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Trader: “Much more to come” for Treasury Rally, Dollar Slump

By Heisenberg

Former FX trader Mark Cudmore was right.

And so were we.

Just hours before the Fed’s “dovish”, “just right” hike sent yields plunging across the curve, Cudmore said the following:

Fed rate increases should send Treasury yields up, right? It looks more likely the opposite is going to happen following the expected central bank rate rise Wednesday

We added this:

And my, oh my – if that happens and all of the shorts in the belly of the curve have to cover, it would be quite the spectacle. 

Belly

Indeed, Wednesday was basically a replay of the previous two hikes in terms of the reaction in yields:

YieldsHIkes

Of course the dollar plunged as well on the dovish message:

ChartFed

On Thursday, Cudmore is out with what amounts to a victory lap – and a prediction that there’s a lot more room to run in the UST rally and a lot more downside ahead for the dollar.

Via Bloomberg

The initial reaction to the Fed was big. But there’s much more to come still as the message was about as dovish as could have been envisioned, given it was accompanying a rate rise.

  • This column had argued that long-end yields would fall after the Fed hike. An 11 basis-point drop in 10-year Treasury yields on Wednesday might seem significant, but it’s not in the context of what happened at the meeting
  • Apart from lower commodity prices, solid but not exceptional economic growth, and a lack of runaway inflation, much of my anticipation of a dovish market reaction was based on the fact that the market was very much positioned the other way
  • But Yellen didn’t just disappoint the extremely hawkish hopes — she genuinely wasn’t hawkish at all. Of course, she couldn’t be outright negative on the economy and inflation given the Fed was tightening policy — but she went as far as she could in that direction
  • Notably, near-term risks to the economic outlook still “appear roughly balanced,” rather than skewed to the upside as some had anticipated. The Fed emphasized it’s targeting a “sustained” return to 2 percent inflation, rather than just reaching that target
  • Yellen also reiterated that the benchmark rate will persist for some time below levels that are expected to prevail in the longer run, with “gradual” hikes still the plan
  • Not only did the median dot plot not rise above 3 hikes in 2017, but the average barely rose. Only five dots showed more than three hikes this year — the exact same as there were in December. Four hikes weren’t even a near miss — it wasn’t even on the radar of the majority
  • And there was no discussion of the central bank balance sheet either. That was only a tail risk but it’s yet another point lacking for the hawks
  • Everything about this meeting that could surprise dovishly, managed to do so. U.S. yields and the dollar have much further to fall as a result

Global Asset Allocation Update

By Joseph Calhoun of Alhambra

There is no change to the risk budget this month. For the moderate risk investor, the allocation between risk assets and bonds is unchanged at 50/50.

The Fed spent the last month forward guiding the market to the rate hike they implemented today. Interest rates, real and nominal, moved up in anticipation of a more aggressive Fed rate hiking cycle. Post meeting, a lot of the rise came out of the market. Nominal and real 10 year Treasury rates dropped by an identical 11 basis points on the day. Rates fell at the short end too as the yield curve shifted lower but didn’t flatten significantly. The market was looking for a big change in the Fed’s growth and inflation expectations and the dots basically didn’t move. Long term growth expectations are still 1.8-2.0% and inflation expectations were unchanged at 2.0% on the PCE deflator.

Just as or maybe more important was the emphasis in the statement on its “symmetric” inflation target. Rather than say, as they did in the last statement, that inflation was expected to “rise to 2% over the medium term”, the Fed now says “inflation will stabilize around 2%”. I know it seems like a minor change but what it means is that the Fed isn’t going to get too excited if the inflation rate goes above 2% for a period of time. They further emphasized the point by saying:

The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

What all the language changes mean is the Fed isn’t really shifting to a more hawkish stance and that rate hikes will not be coming fast and furious this year. The dot plot indicates the Fed still expects two more hikes this year. The market was starting to price in four (today’s plus two more) and that had to come out of the market after the meeting. This was the most dovish rate hike in the history of rate hikes. Greenspan’s old conundrum was that long term rates weren’t rising as the Fed hiked. The conundrum today is that even short term rates aren’t rising as the Fed hikes. Two year note yields are right back to where they were after the December rate hike.

The post-FOMC moves today were very beneficial for our allocation. Obviously, the move in bonds was beneficial as we are overweight bonds in our moderate risk portfolio. We also have more duration in our bond allocation than most firms; we are much more wary of credit risk than duration risk. The indirect consequence of today’s meeting was felt in currency and commodity markets which was also beneficial. The dollar index fell hard after the announcement as the difference in growth expectations between the US and Europe continue to narrow. That pushed gold and other commodities higher along with commodity sector stocks, all of which are represented in our portfolio.

Overall, our indicators haven’t changed enough to warrant any changes to the allocation. The yield curve sits in the middle of its historic range, providing us with little guidance. Credit spreads narrowed, then started widening again and finished up a bit wider than the last update. But it wasn’t enough to trigger any action. Earnings were up in Q4 and may even be able to get a third consecutive quarter of improvement in Q1 but stock prices have once again outpaced actual earnings growth. In other words, valuations in the US are still sky high. As I’ve stated many times over the last couple of years, ex-US stocks are much cheaper and that is still true. Momentum isn’t telling us a lot either, certainly nothing that warrants a change in allocation.

Continue reading Global Asset Allocation Update

Inflation, But Only Where it Hurts

By Jeffrey Snider of Alhambra

The Consumer Price Index increased 2.74% in February 2017 over February 2016. That was the highest inflation rate registered in this format since February 2012. As has been the case for the past three months, the acceleration of headline inflation is due almost exclusively to the sharp increase in oil prices as compared to the lowest levels last year (base effects). It is the only part of the CPI report which captures anything like it.

The energy price index was up 15.6% year-over-year, compared to an 11.1% increase in January. The gamma of energy and therefore the CPI is already fading, with oil prices having been stuck at $52-$54 during the months of January and February. If WTI remains about where it is now, around $48, the current month (March) will be the last to feature any significant acceleration from oil.

The other parts of the CPI are as they have been consistently throughout. The “core” index, CPI less food and energy, was up 2.2% in February. It was the fifteenth straight month where the core increase was one of 2.1%, 2.2%, or 2.3%. In what is probably the best indication of inflation stripped of energy, the last time the core rate accelerated even slightly was during the second half of 2015.

Continue reading Inflation, But Only Where it Hurts

World Out of Whack: What’s Next for Global Real Estate?

By Capitalist Exploits

Market dislocations occur when financial markets, operating under stressful conditions, experience large widespread asset mispricing.

Welcome to this week’s edition of “World Out Of Whack” where every Wednesday we take time out of our day to laugh, poke fun at and present to you absurdity in global financial markets in all its glorious insanity.

While we enjoy a good laugh, the truth is that the first step to protecting ourselves from losses is to protect ourselves from ignorance. Think of the “World Out Of Whack” as your double thick armour plated side impact protection system in a financial world littered with drunk drivers.

Selfishly we also know that the biggest (and often the fastest) returns come from asymmetric market moves. But, in order to identify these moves we must first identify where they live.

Occasionally we find opportunities where we can buy (or sell) assets for mere cents on the dollar – because, after all, we are capitalists.

In this week’s edition of the WOW: global real estate

Ever since anyone can remember, global real estate prices have been going up. Pretty much doesn’t matter which country you’re from (unless, of course, it’s Syria, or Iraq… or Fuhggedistan): if you bought something in the last 2 to 3 decades, it’s like the ceilings were insulated with helium. Even when the 2008 crisis hit and we had Captain Clever ensuring the world that things were just peachy:

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.” – Ben Bernanke, March 28, 2007

Even with that setback real estate has marched upward. The US, of course, took a decent breather and is only today back to where it was pre the GFC.

But the US isn’t the world, so let’s look at what everyone else has been up to.

Take a look at this:

In the British empire and all its former colonies the inmates pretty much trucked on after a short “uh-oh” moment:

Continue reading at TalkMarkets →

The Corporate Bond Market: The Start of the Matter

By Danielle DiMartino Booth

Of all virtues to which we must ultimately aspire, forgiveness demands the most of our souls. In our naivety, we may fancy ourselves man or woman enough to absolve those who have wronged us. But far too often, we find our pool of grace has run dry. So deeply burdened are we by our emotions that grace to us is lost. How many of us have the strength of resolve to let bygones be gone for good? Those of the cloth recognize the damage self-inflicted scars sear into our souls as they seek to guide us through life’s most difficult journeys. They pray for our deliverance from a painful inner turmoil and with it the peace only forgiveness can convey.

None who have ever heard Don Henley’s The Heart of the Matter could be blamed for thinking divine inspiration itself came down from the heavens to spawn those longing lyrics. But it isn’t just the words that scorch their way into your memory, it’s Henley’s tone, the raw pain that pierces every time you’re caught off guard by the mournful ballad released in 1989. Henley sings of our feeble struggle as no other, grasping for our collective release in humility. “The more I know, the less I understand. All the things I thought I’d figured out, I have to learn again.” In the end, Henley hands down the cruelest of convictions: If you truly want to vanquish your demons, you must find the strength within to forgive.

Astute policymakers might be saying a few prayers of their own on fixed income investors’ behalves. The explosion in corporate bond issuance since credit markets unfroze in the aftermath of the financial crisis is nothing short of epic. Some issuers have been emboldened by the cheap cost of credit associated with their sturdy credit ratings. Those with less than stellar credit have been prodded by equally emboldened investors gasping for yield as they would an oasis in a desert. Forgiveness, it would seem, will be required of bond holders, possibly sooner than most of us imagine.

For whatever reason, we remain in a world acutely focused on credit ratings. It’s as if the mortgage market never ballooned to massive proportions and imploded under its own weight. In eerie echoes of the subprime mania, investors indulge on the comfort food of pristine credit ratings despite what’s staring them in the face – a credit market that’s become so obese as to threaten its own cardiac moment. It may take you by surprise, but the U.S. corporate bond market has more than doubled in the space of eight years. Consider that at year end 2008, high yield and investment grade bonds plus leveraged loans equaled $3.5 trillion. Today we’re staring down the barrel of an $8.1 trillion market.

The age-old question is, and remains:  Does size matter?

Continue reading The Corporate Bond Market: The Start of the Matter

Behind the Curve? Pussycat Yellen Confronts “Largest Dovish Policy Deviation Since the 70s”

By Heisenberg

Some folks will be talking about the Fed today.

In just a few hours we’ll get a hike, but once again, it’s all about the messaging. Any kind of dovish lean would be a (bigly) surprise. What’s got some people spooked is the possibility that, in their rush to prove they aren’t behind the proverbial curve, they get too aggressive with the messaging. Here’s what SocGen said overnight (and please, just forget that you ever heard the term “pussy-cat” in a sentence that refers to Janet Yellen):

The Fed is a pussy-cat that would like to change its spots into something more like a leopard’s. In practical terms, that means that this evening’s FOMC announcement (6pm GMT, with a press conference half an hour later) is all about the Fed’s projections rather than whether they raise rates or not. Anything other than a 25bp rate hike would be a huge surprise to the market. Discounting that possibility on the grounds that the Fed is so (too) obsessed with managing market expectations ahead of policy moves, what we’ll watch are the ‘dots’ showing FOMC’s projections of where Fed Funds might go. Market pricing of Fed Funds through 2017- 19 is at the bottom of what the Fed currently projects. Our US economists think that the 2017/18 dots probably won’t move but beyond that, an upward adjustment is possible to send a signal to the market that the FOMC is serious about normalising policy.

Yes, “to send a signal to the market that the FOMC is serious about normalizing policy.” And see that’s the problem. The Fed already tried that. And since March odds converged on 100%, we’ve seen nothing but signs that while this market will probably be willing to write off one hike as a positive development (you know, as confirmation of the reflation narrative’s legitimacy), anything beyond that in terms of an overzealous normalization trajectory could very well trigger a tantrum and undercut oil prices further.

So is the Fed behind the curve? Or, put differently, are we right to fear an FOMC that sees itself as playing catch up? In short, probably. Here’s Goldman:

Exhibit 1 shows the gap between the funds rate and the rule-implied rates. Positive values indicate that policy is “too tight,” while negative values indicate that policy is “too easy.” The results using the HLW estimate of r* imply that policy is just over 1pp easier than the rule-prescribed rate, while the results using a 2% neutral rate imply that policy is almost 3pp easier. Accounting for the impact of the balance sheet would make both gaps moderately larger. The constant neutral rate assumption implies that the current policy stance represents the largest dovish policy deviation since the 1970s, though it is only half as large as the most extreme gaps of the 1960s and 1970s.

BehindTheCurve

If the Fed is behind, what would it take to catch up? Last week, we showed that the Fed’s projections over the next few years already correct the modestly “too easy” stance implied by its depressed r* view. Under the alternative assumption that critics of the low r* thesis are right and a 2% neutral rate is a better guide, current policy is about 3.5pp too easy and the Fed’s terminal rate estimate about 1pp too low, requiring 1 additional hike per year beyond those already planned to catch up by 2020.

Got that? Ok, good.

Continue reading Behind the Curve? Pussycat Yellen Confronts “Largest Dovish Policy Deviation Since the 70s”

China Starts 2017 With Chronic, Not Stable and Surely Not ‘Reflation’

By Jeffrey Snider of Alhambra

January-February economic statistics do not really indicate stable let alone, as “reflation” would have it, restoration

The first major economic data of 2017 from China was highly disappointing to expectations of either stability or hopes for actual acceleration. On all counts for the combined January-February period, the big three statistics missed: Industrial Production was 6.3%, Fixed Asset Investment 8.9%, and Retail Sales just 9.5%. For retail sales, the primary avenue for what is supposed to be a “rebalancing” Chinese economy, that was the lowest growth rate in more than a decade, the first time below 10% since the January-February period in 2006.

Analysts had been expecting Chinese retail sales to rise either 10.5% or 10.6%, depending on the source collating expectations, meaning that actual sales missed by a wide margin during the holiday period. What was perhaps most noteworthy was the growing dichotomy between online sales and retail sales overall. Virtual sales rose by more than 25% year-over-year, echoing a similar dynamic we have observed in US retail sales since early last year. Consumer prices according to government statistics have been stable (and actually decelerated sharply recently) and therefore different than in the US, so it might not suggest the same oil price effects as here but instead a similar underlying baseline weakness that hasn’t dissipated even though the worst of the “rising dollar” is now a year in the past.

The rest of China’s statistics propose the same assumptions. Industrial production at 6.3% is no different at all than the level of growth it has been for two years now. The noticeable lack of volatility in the changes month-to-month continues to suggest (louder) less reliability, perhaps, than might be hoped for (like China’s GDP estimates). If there were actually some appreciable acceleration in Chinese industry we would expect to see it here, meaning that it is very likely only the downside that might be obscured by an almost perfect and increasingly likely artificial sideways trend.

Continue reading China Starts 2017 With Chronic, Not Stable and Surely Not ‘Reflation’

Keeping it Real

By Tim Knight

This post has to do with something which may seem like an oxymoron: integrity in financial prognostications. What inspired me to address this topic? Oh, that’s easy:

0314-gart

As you can see, back on February 22nd, Dennis “Commodity King” Gartman went on CNBC to declare that, at long last, for the first time in about five years, he was bullish on crude oil.

Savvy traders jumped on this and, knowing Gartman’s tendency to generate reputational pratfalls, shorted the bejesus out of crude oil and were richly rewarded for it. But this is not about Gartman’s well-documented tendency to, shall we say, not have a perfect record. It has to do with this “five years” nonsense.

I’m not sure if Dennis thinks (1) we’re all really stupid or (2) we don’t have access to this here newfangled “Internet” thing, but it would only take a kindergarden student about 7 seconds to completely refute the aforementioned assertion. I offer Exhibit A:

0314-mostbullish

So as you can see, in October 2015, Gartman declared himself the “most bullish I’ve ever been on crude”. My arithmetic skills are strong enough to know that February 2017 minus five years is long, long before October 2015.

Continue reading Keeping it Real

“Quick, Buy That (Macro) Dip!”

By Heisenberg

Earlier today, we noted that the correlation between implied vol and equities is breaking down as traders buy cheap protection on expected surges/plunges while the market continues to grind ever higher.

As WSJ writes, “cash flooding in from private investors has pushed up the market overall, but has also led professionals to worry a little more about the risks—both of a meltdown and, conceivably, a ‘melt-up,’ when the market soars 10% or more in short order. The prospect of either big losses or big gains prompts buying of options, pushing up their cost, proxied by implied volatility.”

VIX1

We also noted that when it comes to realized vol, January was the 5th calmest month on record and, to quote WSJ again, “the calm on the surface means it is cheaper than normal to hedge.” You can thank – in part – collapsing stock and sector correlations:

Correlations

(Goldman)

Well, when it comes to suppressed realized vol, we found the following chart from BofAML to be particularly interesting. Have a look at how quickly spikes in volatility have rapidly mean reverted during recent shock events like the US election and Brexit, versus history:

VolCollapse

Consider that, and think back to the following from JPMorgan’s Marko Kolanovic:

Various quantitative and qualitative metrics indicate that markets have become more macro driven and react faster to the new information. A qualitative example shows the reaction time for recent major events (August ’15 selloff, Brexit, US Election, Italy Referendum) that has compressed from weeks to hours. Quantitatively, we are noticing a higher density of market turning points. The average variability of asset trends (averaged across major asset classes) that show turning points occurring at the fastest pace in recent history (~30 years).Given the engagement of central banks with markets and geopolitical developments, it should not be a surprise that markets are more macro driven.

strats

In short: buy that f*cking (macro) dip. And right quick.