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The Gathering Storm In The Treasury Market

September 22, 2018

The Gathering Storm In The Treasury Market

Summary

  • Our analysis provides kind of a Grand Unified Theory (GUT) of what is currently taking place in global financial markets
  • The massive borrowing by the U.S. Treasury is crowding out emerging markets capital flows
  • The structural factors that have kept long-term interest rates low and term premia repressed are fading
  • We expect a measured move in the 10-year Treasury yield to 4.25 to 4.40 percent, much sooner than the market anticipates

“Reagan proved deficits don’t matter.” – Dick Cheney

Memo to Dick Cheney:

  • Deficits and the public debt are starting to matter. Really. 
  • It is now more strikingly true than ever given the U.S. public debt-to-GDP is more than 3.4x higher than when President Reagan took office.  

Emerging Market Debacle 

Go no further than the debacle currently taking place in the emerging markets (EM), which began in the second quarter of this year, to witness the consequences of the U.S. Treasury’s trillion-dollar-plus demand shock for global funding.

 

Treasury_EM_Currencies

 

EM_Relative FX Vol to DM

In a closed financial system and a non-QE world,  price (interest rates) would adjust to move the capital and debt markets back to a more sustainable equilibrium.   The rise in interest rates would force the government to borrow less as higher interest rates crowd out other spending.  Also, the supply of loanable funds to the government would rise as savings increase.

That is not the world we now inhabit, however,  where global financial repression by central banks has resulted in a “rent control” like shortage of dollar funding.   The shortfall is now being plugged, in part, by the residual capital flows, which had been chasing yield in the emerging markets over the past several years.

That is the sucking sound you have heard since late April.

…click on the above link to read the rest of the article…

Is Trump Starting To Lean On The Fed Or Setting It Up?

July 20, 2018

Is Trump Starting To Lean On The Fed Or Setting It Up?

President Trump said in an interview with CNBC’s Joe Kernan this morning he “does not agree”, is not “thrilled” or “happy” with the FOMC’s interest rate hikes.  The full interview and transcripts will be available tomorrow.

Jul19_Trump Interview

Click here for excerpt of interview

You Heard It Here First

Presidents never, or rarely comment on monetary policy or currency market moves. for that matter,  x/ the hackneyed meme “a strong dollar is the best interest of the United States.”

President Trump hit them all in this interview today, from the Fed to the Euro and Chinese RMB (“dropping like a rock”).  It doesn’t surprise us.

Recall our March 21st post, The Biggest Risk At The Fed.

But this doesn’t concern us as much as the Fed’s independence.

“Just let it rip”

That is we are worried more about the freedom from White House pressure and interference in conducting monetary policy than getting a few bps wrong on the Fed Funds rate.   This is especially true and relevant given the strongman tendencies and  lack of respect for institutional norms of the current president.

Here is Larry Kudlow, the president’s new chief economic adviser:

“Just let it rip, for heaven’s sake,” Kudlow said of economic growth in the U.S., during a more than hour-long interview Wednesday on CNBC. “The market’s going to take care of itself. The whole story’s going to take care of itself. The Fed’s going to do what it has to do, but I hope they don’t overdo it.”  – CNN
– Global Macro Monitor,  March 21, 2018

We were assured by Fed insiders shortly after that post in March Chairman Jerome Powell was tough and we should not underestimate his independence.   He has thus far proven to be an extraordinarily competent Fed leader.

…click on the above link to read the rest of the article…

Lies, Damned Lies, And Statistics…And The CPI

February 16, 2018

Lies, Damned Lies, And Statistics…And The CPI

The first three of those words are attributed to the British Prime Minister,  Benjamin Disraeli, and also sometimes associated with Mark Twain.

You know our skepticism of most government data, especially the BLS calculation of inflation in consumer goods and services.  The data are so massaged by seasonal and hedonic adjustments, and even full-blown methodological revamps when the numbers do not fit the objectives of the government, they just don’t reflect reality.

Go back to 1982 when the BLS came up with the concept of “owner’s equivalent rent (OER),” a large component of how the price of shelter is calculated in the CPI.  This was in response to the government believing rising housing prices were distorting the true cost of housing.  Houses were then recategorized as capital goods.   The data for OER is not hard,  not a real world  data point that can be measured,  such as egg prices.

A friend pointed out the following in today’s Wall Street Journal today,

A monthly measure of what households pay for everything except gasoline and food rose a seasonally adjusted 0.349% in January—the strongest one-month increase since March 2005—driven by broad-based increases in costs like rent, clothing and medical services.  – WSJ, February 15

We wonder out loud about the 0.349 percent print.  Round it down, Charlie Brown!

Just another 0.001 percent and the BLS would have posted a core CPI monthly change of 0.4 instead of the 0.3 percent. The market response?

The headline number print of 0.5 percent was also very close to its rounding point.   Going out three more decimals, the number was .5448 percent.  Another 0.0012 percent, headline CPI prints at 0.6 percent.

Could they have?

Bureaucrats day trading (the data not securities) the monthly economic data?  The word comes down from on high not to kill Goldilocks with RoundUp?

You decide.

File this one under all things rigged and don’t cry for me, Argentina!

Interest Rates Starting To Bite

December 18, 2017

Interest Rates Starting To Bite

We have long held that interest rates have been so low (especially real rates) that it will take some time to reach a level for them to really matter and impact markets. The 2-year yield crossing over the S&P500 divie yield this past week for the first time in the last ten years is unlikely to slow the momentum driving risk markets. Nevertheless, they are getting closer to the zip code — after two years since the tightening cycle began — where they will begin to impact fundamental valuations (what is the fundamental value of Bitcoin?) and the relative pricing of risk assets. Keep it on your radar.

Long-term rates are so utterly distorted by the central banks we are not sure if the markets even pay attention anymore. Pancaking of the yield curve? Not the signal it used to be.  Meh!

The above, of course, is somewhat offset by the massive stock of central bank money in the global financial system which has driven up asset values to a level that has finally kicked the real economy into third gear.  This has created the perception of a Goldilocks global enviornment and positive feedback loop between markets and the economy.  Now add fiscal stimulus.

The unprecedented reservoir of the mix of this type of money is still so full it will take some time to drawdown central bank balance sheets to parch the risk markets. A higher share of central bank money relative to credit based bank money reduces global systemic risk and thus asset price risk premia.  Thus, additional market distortions.

The party continues.  Momentum is a powerful thang!   Until it isn’t.

…click on the above link to read the rest of the article…

What’s The Matter With Inflation?

September 29, 2017

What’s The Matter With Inflation?

What’s The Matter Kansas  inflation?

The divergence of official inflation as measured by the government versus inflation realized by the consumer and businesses has never been greater, in our opinion.   Go ask anybody on the street in America and Europe if think “doing life or business”  is getting  more expensive. 

We have some thoughts on what is the matter with the inflation data:

  1. Defining inflation – what is your definition of inflation?  What are we trying to measure?  The prices in a  consumer basket of goods and services?   Wages?  Asset prices?
  2. Measurement problems – the official measurement procedures seem archaic given the advent of big data in the past few years.   Even Bloomberg is out with a recent piece warning the Fed about low-balling inflation due to measurement errors.

    Low-Balling Inflation Puts the Fed at Risk

    Beware of any metric that doesn’t fully reflect housing prices.

    The U.S. has an inflation problem. It has nothing to do with inflation being too high or too low. Unlike the raging inflation of the 1970s, it doesn’t need to be solved with a lengthy and painful recession. Instead, it is a problem of measurement because the cost of housing — the single biggest expense for many Americans — isn’t explicitly included in the inflation data. 

    …Recent research from the Bank for International Settlements finds that the transmission mechanism for monetary policy has shifted. In their paper “Monetary Policy Transmission and Trade-Offs in the United States: Old and New,” Boris Hofmann and Gert Peersman concluded that changes in monetary policy — rate hikes or rate cuts — are being filtered into the economy increasingly through housing prices and less so via businesses raising prices as in years past. So even though the Federal Reserve’s policies are causing those prices to rise, they aren’t registering in the form of higher overall inflation.

     

    …click on the above link to read the rest of the article…

     

Asset Markets, The Sports Illustrated Jinx, And The Dodgers

September 9, 2017

Asset Markets, The Sports Illustrated Jinx, And The Dodgers

Why do stocks and assets markets crash?

Why is there is a Sports Illustrated jinx and magazine cover stories often signal a sign of a top or bottom of the subject being portrayed?

Regression to the mean, or, more simply, just moving back to the long-run averages.   

Dodgers Tank After SI Cover Story

After going on a tear of 51-9,  the best 60 game winning stretch in 105 years,  the ink was barely dry on the August 28th Sports Illustrated’s cover, which read, “Best Team Ever,” before the Dodgers went into a major tailspin.

Dodgers_SI_Jinx

.

“Best. Team. Ever?” The ink was barely dry the cover of our Aug. 28 issue—which hit newsstands Aug. 23, with a corresponding comparison to the greatest teams in history online—when the Dodgers fell into a tailspin that they have yet to escape. Through Aug. 25, they had gone 91-36 for a .717 winning percentage, which put them on a 116-win pace, good enough to tie the 2001 Mariners for the highest total of the 162-game expansion era. Since then, they’ve lost 10 of 11 to the Brewers, Diamondbacks and Padres, and while they still have an ample cushion to win the NL West and wrap up homefield advantage in the National League playoffs, they’ve shown that even if the infamous Sports Illustrated cover jinx is a myth, this squad is hardly invincible.  –  Sports Ilustrated, September 6

Sports Illustrated Cover Jinx A Myth?

We disagree.

Teams, players, politicians, companies,  markets or, whatever or whoever, always seem to be cover stories either at at their peak or nadir.   For sure,  the Dodgers 51-9 winning stretch was unsustainable, and the law of averages had to kick in.

Black Swans Are Rare

We do admit there are on rare occasions when Black Swans come along that defy all probabilities and shatter age old records.  Rarely.

…click on the above link to read the rest of the article…

The Ambiguity of Stock Value: Why It’s So Difficult to Call The Top

June 29, 2017

The Ambiguity of Stock Value: Why It’s So Difficult to Call The Top

This is one of our favorite posts of all-time.

Thought it apropos to re-post given that everyone and their mother is trying to call the top in stocks.  It’s all about yield-seeking capital flows, my friends.   Tell us what interest rate is the tipping point which thwarts that behavior and we will tell you when the stock and credit markets top and flop.

“John Bull can stand many things, but he cannot stand  2 , 0, .5 ,1, 1.5 , 2 percent”  – Bagehot

We are still far from the tipping point interest rate that sends the yield seekers back to their caves, in our opinion.

I just borrowed 5-year money for my daughter’s first car at 2.64 percent.  That is less than 85 basis points over the 5-year note, for a used car!

Expensive Assets
Yes, absolutely, all assets are incredibly expensive.  But pension funds are not going to make their nut sitting in cash waiting for them to get cheaper.   Seniors in Europe can’t eat with their interest earnings from negative rates.

Argentina floating a 100-year bond at 7 percent-ish, even after defaulting several times over the past 30 years, is definitely the warning bell of a credit bubble closer to the top.   And a contrarian call inflation is about to ignite.

The FOMO * yield and return chasing behavior of the markets  reminds us of portfolio managers running to catch the Titanic,  knowing full well the ship is going down.  They just want to enjoy the 3-day party.

How long will the party last?   O Lordy, help us.

* Fear of Missing Out

The Ambiguity of Stock Value

Posted on December 27, 2010

…click on the above link to read the rest of the article…

History’s Biggest “Butterfly Effect” Occurred On This Day

June 28, 2017

History’s Biggest “Butterfly Effect” Occurred On This Day

Posted on June 27, 2017by

The butterfly effect is the concept that small causes can have large effects. Initially, it was used with weather prediction but later the term became a metaphor used in and out of science.

In chaos theory, the butterfly effect is the sensitive dependence on initial conditions in which a small change in one state of a deterministic nonlinear system can result in large differences in a later state. The name, coined by Edward Lorenz for the effect which had been known long before, is derived from the metaphorical example of the details of a tornado (exact time of formation, exact path taken) being influenced by minor perturbations such as the flapping of the wings of a distant butterfly several weeks earlier. Lorenz discovered the effect when he observed that runs of his weather model with initial condition data that was rounded in a seemingly inconsequential manner would fail to reproduce the results of runs with the unrounded initial condition data. A very small change in initial conditions had created a significantly different outcome.  — Wikipedia

On this day in history, June 28, 1914, the driver for Archduke Franz Ferdinand,  nephew of Emperor Franz Josef and heir to the Austro-Hungarian Empire,  made a wrong turn onto Franzjosefstrasse in Sarajevo.

Just hours earlier, Franz Ferdinand narrowly escaped assassination as a bomb bounced off  his car as he and his wife,  Sophie,  traveled from the local train station to the city’s civic city.   Rather than making the wrong turn onto Franz Josef  Street, the car was supposed to travel on the river expressway allowing for a higher speed ensuring the Archduke’s safety.

Yet, somehow, the driver made a fatal mistake and tuned onto Franz Josef Street.

…click on the above link to read the rest of the article…

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