“Coiled Springs,” Trump the Rates Strategist and “the Elephant in the Room”

By Heisenberg

Barring some kind of geopolitical catastrophe, it seems unlikely we’re going to get anything on Thursday that’s “bigly” enough to overshadow Trump’s comments to the Wall Street Journal (published Wednesday) when it comes to reshaping how the market feels about the reflation narrative.

Yes, we got bank earnings and claims, but when it comes to trading USD and/or Treasurys, there’s nothing like a Trump bomb (or five) to throw everyone for a loop – especially when the yen and the 10Y were already looking for any excuse whatsoever to rally following the “dovish” Fed hike, the health care bill failure, and recent geopolitical tension.

Meanwhile, the euro is just waiting (rather impatiently if you look at vol) on the French elections, which will determine one way or another whether we see parity or not.

Make no mistake, these considerations are really all you should be concerned about. Or at least that’s how we see it. Because while equities are the sacred cow for now, there’s only so long stocks trading at record high multiples are going to be able to withstand an incessant grind lower in 10Y yields and USDJPY.

Here with more on this is SocGen’s Kit Juckes…

Via SocGen

President Trump doesn’t like a strong dollar, does like low interest rates, may yet offer Janet Yellen a second term, recognises that China isn’t a currency manipulator, and is struggling to enact policies that will boost US growth. Looked at in that light, perhaps it’s only to be expected that the dollar is drifting lower. The medium-term case for the euro to usurp it as strongest of the major currencies grows steadily even if European political uncertainty holds it back in the short term.

10-year Treasury yields are now 22bp lower than they were at the start of 2017. The failure of the healthcare bill and mixed economic data have done most of the damage, though geopolitical uncertainty has played a part and the weight of positioning was a major factor too. With JGB yields down just 4bp and Bund yields down only 1bp, relative yields have been a major driver of dollar weakness against the yen, and a reason for it to fail to make gains against the politically-anchored euro. Even more importantly, lower US yields have provided support for emerging and higher-yielding currencies, despite a series of political risks shaking several EM currencies. The Mexican peso is 2017’s strongest currency and the dollar is only up against a handful of stragglers.

Looking ahead, it’s tempting but probably unwise to write off the dollar’s prospects completely. The Fed isn’t done tightening yet, the economy isn’t done growing and we don’t think we’ve seen the highs for yields yet. At this point, market expectations of a third Fed hike this year has faded significantly, and by too much. For all that though, further dollar strength is going to be muted because by and large, economic prospects elsewhere are improving too.

At the top of the list of frustrating currency pairs is USD/JPY, which continues to track yield differentials faithfully. The inability of JGB yields to decouple from US ones is the Achilles Heel of the BOJ’s yield-anchoring policy, and we’re in the vicious cycle where a stronger yen weighs on inflation expectations, magnifying the relative real yield move. But, for all that, if we believe US yields are set to recover, and that episodes of risk aversion are going to come and go like rain showers and not stick around like the monsoon, USD/JPY is a buy once US yields find a base. The BOJ will keep easy monetary policy in place for longer than US yields can go on falling.

The euro is more like a coiled spring than anything else. We will know the result of the first round of the French presidential vote in a week and a half, and we’ll know the eventual winner in two and a half weeks. A Marine Le Pen win would be bad for the euro, of course, and probably drag EUR/USD below parity in short order. But any other result is likely to support it. A rally would be slower than a Le Pen-inspired plunge, but 1.10 is likely quite quickly and we don’t rule out a very sharp spike higher later this year. On current market odds, a 27% chance of a sharp fall, and a 73% chance of a slower rally makes for a difficult bet, but in the longer run there is more upside potential than downside.


One question we’ve pondered is whether the best post-election trade is in bond-land or FX. The correlation between yield and FX trades is very high, and the respective moves are rewarded by a proportional volatility over that period, but unless you have the bond trade unhedged in FX terms, it doesn’t make much sense, yet. Meanwhile, in terms of absolute return (but also probably in terms of sleepless nights) EUR/JPY still looks like the biggest potential mover of all. The elephant in the room for trading EUR/USD is still, however, when to go long. Before the first round vote? Between the two votes? Or only when all is said and done?

50+ Global Markets: Today’s Top Opportunities (free)

By Elliott Wave International

[biiwii comment: I just remembered that this event is starting today and wanted to put up a reminder for anyone interested in these extensive, premium services… free for a week.  Here is a screenshot of the real-time menu of items they have updated so far…]

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Fed Rate Hikes, Fiscal vs. Monetary Policy and Why Again the Case for Gold?


I’ve been thinking about the current Fed Funds rate hike cycle, which is logically gaining forward momentum now that the Fed can stand down from its 8-year, ultra-lenient monetary policy cycle.  That is because the Obama administration’s goals required a compliant Federal Reserve to continually re-liquefy the economy as its fiscal policies drained it.

With the coming of Trump mania and its very different fiscal policy goals, we will witness the end of much of what I considered to be the “evil genius” employed by the Federal Reserve, mostly under Ben Bernanke.  When he oversaw the brilliant and completely maniacal painting of the macro known as Operation Twist in 2011, I knew we were not in Kansas anymore.  We’d gone off the charts and off the balance sheet into a Wonderland of financial and monetary possibilities.

What else would you call a plan to sell the government’s short-term debt and buy its long-term debt in the stated effort to “sanitize” (the Fed’s word, not mine) inflationary signals on the macro?  It was evil, it was genius, and it worked.  So too did various other financial manipulations that took place before and after Op/Twist.  And here we are.

The Republican view is one where businesses and consumers are stimulated, not money supplies.  I think it is a better economically, but not by much in this case.  That is because the Trumpian ‘reflation’ would simply be another form of man-made stimulation attempting to deny market and economic excesses from being cleared.  A normal economy goes through normal cycles.  We have not had a normal economy or a normal cycle since at least pre-2000.

Since Alan Greenspan panicked and blew the credit bubble of last decade, we have been on a continuum further into uncharted waters.  Trump’s policies are not going to stop it, either.  Besides, he inherits this (chart source: SlopeCharts).

s&p 500 and monetary base

What we see above is a dangerous correlation between Monetary Base, which is the product of monetary policy, and the S&P 500.  We see that the S&P 500, which followed the Base in lockstep for much of the bull market, is playing a little catch up to the Base, which itself is only bouncing within a topping structure.  That is a dangerous looking chart if the assumption that monetary policy will be withdrawn as fiscal policy is anticipated/enacted is a good one.

Continue reading Fed Rate Hikes, Fiscal vs. Monetary Policy and Why Again the Case for Gold?

No Mere Trivia

By Jeffrey Snider of Alhambra

There is a grave misunderstanding about the reasons the Fed is “raising rates” in the first place

We are at the stage ten years later where it is still necessary to define terms. In every finance and economics textbook, the chapter on monetary policy defines “tight” money as when the Federal Reserve (or whatever central bank) raises its policy rate(s). Conversely, “accommodative” money is where it lowers the rate(s). In the US system, the technical reason given is open market operations, where the FOMC acting through the Open Market Desk of its New York Branch (FRBNY) will buy and sell securities as necessary to achieve the target rate.

From the perspective of the banking system, that means the Fed will, if pushed, provide whatever level of bank reserves necessary to keep the Effective Federal Funds rate sufficiently near the policy rate. When the policy rate is being raised, as it was in the middle 2000’s, it was in theory moving upward because money market participants fully believed that the Fed would sell bonds into the market (if needed) to reduce the level of available reserves – “tightening.”

That policy was instituted at that time because the FOMC felt the change in stance was warranted given an economy that finally appeared to be recovering from the unusually durable after-effects of the unusually mild dot-com recession. The Fed raised the federal funds rate to achieve that “tightening” so as to reduce economic momentum before it became overly inflationary. It is this assumed set of conditions which are used today to characterize the current action of monetary policy.

But on the most basic level, is that what happens? Is raising the federal funds rate truly equivalent to tightening? The answer is emphatically, unequivocally no.

Starting in the middle of 2004, Alan Greenspan’s Fed began a series of “rate hikes” meant to accomplish a “tighter” monetary stance for the reasons stated above. Between June 2004 and June 2006, the FOMC voted 17 times to increase the federal funds target, bringing it up from 1.00% to 5.25%. During that time, inflation continued to accelerate, as did all manner of other monetary indications outside of the traditional money supply statistics (the M’s, including the drastically incomplete M3). There is no way to characterize that period or the year immediately thereafter as “tight.”

From September 2007, however, through October 2008, the FOMC did just the opposite. In much more condensed fashion, the FOMC voted to reduce the federal funds target from 5.25% back to 1.00%. There is absolutely no way to characterize that period as anything even approaching “accommodative”, especially as it encompasses two of the three liquidation events associated with what was truly a bank panic (and the third one followed the introduction of ZIRP).

Continue reading No Mere Trivia

Unparalleled Credit and Global Yields

By Doug Noland

Credit Bubble Bulletin: Unparalleled Credit and Global Yields

New Fed Q4 Z.1 Credit and flow data was out this week. For the first time since 2007, annual Total Non-Financial Debt (NFD) growth exceeded $2.0 TN – a bogey I’ve used as a rough estimate of sufficient new Credit to fuel self-reinforcing reflation. Based on some nebulous “neutral rate,” the Fed rationalizes that it’s not behind the curve. Robust “money” and Credit growth argues otherwise. A Bloomberg headline from earlier in the week: “Taylor Rule Suggests Fed is About 12 Hikes Behind.”

Though not so boisterous of late, there’s been recurring talk of “deleveraging” – “beautiful” and otherwise – since the crisis. Let’s update some numbers: Total Non-Financial Debt (NFD) ended 2008 at $35.065 TN, or a then record 238% of GDP. NFD ended 2016 at a record $47.307 TN, an unprecedented 255% of GDP. In the eight years since the crisis, NFD has increased $12.243 TN, or 35%. Including Financial Sector (that excludes the Fed) and Foreign U.S. borrowings, Total U.S. Debt has increased $11.422 TN to a record $66.079 TN, or 356% of GDP. It’s worth adding that the $2.337 TN post-crisis contraction in Financial Sector borrowings was more than offset by the surge in Federal Reserve liabilities.

For 2016, NFD expanded $2.117 TN, up from 2015’s $1.929 TN – to the strongest growth since 2007’s record $2.501 TN. Household borrowings increased $521bn, up from 2015’s $384bn, to the strongest pace since 2007’s $947bn. Household mortgage borrowings jumped to $248bn, up from 2015’s $129bn. On the back of an unusually weak Q4, total Business borrowings declined to $724bn last year from 2015’s $812bn (strongest since ‘07’s $1.117 TN).

The Bubble in Federal obligations runs unabated. Federal debt jumped $843bn in 2016, up from 2015’s $725bn increase to the strongest growth since 2013’s $857bn. It’s worth noting that after ending 2007 at $6.074 TN, outstanding Treasury debt has inflated more than 160% to $16.0 TN. As a percentage of GDP, Treasury debt increased from 42% to end 2007 to 86% to close out last year.

Yet Treasury is not Washington’s only aggressive creditor. GSE Securities jumped a notable $352bn in 2016 to a record $8.521 TN, the largest annual increase since 2008. In quite a resurgence, GSE Securities increased almost $1.0 TN over the past four years. Treasury and GSE Securities (federal finance) combined to increase $1.194 TN in 2016 to $24.504 TN, or 132% of GDP. For comparison, at the end of 2007 Treasury and Agency Securities combined for $13.449 TN, or 93% of GDP.

Continue reading Unparalleled Credit and Global Yields

The Five-Tool Bond Market

By Danielle DiMartino Booth

The Five-Tool Bond Market, Danielle DiMartino Booth, Money STrong

Willie Mays, Duke Snider and Ken Griffey, Jr.

It’s no secret that these bigger than life baseball players are all Hall of Fame legends. But what about Mike Trout of the Los Angeles Angels? Or the Pittsburgh Pirates’ Andrew McCutchen or Carlos Gomez of the Texas Rangers? What do all six of these greats have in common?

If you guessed that none of them were pitchers, you would definitely be on to something. If you’ve really been doing your homework in the preseason, you would patiently explain that all six were “complete ballplayers,” with above-average capabilities in hitting, hitting for power, fielding, throwing and running. If you wanted to show off, you could elaborate that each has at least three qualified recorded data points in one season in each of the five areas rendering them “five-tool players.” These are the well-rounded players of field scouts’ dreams.

The idea of this quintessential, albeit exceedingly rare player, harkens to another picture of perfection – the bond market. After peaking above 15 percent in 1981, the yield on the benchmark 10-year U.S. Treasury fell in July of last year to a record low of 1.36 percent. That there is what we call the rally of a lifetime. A major contributor to the mountains of wealth that bonds have generated include the venerable inflation-fighting of one Paul Volcker. The three subsequent boom and bust cycles, largely engineered by Volcker’s successors at the Federal Reserve, each made their own contribution and brought greater and greater degrees of intervention to bear on the market and helped push yields lower and lower. In bondland, that translates to prices soaring higher and higher.

Over the years, the castigators were cast aside time and again. As for the few with steel constitutions, who quickly drew parallels between Japan’s intrusions and those of the Federal Reserve, let’s just say they can retire and rest in peace. They bought 30-year Treasury Strips and buried them, giving new meaning to the beauty of buy and hold. To keep the analogy alive, let’s say that at that juncture, the bond market was a four-tool player.

But then suddenly, last summer, something gave way.

Since July, the conventional wisdom has held that bond yields have finally troughed, bringing a denouement to the 35-year bull run. Of course, those comprising the consensus collided in arriving at their conclusions.

Market technicians, aka the chart-meisters, provide the simplest explanation. In 2016, the 10-year yield sunk below 2015’s low of 1.64 percent and rose above its high of 2.50 percent. Technicians refer to such boomerang behavior in short spaces of time as “outside events” that mark the beginning of the end of a cycle.

Continue reading The Five-Tool Bond Market

An Age-Old Relationship Between Interest Rates and Prices

By Steve Saville

When money is sound, interest rates don’t drive prices and prices don’t drive interest rates

The chart displayed near the end of this discussion is effectively a pictorial representation of what Keynesian economists call a paradox* (“Gibson’s Paradox”) and Austrian economists call a natural and perfectly understandable relationship.

Gibson’s Paradox was the name given by JM Keynes to the observation that interest rates during the gold standard were highly correlated to wholesale prices but had little correlation to the rate of “inflation”, that is, that interest rate movements were connected to the level of prices and not the rate of change in prices. It was viewed as a paradox because most economists couldn’t explain it. According to conventional wisdom, interest rates should have been positively correlated with the rate of “price inflation”.

The problem is that most economists did not — and still do not — understand what interest rates are.

First and foremost, interest rates are the price of time. They reflect the fact that, all else being equal, humans place a higher value on getting something now than on getting exactly the same thing at some future time. Interest rates transcend money, because they exist even when money does not. With or without money and all else being equal, getting something now will always be worth more than getting the same thing in the future**. This is called time preference.

Time preference is the root of interest rates and the natural interest rate is a measure of societal time preference. That is, the natural interest rate is a measure of the general urgency to consume in the present or the amount that would have to be paid, on average, to make saving (the postponement of consumption) worthwhile. For example, the average 7-year-old child has a very high time preference, in that if you give the kid a choice between getting a desirable toy today or getting something more in 3 months’ time, the “something more” option won’t be chosen unless it is a LOT more, whereas a middle-aged adult with substantial savings is likely to have low time preference.

When interest rates are properly understood it becomes clear that the paradox named after Gibson is no paradox at all. The reason is that if the money is sound, as it mostly was under the Gold Standard, both interest rates and prices will move in the same direction in response to changes in societal time preference.

To further explain, during a period of rising time preference, that is, during a period when there is an increasing desire to consume in the present, the prices of goods will rise (on average) due to increasing demand and it will take a higher interest rate to encourage people to delay their spending. During a period of falling time preference, that is, during a period when there is an increasing desire to save, the prices of goods will fall (on average) and people will generally accept a lesser incentive (interest rate) to delay their spending.

In a nutshell, there is no paradox because, when the money is sound, interest rates don’t drive prices and prices don’t drive interest rates; instead, on an economy-wide basis*** both prices and interest rates are driven by changes in societal time preference.

Continue reading An Age-Old Relationship Between Interest Rates and Prices

High AMO Says Rates Should Stay Low

By Tom McClellan

High AMO Says Rates Should Stay Low

AMO versus interest rates
January 20, 2017

The Atlantic Multidecadal Oscillation (AMO) is a bit of data that climate researchers use in their modeling of global climate change.  And it turns out that it has interesting messages for us about the long term trends in interest rates.

I will spare you all of the details of the AMO’s computation, but you can download the data yourself at NOAA’s web site, and read more about it at this page.

What we can see in the chart above is that there does seem to be a relationship between interest rates and global temperatures as modeled by the AMO.  The data on AMO only go back to 1856, so we cannot yet see this relationship through multiple iterations of the 60-year cycle.  To help illustrate this correlation better, I have offset the AMO data forward by 6 years.  Why there is that 6-year lag is not something I can answer.

Climate scientists have long known that there is a 60-70 year cycle in global temperatures and other related data.  And bond market analysts have long known about the 60-year cycle in interest rates.  But these two groups of experts rarely talk to each other, nor look up this period’s other usages throughout the ages.  A quick Google search shows lots of other 60-year periods of interest to people.

60-year cycles

My understanding is that the basis for the relationship between temperatures and interest rates lies in agriculture.  Warmer global temperatures are better for crop production, lengthening growing seasons and reducing drought length and severity.

Continue reading High AMO Says Rates Should Stay Low

Lumber’s Message For Interest Rates

By Tom McClellan

Lumber’s Message For Interest Rates

Lumber's leading indication for 2-year T-Note
December 15, 2016

The FOMC is now finally allowing interest rates to start moving where the market has already said they should have gone.  The 2-year T-Note Yield is already up to 1.27%, and the Fed is lagging behind in making an adjustment.  I have shown before that this can be a problem, having the Fed lag behind the message from the 2-year T-Note yield.

The important message that the Fed apparently does not have any awareness of is that there are many more rate hikes in store.  This week’s chart shows how lumber prices tend to know what the Fed should do well ahead of the FOMC being aware.  In the chart above, we can see that the 2-year T-Note yield tends to follow the path of lumber futures prices, with a lag time of about a year.

The fact that lumber prices have been trending higher over the past year conveys the message that interest rates should trend higher in 2017.  This principle works most of the time, although when the Fed puts a thumb on the scale, the correlation can go awry.

The announcement on Dec. 14 of another quarter point rate hike suggests that the Fed is getting out of the thumb-on-scale mode, at least a little bit.  And that should allow interest rates to follow the upward path of lumber prices in 2017.

So now you’re wondering: won’t higher rates have a negative effect on home purchases, mortgages, etc.?  The answer is, yes of course.  But not right away.  It turns out that lumber prices also lead several data series related to housing, including the prices of housing stocks.

Lumber leading indication for HGX Index

The next year should see rising prices for stocks related to homebuilding, as represented by the HGX Index.  That might seem to be in conflict with the notion of rising interest rates, since higher rates make buying a home less affordable.  But higher demand for housing tends to push up both home prices and home mortgage rates.

And there is a perverse kicker.  Those nascent home buyers who have been on the fence about whether it is time yet to pull the trigger may see that the rising rates are taking their home affordability away, and so they could get in a rush to buy while they still can.

Economics is funny that way.  The basic premise is that “people respond to incentives” but they do not necessarily have to respond in exactly the way that the economists determine that they should.

The bottom line is that higher lumber futures prices have meaning for both interest rates and housing related stocks’ prices.  And that message right now is about higher interest rates in 2017, and higher prices for housing related stocks.

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Related Charts

Nov 19, 2015

Housing Starts – Lumber’s Message
Sep 22, 2016

Bond Market Knows What Fed Should Do
Mar 30, 2012

Lumber Says This Is A Top For Housing Stocks

Chart In Focus Archive

Will the Dollar and Higher Rates Doom Stocks?

By Chris Ciovacco

Dollar Breaks Out

With the Fed flip-flopping on interest rates, the U.S. dollar traded inside a two-year consolidation box, which is indicative of indecisive investor behavior. The dollar was recently able to break to the upside with market participants expecting a Fed rate hike in December.

Impact On Multinationals And Consumers

There are valid concerns tied to a rising U.S. dollar. A strong dollar makes American goods more expensive overseas, which can negatively impact earnings for multinational companies. However, the flip side of that coin is U.S. consumers will pay less for imported goods, allowing them to have more disposable income.

What Can We Learn From History?

This week’s video explores the question:

Is it in the realm of historical possibility for stocks to perform well in periods marked by rising interest rates and a strong U.S. dollar?

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.Video


Higher Rates Can Impact Capital Flows

Bonds have recently sold off on expectations for stronger growth, higher inflation, and higher interest rates. The selloff in bonds and the post-election push higher in stocks have allowed the stock/bond ratio to break out of a long-term consolidation box (see chart below). The impact of capital flows between stocks and bonds was covered by The Fat Pitch:

In July, fund managers’ had their highest exposure to bonds in 3-1/2 years. In other words, they expected yields to keep falling. Instead, yields reversed higher and have since risen so sharply that several smart money managers now say that a new secular uptrend in yields is taking place. That is a big call, given that the foregoing secular downtrend has lasted more than 35 years.

Over the past 18 months, investors’ money has been flowing consistently out of equity funds. Where has that money gone? Mostly to bond funds. Money usually follows performance, so it’s a good guess that fund flows might soon begin to favor equities. If past is prologue, then equities should gain and bond yields should continue to rise. Whether that will constitute the start to a new secular uptrend for yields it is far too early to say.

Financials Have Responded

Since bank earnings are impacted by interest rate spreads, higher interest rates tend to be positive for the financial sector. President-elect Trump’s platform also calls for toning down regulations from the post-financial crisis Dodd-Frank legislation. Financial stocks have responded by breaking out from a multiple-year base relative to the S&P 500.

Time Will Tell

As long as the markets are moving based on the higher growth, higher inflation, and higher rates theme, economically-sensitive areas of the market, such as small caps (IWM), mid caps (MDY), metals (JJC), and consumer discretionary (XLY), will most likely continue to outperform more-defensive oriented areas, such as bonds (TLT), gold (GLD), and utilities (XLU). Stocks have come a long way in a short period. Even under longer-term bullish conditions, some “give back” is to be expected.