Yield Curve

While the euro itself has recovered a bit from its worst levels in recent sessions, euro basis swaps have fallen deeper into negative territory on par with the epic nosedive of 2011. We are not quite sure what the move means this time around, since there is no obvious crisis situation – not yet, anyway. A negative FX basis usually indicates some sort of concern over the banking system’s creditworthiness and has historically been associated with euro area banks experiencing problems in obtaining dollar funding. This time, the move in basis swaps is happening “quietly”, as there are no reports in the media indicating that anything might be amiss. Still, something is apparently amiss...

To be blunt about it, the Federal Reserve under interest rate targeting clearly and artificially shifted the treasury curve toward steepness; they did so as a means to influence investor behavior and, as silly as it sounds, mood. In other words, the yield curve is not made solely out of actual market and fundamental conditions, but of influence from decidedly non-market political action (actually only threats of action that have been forced only since 2007). Given that station, there is no real reason to believe that absolute levels bear any similar resemblance to signals of past function... in other words - waiting for curve inversion as a signal of recession is no longer valid.

Does it really take purportedly intelligent people six years to see that the macros are not responding? Better still, isn’t it time for the Fed to explain the exact channel by which its interest rate pegging and forward guidance is supposed to be transmitted to the main street economy? After all, if these channels are blocked or ineffective - then its flood of liquidity never leaves the canyons of Wall Street. In that event, the central bank actually functions as a financial doomsday machine, inflating the next financial bubble until it bursts. Then, apparently, its job is to rinse and repeat.

The question stands: how much longer will the Fed allow the ECB to export its recession to the US on the back of the soaring dollar, and how much longer will the market be deluded that "decoupling" is still possible despite a dramatic bout of weakness in recent US data. Look for the answer in today's BLS report, which - if the Fed is getting secound thoughts about its rate hike strategy in just 3 months - has to print well below 200,000 to send a very important message to the market about just how much weaker the US economy is than generally perceived. For now, however, the ECB is getting its way, and the question of just how much European QE is priced in, remains open, with peripheral bond yields dropping to new all time lows for yet another day, while the EURUSD has plunged to fresh 11 year lows, sliding below 1.094, and making every US corporation with European operations scream in terror.  Looking at markets, US equities are just barely in the red, coiled to move either way when the seasonally-adjusted jobs data hits.

Just like yesterday, it has - so far - been mostly about Asia in the overnight session, where as reported previously, we got the latest central bank engaging in an "unexpected" rate cut, after Reserve Bank of India Governor Rajan cut rates in an unscheduled move days after the government agreed for the first time to give the central bank a legal mandate to target inflation. This was India's second rate cut in 2 months, and yet despite the Sensex surging to a all time high over 30,000, it subsequently ended up closing red on the day, down -0.7%, despite the Indian currency sliding 0.4% to 62.1463 to a dollar. Is the half-life of thany incremental rate cut in an unprecedented barage of global central bank easing now less than a day?

"The Fed is out of control," exclaims David Stockman - perhaps best known for architecting Reagan's economic turnaround known as 'Morning in America' - adding that "people don't want to hear the reality and the truth that we're facing." Policymakers are "taking our economy in a direction that is dangerous, that is not sustainable, and is likely to fully undermine everything that's been built up and created by the American people over decades and decades." The Fed, Stockman concludes, "is a rogue institution," and their actions have led us to "one of the scariest moments in our history... it's a festering time-bomb and we're not sure when it will explode."

Another quarter of no “escape velocity” on main street and a further round of Kool Aid drinker speculation on Wall Street takes us just that much closer to the brink. Yet the Fed remains oblivious and continues to manufacture excuses and equivocations as to why ZIRP should extend into its 80th month and beyond. This is mis-governance on a colossal scale. So when the next thundering crash occurs - it is devoutly to be hoped that “audit the Fed” turns out to be the least of the threats descending on the Eccles Building.

What in god’s name does Janet Yellen think she is doing? Just a few weeks ago she established the ridiculous Fedspeak convention that “patient” means money market rates will not rise from the zero bound for at least two meetings. Now she has modified that message into “not exactly”.

Following a quiet overnight session in which the main event appears to be a statement by Chinese premier Li for more active fiscal policy, which has pushed the metals complex higher, although technically every other asset class as well, with US equity futures set to open in fresh record high territory, even as 10Y yields around the world continue to decline, attention today will fall on the CPI print due out shortly, because if consensus is correct, January will be the first month this decade when US inflation posts a negative print, mostly due to the delayed effect of sliding commodity prices. As Deutsche recaps, the most important number today is the headline CPI where the headline YoY rate is predicted to be negative by the market (-0.1%) for the first time since 2009. Over this period the YoY rate stayed negative for 8 months. However before this we hadn't seen a full year decline since August 1955. In other words, a few months before what may be the first US rate hike for a new generation of traders, the US is set to print its first annual deflation since Lehman, transitory or not.

Following the first of two Janet Yellen testimonies to Congress, the market read between the lines of what the Fed Chairman said when she hinted that "the Fed needs confidence on recovery and inflation before beginning to raise rates" and realized that the case of a June rate hike is suddenly far less realistic than previously expected, as a result not only did we see another blowoff top in stocks to fresh all time highs, a move which sent the USD lower, has pushed the median EV/EBITDA multiple to the mid 11x (!) range and the forward PE to just shy of 18x ironically coming on a day when the Fed itself warned about "stretched" equity valuations, and led to brisk buying of global Treasurys across the board, pushing the 10 Year in the US back under 2%, and due to the global convergence trade (because if the Fed returns to QE, it will be forced to buy up Treasuries not just in the US but around the globe, since net issuance including CBs globally is now negative) and leading to today's German 5 Year bond auction pricing at a negative yield for the first time ever.

It turns out that the next best thing to Greek contagion in this bizarro, centrally-planned world is... anti-contagion.

Yet another weak Japanese bond auction (this time 5Y maturity - lowest bid-to-cover and biggest tail since 2013), on the heels of last night revelations of a growing chorus of JPY-devaluation-fears has many wondering if the faith they placed in The BoJ's grandest experiment was wrong after all. With speculators now net short for Japanese stocks for the first time since Abenomics was unleashed, a series of weak bond auctions and a spike in JGB yields since the ECB unleashed QE, and now a surging JPY (tumbling USDJPY) as carry trader around the world pull back on leverage and exposure... perhaps - the idea that a nation can devalue itself into prosperity on the backs of the rest of the world was total idiocy after all and Kyle Bass' Potemkin Village is about to fall.

The monetary politburo has every reason to fear Rand Paul’s demand for a “policy audit” of the Fed. An honest one would show that its so-called “independence” has been monumentally abused in a manner which is deeply threatening to both political democracy and capitalist prosperity. Needless to say, we can’t have that audit soon enough. In short, what the nation really needs is not an “independent” Fed, but one that is shackled to a narrow and market-driven liquidity function. The rest of its current remit is nothing more than the self-serving aggrandizement of the apparatchiks who run it; and who have now managed to turn the nation’s vital money and capital markets into dangerous, unstable casinos, and the nations savers into indentured servants of a bloated and wasteful banking system.

As UBS' Maury Harris proclaims in the headline, "don't be out of the office on June 17th" - the mid-year FOMC meeting. Today's jobs data will only serve to boost the Fed's confidence that they are reading the labor market correctly, and that is being rapidly 'priced-in' to the short-end of the yield curve as implied rates surge...