As the mainstream media finally made a big story out of capital flows after ignoring the topic with impunity for 33 straight weeks (of $90 billion worth of outflows), the question many ask themselves is whether last week's minimal inflow into domestic equity funds is indicative of a shift in risk sentiment, and more specifically whether the outflows in bonds will if not accelerate, then at least remain at their current elevated levels. Probably the best answer to that will come from looking at not only the price action of the most liquid rate instrument, the 10 Year, but the actual net money flows for all UST contracts. While the first can be done with any charting program, the second is slightly more complex and for that we go to Credit Suisse's Carl Lentz and Eric von Nostrand.
As the chart below shows, as always happens when there are regime changes, the bulk of the actual money move occured well before the marginal buyers, or in this case sellers, managed to move the 10 Year Titanic around. What is curious is that the "Net Lifts" (red line) in the TY and derivatives basket peaked at the end of Q2, and has been declining ever since in a pretty much straight line fashion. We say curious because as the gray line shows, bonds actually continued their ascent, with yields approaching 2% in the start of Q4, and just after QE2 was a go. Indeed, nowhere have we seen a more pronounced sell the news event in 2010 than what happened to long bonds following Brian Sack's return to POMO markets. Yet while the 10 Year yield is not at either extreme, recently seen just north of 3.3%, the net lifts have bottomed, and the revulsion appears to be complete. Does this mean that with smart money no longer bailing, it has no other choice than to start buying again? And will this lead the actual move in yields lower just like it did 6 months earlier? We will keep readers updated on this very interesting data point which may just be the best leading indicator of what is happening in rates.
And, a curious tangent, the very same Eric Van Nostrand appeared on Bloomberg Surveillance yesterday, with the following circular analysis of why the mere presence of QE2 means that QE2, 3, and infinity are sure to follow.
"The Credit Suisse view is that there would be little point for the Fed to get involved in QE2 if they weren't already committed to QE3, and the reason we say that is that the 600 billion that's planned through June isn't that big when compared to the GDP, when compared to the debt stock. So if the market starts to expect that the Fed's not going to be buying anymore treasuries after June, then all that's going to lead to is a rush to sell in advance, which is definitely not what the Fed wants."
In other words, should Ron Paul make some - any - headway in ending the US domination of the currency debasement game, and the marginal benefit of nearly $3 trillion in monetary stimulus (by then) disappears overnight, watch out below. Which is why, as we have repeated many times, any predictions about what happens in 2011 are by and far irrelevant. The only that does matter is what happens i) to the Fed and ii) to future iterations of QE. Everything else is a pure derivative. And to those who naively believe they can predict points i) and ii) above, we have some BBB-rated CMBX 3 we can't wait to offload at par.