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.