more inflation.
Bulls who are confident in the market’s origins and in line with heroic and very capable policy makers should be buying the current correction. I assume they are backing up the bravado with action and buying this “new secular bull market” opportunity.
Bears who are confident that the macro market’s books have been cooked should realize that these things do not just unwind the moment a few people begin to cotton on to the idea that manipulation never works in a sustainable or healthy way but rather, they should keep an eye on the 30 year yield and its EMA 100 ‘line in the sand’ as we have called it in the past at important macro turns.
That chart is a road map. We are going to a yield limit and it is due to bond market supply and demand dynamics. It can be argued that the Fed is in a box and needs a broad market liquidation in order to quiet down the signals.
The United States benefited from a labor arbitrage and a steadily rising bond market last decade right through 2012. This was in large part compliments of China’s desire to build out its economy and use the chronic debtors in the US (consumer nation) to do it.
The EMA 100 has limited the yield at every point over the last few decades. The degree to which global markets have been tampered with over the last 2 years calls into question whether or not the yield will finally breakout this time. If it breaks out, the US will likely see its ‘organic’ recovery go right down the tubes. If the yield is once again repelled, we will likely see a rush to T bonds amid a flight to ‘safety’ and an asset market liquidation. That could fuel a future leg to the current cyclical bull. Could, not ‘would’.
Big events have tended to happen at and around the EMA 100. The most recent example featured mobs with pitchforks calling for the head of “Helicopter Ben” and Bond King Bill Gross poking him in the eye with a big bet on inflation by shorting T bonds in 2011. That was a big turn from the secondary inflation hysteria after the big one blew out in 2008.
What will happen this time? Hey look, they have messed with the market’s ‘organic’ functioning so thoroughly that it is anybody’s guess. The precious metals appear to have spent 2 years recalibrating in preparation for a new phase. The US dollar is still bullish but in danger of losing a technical underpinning (reviewed in NFTRH this week), Europe’s market appears to have higher to go in the near term. Countless other markets and indicators appear to be heading toward pivot points, whether bullish or bearish.
It is beyond this post’s scope to get into a detailed analysis. We’ll just end by asking readers to doubly question any and all assumptions or overly confident predictions going forward. Especially the ones that stimulate a greed response. Changes are coming and if they coincide with the 30 year yield’s status as they have in the past, they are coming soon. Do the work.
The 30 year yield continues to step higher despite Fed purchases. This would probably cool down a bit if the stock market takes its needed correction. The Fed could use a little help on the buy side. How about some help from the stock market momentum freaks? Drive rates back down a bit and renew the longevity of the Fed’s asset purchase operation?