Blain: "Stop Worrying About The Yield Curve, Something Much Worse Is Around The Corner"

From Blain's Morning Porridge, Submitted by Bill Blain of Mint Partners

Stop worrying about the US yield curve - its a distortion. Something much worse is around the corner....

A bit of a feeding frenzy in the new issue primary bond market as 21 deals hit the screen and went fairly well. With Thanksgiving tomorrow it’s likely the tail of the week will be very quiet, but our primary trading team reckon there is still plenty of momentum. We’re likely to see another two weeks of proper activity before the holiday slowdown. There are a large number of deals queued up and still to come to market.

I wonder if the Credit Markets will be as busy next year?

It rather depends. Regular readers will know I’m uber-bearish and expecting the big bond market crash coming sometime soon, but others point to the US yield curve as evidence of a slowdown and therefore favourable conditions for the bond binge to continue – what’s not to like for issuers looking for almost zero cost money?

Frankly, there is far too much guff and nonsense about the US yield curve… so, it’s time for me to scare you some more, and add some Blain mumbo-jumbo to the mix.

It’s pretty simple.

The flatter US curve is NOT sending a deep meaningful warning of looming recession. It’s hiding something much worse….

The short-end of the US curve reflects what the Fed has done in terms of hiking rates. But, the long end of the US Curve (10-30) is being driven by very different forces. It has flattened because of interest rate differentials between the ZIRP rest of world and the rate normalising US, but also on the fact external investors effectively drive US rates because they are the forced buyers! Ongoing QE distortions in Europe and Japan are still driving close to Zero domestic interest rates – forcing investors offshore. Global demand for duration partially explains why the US 10-30 curve appears to have flattened.

The transmission effects of $5 trillion QE in last three years is a massive allocation towards US assets – which explains why the 10-yr is sticking round 2.5% and the term perimum is negative. Remove these effects of global distortion and the US curve would look much steeper and cause far less fear, panic and mania than the yield curve doomsters perceive.


The yield curve is not the thing to worry about..

I did read another yield curve view on Bloomberg: “The yield curve is inexorably flattening because duration is the hedge, not the risk, when it’s paired with a long equity component.”

Anticipating the imminent stock market meltdown with long duration bonds kind of makes some sort of sense – but I’m convinced that is going to be a massively expensive strategy.

Why? Because something much more wicked this way comes…..

That dark thing is inflation.

Over the last 10-years – since the Global Financial Crisis – we’ve seen the main drivers of inflation stagnate across the board. (I’ve argued many times if you want to see inflation then look at financial assets.) While prices and inflation signals have flat-lined, the inflation Central Bank feared they would create through QE has been incubating in massively inflated real assets – stocks and bonds.

My Macro Economist colleague Martin Malone reckons an inflation shock is now a 50% plus risk! He points out all the major inflation drivers are coming back on line.  

  • Global inflationary expectations have risen dramatically this year
  • Inflation data – which was deflationary 5 years ago, then flat, has now accelerated towards more normal levels
  • The safe asset long-term rate – in effect government bonds – are beginning to normalise
  • Output gaps are increasing and positive around the globe
  • Real Asset Prices – particularly housing and real estate rose dramatically over last 3 years
  • Risk Assets – like bond and stocks remain hugely inflated
  • Oil and commodities prices are rising
  • Jobs are being created around the world, and increasing number of countries now looking at supply side fiscal policy means wage inflation looks inevitable! The Philips Curve returns!  

Malone has quantified all the inflation drivers and added them up. He reckons in inflation drivers haven’t been this high since 2007! (If you want the numbers – let me know!)

Ask anyone on the street about inflation and they’ll tell you it’s very real. Wages have stagnated for 10-years, but prices are clearly rising. And look at UK housing – up 50% over 5-years!

One further driver of inflation may be China. (Yep, I know – it’s too easy.. If in doubt about markets, blame China.) For years I’ve been arguing the real risk in China isn’t creating enough jobs to keep the populace happy – it’s actually been about a revolution caused by the increasingly perilous state of the Chinese environment.

The leadership has now made the environment the number 1 priority – they get it and are acting accordingly. Pollution is the enemy. It’s not just coal fired power stations, but agriculture is a major source of river pollution – especially from Pigs. So piggeries have been “emptied” and hog prices are through the roof. As these supply side policies hit prices, the government is forced to raise wages. Wage inflation driven by rising food prices.

Go figure what happens elsewhere as China drives up protein and carb prices.

* * *

And… back to Germany… I am indebted to some German readers for pointing out my knowledge of the German constitution is not a sound as it should be (the word being “inadequate”!) It’s not Merkel who can call an election, but former SPD vice-chancellor and now BundesPresident Steinmeier who makes that call. He is vehemently opposed to a second election. As a result it’s likely we’ll see a drawn out process and votes before an election can be called, giving time to put together a new grand coalition in which either the SDP participates with a strong left-wards shift, or a weaker minority government is imposed which will further focus German policy internally rather than at Europe.

One theme suggested last night is the SDP offering to participate in a new Grand Coalition – but only if Merkel goes…  Time to hedge the Dax?   


wmbz Wed, 11/22/2017 - 07:28 Permalink

Stop worring about anything, period!It's all under control, true markets died off many, many moons ago. No crash (will be allowed) to happen, the machines are on it, sit back and relax.

The Alarmist JRobby Wed, 11/22/2017 - 15:37 Permalink

"Wages have stagnated for 10-years, but prices are clearly rising. And look at UK housing – up 50% over 5-years!"

Dude, that sounds like the recipe for demand destruction, which ultimately leads to deflation.

And BundesPresident Steinmeier will sooner nominate an uncontroversial nobody to be the Chancellor of a minority government before allowing a second election that will give AfD even more seats.

In reply to by JRobby

Ivan de beers Wed, 11/22/2017 - 07:32 Permalink

Now that the yield curve conspiracy theory has passed, a new boogeyman has been discovered. Tyler Alex Jones Durden reporting for infowars ZeroHedge. Have a great day folks

aurum4040 Ivan de beers Wed, 11/22/2017 - 07:53 Permalink

The main driver of the inflation is oil consumption and prices, just as it was in 06 07. Oil just blew past 57. Its heading higher and the feedback loop continues. Dollar going lower. The market is moving higher until we cant afford to keep the economy afloat. What happens in the bond market thereafter is the question, especially for UST. 

In reply to by Ivan de beers

Endgame Napoleon Wed, 11/22/2017 - 07:34 Permalink

When your economy is dependent on the whims or the perceived necessity of foreign investors, your Republic starts to break down. Inflation is already here on the items that count the most, like housing.

TheLastTrump Wed, 11/22/2017 - 07:46 Permalink

Some people like to talk shit about Breitbart. Me, I keep finding stories like this that either never get mentioned in media or are brushed aside since they don't fit the narrative.

H-1B's need to get shut down. Fuckerberg et al needs to pay some fines. Big ones. Enough to build a wall and more.…

"Foreign nationals now outnumber Americans in high-paying, high-skilled, white-collar jobs in Silicon Valley, California – the hub of the United States tech industry.

Silicon Valley Leadership Group President Carl Guardino touted the statistic in a report, revealing that 57 out of every 100 jobs in Silicon Valley that require at least a bachelor’s degree are taken by a foreign-born resident."

dark_matter backwaterdogs Wed, 11/22/2017 - 10:14 Permalink

At the big hi-tech company I recently left almost all new hires had to be URM's, i.e. under represented minorities. This means black/hispanic/women which essentially means women from India (can't find any black/hispanics/American women with engineering degrees). They hire these women and force them on engineering managers. They aren't up to doing much so they have them run tests or something else that doesn't require much skill. At the same time older white guys (who built the company) are systematically eliminated. They really believe the mythical man (or woman) month. All engineers are created equal.

In reply to by backwaterdogs

biker_trash backwaterdogs Wed, 11/22/2017 - 12:25 Permalink

My division is being taken over by Mandarins who are more racist then any good ole boy from the south. They are elitests who view the world through the lens of their old social systems. The only reason I'm still here is because I'm a practical resource that can fix equipment. The only thing I have going for me now is that they don't like to get their hands dirty. None of them can acutally change a tire let alone troubleshoot a semiconductor tool.      

In reply to by backwaterdogs

east of eden Wed, 11/22/2017 - 07:54 Permalink

The US, which has a nominal debt-to-gdp of what 107% (actual, which includes unfunded liabilities is in the stratosphere at 750%), can barely get bid to offer ratios above 2.5 these days, while Japan, with a 'nominal' debt-to-gdp ratio of 370% gets bids in the range of 4.7. Do you think the world knows something the US doesn't?

J J Pettigrew Wed, 11/22/2017 - 08:07 Permalink

From 2009 to 2016 prices up 15%....and all we heard was "deflation risks".The goal of the Fed is 2% inflation...someone ask them....."That's a price increase of roughly 22% every ten years. I thought the Fed mandate was Stable Prices?"CPI is a insurance SPIKING DOESNT EVEN MOVE THE CPI is weighted so low...Now, if the inflation rate, as they measure it, is the allegedly disappointing 1.7%, that is almost a 20% increase in prices every ten years....and that's NOT ENOUGH?????The Fed must be quesitoned. They are operating outside their mandates. They have no right to promote inflation (a tax). 

forexskin Wed, 11/22/2017 - 08:11 Permalink

While prices and inflation signals have flat-lined, the inflation Central Bank feared they would create through QE has been incubating in massively inflated real assets – stocks and bonds.

How can anyone living in the real world have any patience with this shit? The narrative promoted here still assumes an "efficient market" and all that implies, while the QE / monetary manipulations are having the exact intended effect - wealth concentration = control of the J6P. The so called inflation has not just hit the stock and bond markets, it has limited disposable income with limited wage increase tracking (middle class asset accumulation potential) and an increases across the board in living costs (middle class sliding downward and evaporating).Sure lots of wage pressure on the bottom end, but talk to anyone in those desperate-to-hire retail and entry level manufacturing jobs. To the person they are barely scraping by, not able to get out of debt, often on EBT, distracted by their hand held soma electronics. Who the fuck is doing it to whom? The country's steering wheel is in the hands of the elite, and they control the cookie jar and who controls the cookie jar controls the past, present and future.The narritive here is hidden behind the market explaining jargon - the power has lined up the levers of control, and buddy, it ain't in your hands. They are afraid of citizens with the power to control destiny, and prefer blind consumers becoming deaf, mute and stupid.Whether Trump's election is good or bad, it telegraphed the nation's mood loud and clear - BFYTW DC elite.

buzzsaw99 Wed, 11/22/2017 - 08:18 Permalink

this is crap:Ongoing QE distortions in Europe and Japan are still driving close to Zero domestic interest rates – forcing investors offshore. Global demand for duration partially explains why the US 10-30 curve appears to have flattened...BULL FUCKING SHIT.  did he do any research at all?  japanese holdings have been flat to down for the past two years.  same same with china.  the eurotards are so afraid of currency risk that they're rather buy a euro denominated NIRP bond than a 2+% usa treasury note/bond.   furthermore...his inflation thesis is crap as well.  the only way inflation is a problem is if central banks step in and fuck up the bubble eCONoME.  it took blowing the bubble eCONoME to the proportion it's at now just to get to their precious bullshit 2% target in the first place.  YOU THINK THEY'RE GOING TO FUCK THAT UP??this guy is going on my shit list of people i don't read anymore because i get dumber every time i read his crap.

Iconoclast421 Wed, 11/22/2017 - 08:22 Permalink

What a frickin tard. Inflation? We've had massive inflation over the last 10 years. And these idiots still pretend it is this big bad wolf hiding around the corner? No, it isnt. It will never jump out of the shadows because they will simply continue to doctor the data to hide it, and laugh as people are bent over the table with 5 figure health care deductibles and other "undocumented" price explosions.

dltff-ya Wed, 11/22/2017 - 08:51 Permalink

Projections of the fraction of the federal budget that goes to debt service seem too hard for
anybody to offer,(6 percent now) but this number seems to me to be the number to watch. For the individual around the kitchen table, the bills this month compared to the interest payments to the credit card company is what to worry about. Fractions of total debt to GDP, seems to me, not so important a number to watch.
If you have to beg the visa card company to take a haircut so you can buy your pasta noodles and peanut butter, well that seems like an awful dim prospect.

Suppose we are in a recession and the debt service fraction of revenue is say 15 percent.
If we raise taxes, the economy may tank with even less net revenue. With the entitlements and defense a sacred cow, a bad recession may could precipitate a crisis seems to me. Especially if
the feds decided to fund these 2 cows by even more government debt. Maybe such a looming crisis would force a decrease in defense, or maybe seniors and Medicare would need the haircut.
If Medicare-for-all or some expensive national health plan increases the entitlement fraction,
maybe the length of a recession that could be tolerated before debt service and entitlements become greater than income, and the answer would be to fund the shortfall with more debt. Default of the
federal government seems like a ridiculous thing to worry about, but one could write a nightmare
scenario for this to happen. Thats what we do a ZH, isn't it?

USofAzzDownWeGo Wed, 11/22/2017 - 10:11 Permalink

blah blah blah, just short the VIX and be happy. UVXY and VXX has done nothing but go down to $5, do a reverse split to 35, then crash again to 5, then reverse split again to 35................ over and over and over and over and over the last 9 years. Just play this and live good. 

XBroker1 Wed, 11/22/2017 - 11:22 Permalink

China has bascially zero food oversight. So, it's probably a good thing they scale back. Let them pay 10x as much for safe, imported western food.