The divergence between the 'hope' melt-up in stock markets and the 'nope' collapse of the US Treasury yield curve has never been so wide... and has never engendered so many excuses by commission-takers and asset-gatherers for why the latter is wrong and the former correct.
One thing is clear, as The Fed tightens rates, the market is increaingly insensitive to the next tightening as financial conditions have eased dramatically as the Fed tightens. Former fund manager Richard Breslow suspects 'you ain't seen nothing yet' as the linkage between FOMC raising rates and a flattening yield curve suggests this tradable trend is far from over.
The yield curve in the Treasury market has continued on its flattening way. Look at a one-year chart and it shows a relentless, if at times choppy, move from its widest at the beginning of the period to today’s new tight. Everyone seems to have their theories why and what it means, giving clear proof that great minds can differ. And even the bond market isn’t simply well-established science. One thing that they do agree upon is the obvious: it’s been a clear, tradable trend. But before we start waxing eloquent on the historic magnitude of the move, keep in mind, this tightening absolutely pales in comparison to several others of the last 25 years.
It’s perhaps been so confounding only because, for all the ink spent on it, it’s been relatively gentle and gradual compared to past episodes. And why should that be?
Perhaps because the FOMC has been raising rates at such a slow, methodical pace. And even then, investors continue to doubt the dots, despite December being taken as a given.
[ZH: As we noted previously, financial conditions did not snap tighter until The Fed has tightened rates to 5.25% in 2007]
Yield-curve moves have been intimately linked to FOMC policy direction and the speed of change. So, consider what might happen should the market come around to the Fed’s forecasts. Or the other way around. But don’t think the spread is necessarily anywhere near some impregnable floor.
And, most certainly, avoid falling for the notion that all by itself it will tell you where the economy is headed. That’s only the case if you believe the Fed always ends up over-doing it. Which may indeed explain the Greenspan era and why bond traders loved him so much--once everyone was able to put the 1994 spat behind them and he worked so hard to make it up to them.
All of this raises another angle to ponder. The Fed continues to enjoy a tremendous free-ridership advantage of tightening while the ECB and BOJ keep pumping in liquidity. Investors are forced to keep buying Treasuries on any back-up, and if not gagging on the prices, certainly retching every time there’s a lecture about complacency. Governor Kuroda has been emphatic that Japan must motor on pumping in liquidity with inflation continuing so low. President Draghi was able to fend off those who wanted a “clear exit” from asset purchases.
Many doubt, however, this forward guidance will hold. It’s not as if QE is exactly popular any more. And if economic slack continues to disappear any hint of inflation will be met by two competing responses.
Calls to let prices overshoot and be patient. And markets rushing to price in policy shifts from these two banks. That’s when all the back-slapping about how well it’s all going gets tested. It’s unclear whether this “all clear” sign for the rest of the world will let the Fed loose or make them rein in their ambitions.
The only thing we can be reasonably sure of, Breslow concludes, is the Fed realizes that whatever happens they need to make hay while the sun shines and history argues that is a curve flattener.