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Oil And Treasuries Paint A Divergent Inflation Picture, Yet Is It Even Relevant?
While the capital markets debate has recently shifted to a discussion of who is right: whether equities, surging higher in expectation of something close to Zimbabwean hyperinflation, or the bond market, where yields have been declining, indicating the much more rational credit world is seeing deflation as the norm for a long time, a different perspective of this divergence can be witnessed by comparing treasury curve flattening versus commodity price movements.
The chart below demonstrates the highly correlated performance between the price of oil and the steepness of the Treasury curve as indicated by the 2s10s since the March lows. Yet an odd recent divergence is that the 2s10s has tightened considerably even as oil has continued to attain new highs. One argument here is that oil is driven exclusively by the dollar (devaluation) trend, which in turn is impacting all medium and high beta assets (the dash for trash being a great example).
The preliminary conclusion is that bonds are reflecting a deflationary environment while commodities and stocks are betting on inflation.
As risk has returned with a vengeance and alpha is being chased across asset classes with little to no discrimination, in effect converting the market into one big alpha trampoline, the only remaining rationality seems to be evident in bonds.
Yet even that conclusion could be premature.
As Zero Hedge has pointed out, it is likely that the Treasury market has been gamed via various machinations by the Fed to i) encourage direct bidder interest and ii) to encourage indirect bidders to swap out of agency holdings into Treasuries, (in the same time blurring the distinction between direct and indirect bidders) while equities have been manipulated via three relatively simple schemes including i) massive rolling short squeezes and stock recalls across critical stock classes (financials and REITs being two key examples), ii) HFT strategies designed to encourage momentum chasing in the failure of all other quant factors, and the displacement of traditional market neutral funds, while masking for liquidity provisioning and iii) collapsing stock market volume, with bid interest represented by bankrupt companies due to straggling (and struggling) money managers who are now literally betting the farm on the worst of the worst just to generate a little market outperformance (while traditional L/S 170/70 hedge funds like RenTec's RIEF have been getting killed all year long). In other words, both stocks and bonds are potentially being manipulated to a point where they bear no reflection of the underlying assets, whose values they are purported to represent.
As for the commodity market, while the CFTC laments the passage of a time when several major banks could easily manipulate all commodites, China has quietly taken matters into its own hands and has informed ISDA that it will soon be unliaterally terminating commodities contracts, having said enough to the persistent irrational market which day after day gets the CFTC's blessing to continue mispricing assets courtesy of a select few speculators.
Is it thus surprising that fewer and fewer investors remain in the market (just observe NYSE stock volumes as the Buffett mantra of "buy and hold" is now dead) as the only entities left to speculate amongst each other are a few computers and ever decreasing numbers of degenerate gamblers. Framed in this light, is the debate about inflation versus deflation based on asset trends really relevant: a bizarro market dominated by animal spirits and intraday greed has ceased to indicate any long-term trends and our advice is to simply enjoy it for what it is - a ponzi casino, whose only real correlation is the Madoff pyramid, in which the mechanism works as long as there are marginal gullible investors. However, once the game of musical chairs ends, investors/speculators should not be surprised to find that the game was rigged from the start and there were no chairs to begin with.
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Your concluding paragraph says it all.
I hope you don't get the Robotrader treatment due to your demeaning of "degenerate gamblers".
The decline and fall of America has begun and with it the rest of the Western world.
Actually .....little has changed....
Here is he impetus....
The movement of $1.00/50.00 is competitve with holding 3 year debt....Do it 3x per year....one gets to be a performance hero....
Hence small near term movements are thought more likely than any other play...
Times have changed....and are going to be a lot better....
........................................
Why ? The future of direct access electronic trading will get cleaned up by relevent regulation and defragmentation...by default....
Smaller dollar amounts are far more nimble....and hold the keys to the performance future....
Smart...seasoned direct access electronic traders will be able to smoke past big pool largeness....
..........................................
The keypoint being that direct access trading technology has/will totally render useless the exchange model....
An exchange has just become "software"....and even govt. agencies can handily see what the exchanges really should be....serving their utility type name changing electronic time stamping function on a nil cost first come first served basis....
The "gaming" of exchanges is soon going to be a dead game....and management is going to rule the day....and being "large" will guarantee underperformance and securities prices to actual cash return issues....
Well, I've read that the bond market is the smart market - And stocks 'r stupid...
Although the junk bond funds have been doing OK the past few days. Sorta.
Sure, but you have to remember that no stone has been left unturned by our "masters" to utterly and totally manipulate the bond market and mislead its investors. Were it not for witnessing the BLATANT manipulation in the stock market lately, I'm sure many of you would not even consider the notion of government manipulating markets. I cannot help but laugh when I see equity market players counting on elliot "waves", fib retracements, et. al. to guess and time a particular outcome when in fact today all the stock indices are no better than if someone (i.e. the government/Fed) painted them by hand.
Bingo!
"I cannot help but laugh when I see equity market players counting on elliot "waves", fib retracements, et. al. to guess and time a particular outcome when in fact today all the stock indices are no better than if someone (i.e. the government/Fed) painted them by hand."
Bingo x2
Certainly Ben and the POMO operations are suspect in the framework of considering 2s to 10s over the last several months, but the yield curve can only be manipulated in the short term. The market is far too vast and wide in ownership as shown below. Central banks can set short term rates to zero but the market takes care of the rest of the curve. The bond market knows that QE is on it's way out so that is baked in the cake. The message is clear to me that hyperinflation is not the key concern to the bond market, in my humble opinion. Looks more like ZERO growth.
As of the 27th of August:
Total Outstanding Debt: $11,725,477,836,090.85
Debt held by public: $7,393,885,646,934.29
Intergovernmental Debt: $4,331,592,189,156.56
Debt held by public=The Debt Held by the Public is all federal debt held by individuals, corporations, state or local governments, foreign governments, and other entities outside the United States Government less Federal Financing Bank securities. Types of securities held by the public include, but are not limited to, Treasury Bills, Notes, Bonds, TIPS, United States Savings Bonds, and State and Local Government Series securities.
Intergovermental Debt are Government Account Series securities held by Government trust funds, revolving funds, and special funds; and Federal Financing Bank securities. A small amount of marketable securities are held by government accounts.
For more info in these numbers: http://www.treasurydirect.gov/NP/BPDLogin?application=np
"The market is far too vast and wide in ownership as shown below. Central banks can set short term rates to zero but the market takes care of the rest of the curve."
Much of that is short term and the FED has bought a lot of not only treasuries but also agency MBS, which CM and ZH have pointed out have been recycled back into treasuries by foreign CBs.
http://www.chrismartenson.com/blog/shell-game-how-federal-reserve-moneti...
http://www.zerohedge.com/article/fed-enabling-foreign-central-banks-swap...
Outstanding public debt is "$7,393,885,646,934.29"
The FED has spent nearly 1/7th of that buying Treasuries and agency MBS this year, and still has like 400-450 billion in agency MBS it may purchase this calendar year.
"The bond market knows that QE is on it's way out so that is baked in the cake."
Maybe. Why do you think QE is out? Are you thinking QE only equals the 300 billion in treasuries purchases? The POMO is largely about the 1.25 trillion in agency MBS purchases. There is still (I believe) approximately 400-450 billion more to spend in the agency MBS POMO, which is way more than the sum of the 300 billion in treasury purchases in the POMO.
The end of QE may come, but its not predicated on the expiration of the 300 billion treasury purchase program in October. There are still a huge amount of agency purchases that may occur over the next four months.
In addition, the FED's CMBS loan facilities are just getting rolling and are expected to be heavily used. Liquidity is not drying up IMO.
No central bank can control the yield curve. It cannot be done. I have traded since 1985--anyone that believes the Fed can really, truly, with all their dollars make it work--is wrong. As far as agency purchases are concerned--it's Japan all over again. The world is bigger than the Fed.
Yes, but Howard, see my point below, in the short term, the Fed can influence the long end of the curve through MBS buying, which forces MSR hedgers to hold USTs.
The cap comes off the MBS market, it drags the UST market up with it.
"the Treasury market has been gamed via various machinations by the Fed"
Yeah, no shit. In fact, interest rate swaps - comprising a massive portion of the derivatives quagmire - are responsible for generating immense artificial demand for Treasuries, and thus misleading many market participants, who don't know any better, into the "deflation" hoax.
I fail to understand your comment. Swaps have been around 25 years and are probably the more benign of instruments in the derivatives arena and serve a useful purpose in asset/liability management. Please enlighten me as how fixed for floating via different currencies creates "artificial demand" and if you have data to support it, it would be greatly appreciated.
If corporate, all is covered on a notional/time trade. Naked would be as stupid as AIG--and would involve the same logic they used writing CDS on everything under the sun. Are there rampant naked IRS's happening? I don't know. But I still don't see how even that would create "artificial demand" for TSYS.
Andy,
I've got a friend that traded swaps for 20 years that will return from vacation after Labor Day. He will know the answer on naked swaps, which would only have been played in by hedgies and arbs--but the arbs are in and out so they really don't count. I've tried to wrap my brain around this from every angle to see if it could be a potential problem since IRS are almost always longer term contracts. Additionally, counterparty risk is monumental when CFO's or their appointed underlings are making the decision to enter into them.
Here's my basic premise for investigating: 2 years ago there were few markets to make money in sans commodities and timing those trades or just shorting subprime and equities. Insurance became the big game i.e. CDS and the fools at AIG amongst others thought they had the winning trade. Writing puts or writing calls uncovered with no stop loss is always a fool's game. However, we do have many opaque speculative hedge funds that could have been stupid enough to play the round robin game in IRS. If so, depending on the currency in question and the length of the swap, some may be in prayer mode without anyone knowing, perhaps a Black Swan in the making or perhaps me just thinking too much. So I greatly appreciate your taking the time to ask the question and I will get back to you with at least a probability of this being an issue. It may be nothing at all.
Gordon is still wrong about "artificial demand" because it would not in any way be artificial--it would be real demand. And the truth is if there are naked shorts in IRS they would be in and out hedging their bets since the 10 year yld is essentially flat since early 2008. If you have ever managed a market maker's delta neutral MBS option portfolio in a volatile market, as I have, you are dealing with gamma blows that can take you down in no time at all. IRS are far simpler instruments with distinct time horizons--my guess is they would be using options, not outright buying to hedge, unless they were totally braindead. You would not assume more market risk if your intention was to hedge a longer term short--you would pay the premium.
So I'll get back to you. I appreciate your ZH contributions and respect your investigative mind.
All the Fed MBS buying does create demand for USTs for MSR hedging. But as I say below, I think the bigger issue in ALL markets is the excess liquidity generated by the $800B (and counting) printed to buy MBS and agency debt. What we have is liquidity looking for yield in all markets.
It will be interesting when that liquidity dries up.
Would you say the chain is correct?
FX -> swaps -> gov't bonds -> corp bonds -> equities
Couldn't agree more. I can't see the point of examining past trends to help to predict the future anymore when there is so much blatant manipulation.
Someone wake up those technical analysts. Mass-market QE alone has killed their religion. Perhaps technical analysis was only ever a way to rope in more wannabes. After all, if you and your mates control the market you can ensure TA works. Until it doesn't.
And how on earth can those Elliot Wave advocates cling to their theories with so much certainty given the changing environment?
For what it is worth, I think Doug Noland over at Prudent Bear has it better than anyone else I've read. He's an expert on credit bubbles and is smart enough not to predict either inflation or deflation. As far as he's concerned, the maniacs are running the asylum. All bets are off and all us outsiders can do is stay flexible.
http://www.prudentbear.com/index.php/commentary/creditbubblebulletin
Well said. I fully agree. They can paint the tape and rope-a-dope. Too much evil in this market for any long term good to come of it. Rest assured, no analysis however complex, will predict the event that will rid this world of its massive corrupt and antiquated paradigm. The lesson here to be learned, in my opinion, is of a higher nature. Going forward, what road does humanity choose? We must come up with a better system based on certain universal principles. This is why we are really having these discussions (here.) We know we are getting pimped but still choose to work the track. What is wrong with us?
I thought that same thing while listening to Marla Friday. Lotsa stone throwing, but lotsa trading still too. As TD stated maybe being aware and enjoying it for the casino it is might be the healthiest way to do it, although I'd hate to be "enjoying" this right now if it were my day job. Thick skinned mofo's making it happen.
QE has changed the game. The PPT should be renamed. Theyre in every market every day. GTFO. Unfortunately Gordon Geko , Gold is not a safe haven in this environments. Its gamed as much as the next security and should capital markets degenerate to the extent the gold bugs predict , you'll first have confiscations of property rights (including gold as in the 30s) and then civil breakdown that make holding a nugget or 50 a hazardous affair and mark you out as a target. Might aswell just buy more guns and food if you want a real safe haven.
Any reason why you believe that this "confiscations of property rights" wouldn't also include your guns and food too?
Gold may be gamed, but it can not be conjured into existence by men in dark blue suits.
A grown man can easily carry $50K in gold in his 2 front pockets. That's as secure as I need. If we get to the point that we're worried about our government having access to our front pockets, we're going to have plenty of other things to worry about.
Better to have gold and not need it then to need it and not have it.
Absolutely
1. Guns: check. Rifles, pistols, plenty of ammo.
2. Food: check. Plenty of reserves in three different places.
3. Gold: check. 1/10 oz Eagles, 1/2 oz eagles, 1 oz eagles.
4. Silver: check. 1 oz eagles for spending.
5. Dwelling: 2 houses, both with plenty of the above.
6. Transportation: 4 motorcycles, plenty of gas cans filled.
7. Wife and brother are doctors so plenty of meds.
So, if everything turns out OK, no big deal.
IF, on the other hand, the shit hits the fan, then I'll be more than glad and more than busy.
Actually I have done similar planning and work. Those are definitely the essentials.
Good stuff! You might consider solar power/ buying farmland as well. Getting of the grid, there's quite a few transition towns popping up as well. Being in a group is going to be the difference between surviving and dying in this great crash.
Nice...+1
This is scarry. If that is what going to happen in US of A (i mean shit hitting the fans), I cann't imagine the condition in third-world countries. What happens in China,then? Millions and millions are out of job abd on the road.
Manipulation is too strong a word. The system is designed to inflate financial assets. The system broke for awhile. It's back in working order. It evolves. Within the confines of the system the prices are rational. It only doesn't make any difference when the system breaks. Which it has done with increasing regularity over 22 years.
The most important tell is that the elites have embraced belief itself as the ulitmate fundamental with this Behavioural Economics movement. It is a particularly sad sort of desperation.
Fake it till you make is NOT an economic policy. It's a con game.
Interesting thread. I see big head shoulders movement and we just hit top of head with stocks. they say baltic dry leads stocks by three months and it has dropped a lot. may was the head in bonds. I don't mind the delay between these markets as I EXPECT IT. I agree with all the manipulation you don't knw what the hell is going on.
This is how its always been. I dont think 90% or more of the people who invest in the markets have ever had a clue. Its the same game different, just a different point in time with different distributions and players.
Great article Tyler. The only thing I disagree with is that there are chairs -- they are called gold. ;)
...with silver arm rests.
The stock market is not rallying in anticipation of inflation, as you suggest. It is rallying because it is being manipulated by the Federal Government. The reason it is being manipulated is the same reason the government bailed out the banks: to prevent a collapse in confidence which would have been succeeded by a collapse in demand.
But, as the Federal Government is fully aware, the collapse in demand has only been stretched out a few months longer. We will be in a fullscale deflationary collapse in demand by November.
This will be followed by a new $2 trillion stimulus bill proposed in February. But consumption will keep collapsing.
As you suggest, bond yields are also being kept positive by manipulation. This is also to prevent a collapse in confidence, followed immediately by a collapse in consumption.
The point is that demand is tanking. This is something which cannot be stopped, and can decreasingly be managed.
I see the rise in stock, bond, and commodities markets all related - they are indicative of excess liquidity flooding all markets. Banks are putting excess reserves into USTs, equities, commodities, whatever.
Likewise, if/when liquidity gets removed, they may all crash simultaneously. Though I feel comfortable with my oil holdings, for now, as the crash of the USD should keep oil strong. But I have my finger on the sell button, just in case.
was talking to somebody working in credit card industry - new rules taking effect will drastically alter credit spend on cards. Debit card sales have already overtaken credit...music has stoped playimg for that industry. The reversal effect wil be 10X the clunkers program..
Good discussion.
However, anybody who believes that deflationary collapse will not inevitably result from and is ultimately worsened by QE must have missed the election results over the weekend which was, in terms of Japanese politics, tantamount to a bloodless coup.
QE only assures that the inevitable deflationary collapse will only be deeper and more prolonged than what would have otherwise been experienced if the market pricing mechanism was allowed to function properly through the required deleveraging and liquidation. As investors are becoming increasingly aware that asset prices are being manipulated and totally divorced from underlying economic fundamentals, they will increasingly withdraw from the rigged casino and seek refuge in government debt. It's simply human nature not to want to pay too much for something.
The volatility over the last 10 years in asset prices for equities, bonds and real estate is now scaring off the vast majority of investors in the world just as it has done to the pensioners holding all the money in Japan -- at least the ones who invested prudently in postal savings accounts.
Ziggy
While eshewing equity markets may be the general direction for investors, realize that a lot of private money is held within mutual funds, which, by their very nature (getting fees paid for assets managed -- not performance), encourage investors to "have long term outlook". Thus, Mutual Funds always want to be invested in the market, otherwise they will go out of business. The conflict of interest here is frightening for vast majority of funds. And that pretty much goes for most funds, with exception of certain strategic/hedged strategies (Hussman Strategic Growth Fund comes to mind). Otherwise, it may take another 'lost decade' for long term investors to wise up and pull susbtantial amount of money out of these funds, and thus out of the market.
They play the trading ranges and they buy in on the technical lows and sell on the technical highs and deal with the news in between, in most cases getting it first.
If you can't think like a market maker and beat them at their own game, then stay out.
With regard to interest rate swaps
http://en.wikipedia.org/wiki/Interest_rate_swap
massive leverage and lack of liquidity can come from many places...
http://www.bearcave.com/bookrev/genius_fails.html
Posted by TD at the top...
As for the commodity market, while the CFTC laments the passage of a time when several major banks could easily manipulate all commodites, China has quietly taken matters into its own hands and has informed ISDA that it will soon be unliaterally terminating commodities contracts, having said enough to the persistent irrational market which day after day gets the CFTC's blessing to continue mispricing assets courtesy of a select few speculators.
As for Oil..
The price of oil can be moved any way the wind blows by any number of like minded players seeking the same objective.
US Dollar has been giving bullish signals for several months now.
10 year daily chart is turning bullish too.
More here:
http://www.zerohedge.com/forum/market-outlook