"Nothing Makes Sense Anymore" Traders Fear Debt Market Distortions Signal "Something Big Is Brewing"Submitted by Tyler Durden on 11/16/2015 19:00 -0500
In the last few months we have warned of the "perversions" in US money markets (here, here, and most recently here) adding that "to ignore them at your own peril." And now, as Bloomberg reports, it appears the mainstream is beginning to recognize that something very strange is going on in debt markets. Across developed markets, the conventional relationship between ('risk-free') government debt and other 'more risky' assets has been turned upside-down. "Everybody in the fixed-income market should care about this," warns a rates strategist and in fact, it’s hard to overstate how illogical it is when swap spreads are inverted, as JPM warns the moves in swap-spreads "should be viewed as symptomatic of deeper problems."
Once again we feel the close tug of systemic illiquidity as it transcends the usual noise about assurances to ignore or trivialize all this growing uncertainty. Even though stocks and other assets have been trading in their own world mostly free from all this more hidden esoterica, the full weight of this analysis suggests that can’t be more than a temporary deviation. Since it is the angle of economy that is ultimately driving all of this, everything depends upon a global economy that has already been beaten down far past anticipation.
With crude stocks moving up solidly despite inventories being still almost one-third above the “cycle” trend from 2009 through 2014, the economics of that behavior suggest the opposite of what the FOMC would like to project. And that would seem to bridge the eurodollar curve’s front and back ends, aligning it with commodities more generally. In that view, eurodollar futures are suggesting exactly what they have been for almost a year and a half – that the Fed might or might not act, but if they do it won’t alter the economic course but only wield the potential to make a bad (and growing more so) physical and general economy situation that much worse.
While the stock market had one of its best months in years, it was, like the jobs report, uncorroborated by almost everything else. The junk bond bubble, in particular, stands in sharp and stark refutation of whatever stocks might be incorporating, especially if that might be based upon assumptions of Yellen’s re-found backbone. As noted on several prior occasions, swap spreads have been sinking fast and to unprecedented levels. Though mainstream commentary will provide plausible-sounding excuses, mostly about corporate or even UST issuance, that is only because these places will not even consider that Janet Yellen has it all wrong; thus, they only search for possibilities that allow that narrative to remain undisturbed even though that narrative itself can never account for negative spreads.
At the height of the financial crisis, the unprecedented decline in swap rates below Treasury yields was seen as an anomaly. The phenomenon is now widespread, as Bloomberg notes, what Fabozzi's bible of swap-pricing calls a "perversion" is now the rule all the way from 30Y to 2Y maturities. As one analyst notes, historical interpretations of this have been destroyed and if the flip to negative spreads persists, it would signal that its roots are in a combination of regulators’ efforts to head off another financial crisis, massive corporate issuance (which we are seeing), China selling pressure (and its impact on repo markets) and "broken" wholesale money-markets.
Despite the world seemingly exuberant at Turkey's fraud election, sparking the biggest rally in the Lira since Nov 2008 (confirming once again that "markets love totalitarian governments,") it appears the centrally-planned machinations of the US equity markets are not living up to their promises of wealth for all (and rate-hikes don't matter). US and Japanese equity futures are opening notably lower, erasing all of the post-Fed exuberance with Dow Futs down over 200 points from pre-BoJ hope highs. Finally, gold futures were hammered lower at the Asia open (on heavy volume) only to rip back to practically unchanged.
How We Got Here: The Fed Warned Itself In 1979, Then Spent Four Decades Intentionally Avoiding The TopicSubmitted by Tyler Durden on 10/30/2015 17:45 -0500
At least parts of the Fed all the way back in 1979 appreciated how Greenspan and Bernanke’s “global savings glut” was a joke. Rather than follow that inquiry to a useful line of policy, monetary officials instead just let it all go into the ether of, from their view, trivial history. But the true disaster lies not just in that intentional ignorance but rather how orthodox economists and policymakers were acutely aware there was “something” amiss about money especially by the 1990’s. Because these dots to connect were so close together the only reasonable conclusion for this discrepancy is ideology alone. Economists were so bent upon creating monetary “rules” by which to control the economy that they refused recognition of something so immense because it would disqualify their very effort.
Eurodollar curve captures the mechanics of Fed expectations in a simple way. Away from the very front end, the curve dynamics is displays a rather rigid structure where a single risk premium parameter explains bulk of the spreads movement in different sectors of the curve. Typically, in anticipation of Fed hikes or cuts, the market makes up its mind about the terminal Fed funds (Greens) and begins to price in the rates path around that. The more aggressive the initial hikes are, the less they will have to do later
Doing as Yellen and her counterparts demand is the biggest risk of all. The Yellen Doctrine requires that central banks be both correct and able, abilities that have been (and can only be) in utter short supply. Her view would show more proactive and effective central bank management where only reactive and impromptu, last minute white-knuckling has abounded. Central banks have been in the past year only holding on for dear life, which is where obscurity has been their benefit. In the end, however, it will bring about their own downfall as it only serves to make matters worse. Yellen wants the central bank to be viewed as almost godlike, but they continually reveal themselves weak, deceptive and ineffectual; eschewing all long run sustainability in order to just make it through one day at a time.
Austerity: Also known as “sado-fiscalism”. A forlorn attempt to stave off government bankruptcy.
Keynesians: Economists “who hear voices in the air (and) are distilling their frenzy from some academic scribbler of a few years back” (John Maynard Keynes).
There can be little doubt that the massive, unprecedented surge in inventory accumulation (which counts positively to GDP) will eventually be liquidated. When it does the US enter recession, global dollar liquidity crashes, the value of dollar surges even higher, pulling EM further down and a world recession will be upon us again. In this scenario central banks panic...
While record mainland deficits covered by the petroleum sector is nothing new in Norwegian budget history, on the contrary it is closer to the norm, the 2016 budget did raise some eyebrows. The other side of the ledger, the net inflow to the SWF from activities in the North Sea will, again according to budget, be lower than the required amount to cover the deficit. This has never happened before and is testimony of the sea change occurring in the world of petrodollar recycling.
"We believe the US will be in recession before the end of 2016 and then things will be really interesting. How will the public receive news of more QE, NIRP, forward guidance, cash bans and capital control in a time when faith in central bank omnipotence disappears?"
At the height of the financial crisis, the unprecedented decline in swap rates below Treasury yields was seen as an anomaly. The phenomenon is now widespread, as Bloomberg notes, what Fabozzi's bible of swap-pricing calls a "perversion" is now the rule all the way from 30Y to 2Y maturities. As one analyst notes, historical interpretations of this have been destroyed and if the flip to negative spreads persists, it would signal that its roots are in a combination of regulators’ efforts to head off another financial crisis, China selling pressure (and its impact on repo markets) and "broken" wholesale money-markets.
There is growing turmoil in buybacks that threatens the very fabric of the stock bubble. That was always the primary transmission of the foundation of its current manifestation, corporate debt, into asset prices; especially the huge run following QE3 and QE4. The problem once momentum fades is that investor attention turns toward valuations that were repeatedly ignored before. As long as everything is moving upward and any fundamental downside is completely contained (in perception) as “transitory” then valuations are easily set aside as one form of rationalization. The effect of reversing momentum is for a more honest measurement; particularly by force of change in economic sentiment which is almost always concurrent.