When The "Worked So Far" Meme No Longer Works

Tyler Durden's picture

There is a potentially new macro paradigm evolving which Saxo's Steen Jakobsen calls: Reality Hits as the Marginal Cost of Capital Normalizes. The Bermuda Triangle of Economics is that the world, so far, has been kept in artificial equilibrium by the way quantitative easing (QE) and fiscal policies bring support and endless liquidity to the 20 percent of the economy that mostly comprises large and already profitable companies and banks with good credit and good political access.

The premise for supporting these companies is based on the non-existent wealth effect which unfairly culminates in supporting the haves to the detriment of the have-nots. However, as Jakobsen notes below, things are rapidly changing.

The recent increase in yields has happened despite no real improvement in the underlying data and he sees the the next few days as potential major game changers – the bloated VaRs will make people hedge and over hedge, and the normalization process of rising risk premiums due and higher real rates (higher yield plus lower inflation) will lead to more selling off of those trades that have "worked so far"... and increase volatility in their own right.


Via Saxo's Steen Jakobsen,

Just as I felt confident in my new macro model: The Bermuda Triangle of Economics, or BTE, the market cycles are changing again. But this recent potential macro paradigm shift is interesting and can also be explained by the BTE model. I call this new phase in the market: Reality Hits as the Marginal Cost of Capital Normalises.




The world, so far, has been kept in artificial equilibrium by the way quantitative easing (QE) and fiscal policies bring support and endless liquidity to the 20 percent of the economy that mostly comprises large and already profitable companies and banks with good credit and good political access. The premise for supporting these companies is based on the non-existent wealth effect which unfairly culminates in supporting the haves to the detriment of the have-nots.


Meanwhile, the 80 percent of the economy that is composed of  productive, innovative, job-creating and less capital intensive small and medium-sized enterprises has been left to fend for itself. This segment is starved of credit and the upshot is the current malaise of low innovation and high unemployment.


Meanwhile, despite the economic distress, we have nothing but silence on the social discontent front, which can only be explained by the “success” of generous entitlements in the developed economies. Indeed, we are the Entitlement Generation. We are not compelled to challenge the government and central bank policies when more than fifty percent of the population benefits from income transfers directly from the state. This is a proof of the old game theory idea that the individual can be rational while the sum of individuals’ behaviour is irrational.

What would upset this equilibrium?


the real tipping point for the old paradigm is only reached via an increase in market volatility – something that appears to be unfolding at the moment.

This is the point at which the market feeds back into the fundamentals by disturbing the false calm of equilibrium through a bloating of Value-at-risk (VaR) models.

When the market gets more nervous, volatility rises and the market jumps back and forth in a discontinuous fashion, moving away from the previous, very long one-way street lower driven by the compression of the risk premium from policy intervention and the resultant yield chasing (combined with benign inflation from the output gap). The culprit for this bout of volatility? Abenomics!

JGB contract historic volatility 50 and 100 days….(Source: Bloomberg LLP)



For all its success in getting the Nikkei higher – and until recently, USDJPY as well, Abenomics also dramatically increased volatility in Japanese government bonds (JGBs), which was certainly not the intention. This increase in JGB volatility had people like me going short USDJPY as this acts as a brake on the simple idea that the USDJPY is a straightforward carry trade driven by the anticipation that Abenomics will have Japan having its cake and eating it too. When bond market volatility jumps, carry trades head south fast. And note how the JGB volatility saw contagion in the US bond market, with the US 30-year mortgage bond yield spiking 76 basis points recently.

The benchmark US 10-year US T-note has moved so much that the world’s most famous bond investor, Bill Gross, has lost 335 bps in his PIMCO Total Return Fund from this year’s high in April. And he is down 169 basis points for the year-to-date in a fund that is known for its stability


30-year US Mortgage rate (Source: Bankrate)




So in short, the dramatic changes to fixed income and overall market volatility probably had 70 percent to do with the failure thus far of Abenomics to perpetuate the themes of QE and easy money. The reason for this (as I have stated several times) is that Japan has come far too late to the party.



What makes Japan’s timing even worse is the fact that risk premiums were already extremely compressed – meaning that they were pushing on a string from the very start as macro players were already gunning for yield and leveraged to the hilt.

Look at corporate and investment yield tickers like HYG and LQD, both of which are down in excess of five percent from the top. So what we are seeing now is also a “normalisation of risk premiums” – which is long-term very healthy and could at best mean that we are moving towards real “price discovery” again in the fixed income market. This will mean that we may begin to know the real price of money both in time and yield – at least in those sectors outside the control of the silly central bankers.

The other major area I want to touch on which makes this move in yield truly alarming is the trend in global current accounts. I have said a few times that the lack of recycling going forward is a major issue not only for the US, but certainly for all current account-deficit countries. (This has been a major drive for the sell-off in emerging market assets and currencies.)




The trend is clear: From surpluses of five to seven percent of GDP – ergo, savings excess that needed to be recycled into US government bonds to avoid currency appreciation, Asia is barely showing a surplus and Brazil, Russia, India and China (the BRICs) will in my estimation move to a collective deficit inside the next 12 months, with Japan joining them on the current account deficit side. This means the biggest traditional institutional buyers of government debt have effectively disappeared, and may begin to even sell their holdings.

Are you worried yet? You should be.

The final straw
Looking at the US economy, the recent increase in yield has happened despite no real improvement in the underlying data. Imagine if the US economy started to slowly pick up from these low levels of activity over the summer due to lower energy prices, a “feel-good factor” in confidence, and a slightly better housing market.

Are you ready for a three percent 10-year yield and a five percent 30-year mortgage rate in an economy with less than two percent real growth?

Probably not, because no one else is either.



I see the next few days as potential major game changers – the bloated VaRs will make people hedge and over hedge, and the normalisation process of rising risk premiums due and higher real rates (higher yield plus lower inflation) will lead to more selling off of those trades that have “worked so far”… and increase volatility in their own right.

I have not even mentioned the constitutional court ruling in Karlsruhe which the Anglo-Saxon press and banks with their usual naïveté of everything German have written off as a non-event. Reading Der Spiegel last night I got concerned about the consensus but judge for yourself. These are very much Decisive days for Euro: High Court considers ECB Bond buys.

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Flakmeister's picture

There has always been economic recovery until there wasn't....

RockyRacoon's picture

It's all in the definitions.  Obviously our definition of "recovery" is not the same as the market players.

CrashisOptimistic's picture

Blah Blah Blah

Cost of capital bullshit.  The Fed has provided 0% short term borrowing to CFOs who have used the money to buy back their own shares.

ZH had the recent article laying out that only 1/3 of EPS improvement over the last few years has been from E.  The rest was contraction of PS.

It's all bullshit.  End to end.

mick68's picture

I've come to expect nothing to happen anymore, after dozens of potential "gamechangers" with the status quo remaining firmly in tact. The sheeple and moneylovers are on side with the elites, therefore simply stating truth has no effect. Truth has to bitchslap the system into submission before anything will ever happen. 


Actual gamechangers: Hot war with real countries involved. ie;Iran, Russia, China.   Comex running out of gold.   USA's fiat being sent back to it by the trillion per year.  Revolution or Coups in the US(if only).  9.9 quake in Japan, or any major city. 


You get the drift.

RockyRacoon's picture

It's about time the pile of string they've been pushing got higher.  Enough to hang themselves with I'll wager.

Now, how do I explain this article to my neignbor so that he gets it?  Nah.  Never mind.

otto skorzeny's picture

Just talk about dumb shit like sports and how good the lawn looks-I've tried the heavier discussions and I get a blank stare.

ebworthen's picture

Someone is going to leave a new roll of aluminum foil in your mailbox if you don't start talking about the weather and Kardashian's baby.

Zero Point's picture

I've glued hair on mine, so I look normal.

SAT 800's picture

You explain it like this; someone has to buy the Bonds the Bankrupt US Govt. issues to monetize it's operations; the traditional large buyers are disappearing; this will cause, ultimately, financial disaster; which will affect him, and you; directly.

RockyRacoon's picture

Nuh-uh.  I'm not going to be the Debbie Downer of the neighborhood.  I wouldn't get any more invitations to the backyard crawdad boils.  Yum.

What's a Kardashian?  Does he play for one of those sports teams?

Midasking's picture

Gold:Dow ratio 1-1???? that day is coming http://tinyurl.com/mem7o7x

SpiceMustFlow's picture

one way or the other, or both simultaneously

SAT 800's picture

When he references Saxo's Steen Jakobsen; what he's referring to is SAXO BANK; an absolutely remarkable instiution. It's a rationally run bank; a fairly good size one, headquartered in Denmark, with a large office in the City, (London); they hire people who study reality instead of the paint job; I am always glad to read anything that comes from there. Also, they have an exrtemely good on-line trading platform which you can fund and use from your computer; it trades Silver and Gold Spot; and FX; among other things. They're compltely solvent and rational and shoud be considered seriously by anyone wanting to diversify holdings and trading accounts. Their customer service and the operaton of  their trading platform is world class; it's flawless.

Kreditanstalt's picture

"This segment is starved of credit and the upshot is the current malaise of low innovation and high unemployment."

Wrong.  No one now even needs credit for any bona fide investment reason...only for dividends, buybacks and speculation.  There is ALL TOO MUCH fake, easy credit available. 

Large companies, banks and the politically-favoured have had access to incredibly easy money courtesy of the Fed's manipulation of interest rates and destruction of anything resembling a free market in credit.

And an unproductive, over-expensive economy will produce low innovation and high unemployment, and in that situation what smaller businesses need even more cheap credit anyway?

There is overcapacity EVERYWHERE.  Who wants to borrow?

SAT 800's picture

You're compltely wrong. Read the article again, carefully. He's referring to the 80% of the economy that could actually produce jobs. Be careful falling in love with the sound of your own voice; this is a man in a position to understand the situation much better than you do; and he doesn't have a day job; this is his job.

Kreditanstalt's picture

Rubbish.  Steen Jakobsen: a Keynesian macro-analyst.  He's probably never walked down a Main Street in years...

He seriously believes "small business is starved of credit"??

Does he ever ask why they would even WANT credit now?

A guy who refuses to believe the problem is SOLVENCY.

Abi Normal's picture

I dunno here, I was listening to my local radio station and they interviewed the top hauncho for the SBA, can't remember his name.  But to boil it down, he said small business' are tightening, as they cannot get loans, due to the fact most of the SBA loans go to Fortune 500 companies.  I found it hard to believe, but he was stating facts that the radio guy grilled him on.  Plus the effects of ObamaoCare are not helping, as they are crippling the decision making of said small businesses.  Maybe the guy is full of it, but the confidence is WAY down right now!  My two cents for what it is worth...

SAT 800's picture

I regard this as a very serious article. what he's talking about is the "sound of the second shoe dropping"; basically what we're all waiting for; the exhaustion; or even first hard date that indicates exhaustion on the horizon, of the buyers of US Bonds. As the head of the Chinese Bank remarked a couple of years ago; vis a vis the projected government financing in the US; "there isn't that much money"; (to buy the bonds). Basically, we might make it through 2013 with only occasional seismic events; but 2014 appears to be un-imaginably far in the future; or part of a future that simply doesn't exist.

thereisonlyonelaw's picture

The collapse is scheduled for September 2015.

lolmao500's picture

Well well well...bullish.


Russia ‘actively engaged’ in Syrian war, Israeli source says

An Israeli security source said that Russia is actively engaged in the Syrian conflict helping Syrian troops by providing intelligence-gathering technology, Al Arabiya’s correspondent reported.

“Russia is effectively and actively engaged [in the Syria conflict] beside the army of the Syrian regime by [providing] drones that are collecting information and data and relaying them to Syrian troops,” said the source on condition of anonymity.

The news comes on the heels of Russia’s statement that it would not allow for a no-fly zone to be imposed over Syria, Foreign Ministry spokesman Alexander Lukashevich said on Monday, according to Reuters.

CrashisOptimistic's picture

Russia is the most powerful nation in the world.

Their active engagement in Syria need be nothing more than a casual reach out of their hand to turn the spigot 1/2 a turn.

If they make their 10.5 million bpd oil output 9.0 mbpd, Obama will retreat faster than the British at Dunkirk.

thelibcentury's picture

perhaps i missed it, but did we ever get a constitutional ruling on OMT? I can't find anything recent (24 hr) in the press stating clearly one way or another...is the decision still in process?

silver surfer's picture


"Tuesday and Wednesday of this week there will be a European family row of sorts before the court in Karlsruhe, with the ECB pitted against the Bundesbank. One thing is certain, the judges are likely to ask endless questions."

thelibcentury's picture

That's my point, why are you ref'ing week old articles when I'm requesting info on the result of what the articles only anticipate? Why don't people read before they take time to respond?

ebworthen's picture

The Fannie/Freddie FHA bubble must be maintained, along with Ben's MBS "babies".

The Bernanke may just announce no end to QE, and the creation of 10 day Treasuries.

At this point I'm so confused by all the bullshit I don't really know what to think, which is probably their goal.

css1971's picture

And cash will be crowned king.

SAT 800's picture

Not exactly. The default failure for the mechanism that's now in place is hyper-inflation. Silver will be crowned king.

sunny's picture

Japan is up today, US markets up today....  WHAT IS THE PROBLEM?  Don't you folks understand that Big Government is doing all it can to keep a majority of voters happy?


Abi Normal's picture

What's to worry about, ole Uncle Ben and Aunt Abe are totally in control of things!  How could anything go wrong.  /sarc off

This whole crapshoot is just that, they have no idea what the outcome will be, and are going by historical standards...but they forget history does not repeat, it just rhymes.  

When the poem goes awry, we all will pay and pay dearly!  You know the drill, beans and bullets to protect those beans...oh, don't forget the water, Reg!

Bloody Romans, what have they ever done for us!

Colonel Walter E Kurtz's picture

In the process of trying to get a main street (small) business loan which is expected to come through in about 2-3 weeks, so can we please just have this ponzi scheme last another 4 weeks or so!

You know what this means, get your money out, cause the bottom is going to fall out in very short order.

I apologize in advance to all ZHer's for the coming calamity.