"The Global Bond Curve Just Inverted": Why JPM Thinks A Market Crash May Be Imminent

At the beginning of April, JPMorgan's Nikolaos Panigirtzoglou pointed out something unexpected: in a time when everyone was stressing out over the upcoming inversion in the Treasury yield curve, the JPM analyst showed that the forward curve for the 1-month US OIS rate, a proxy for the Fed policy rate, had already inverted after the two-year forward point. In other words, while cash instruments had yet to officially invert, the market had already priced this move in.

One way of visualizing this inversion was by charting the front end between the 2-year and 3-year forward points of the 1-month OIS. Here, as JPM showed two months ago, a curve inversion had arisen for the first time during the first week of January, but it only lasted for two days at the time and the curve re-steepened significantly in the beginning of April.

Fast forward to today when in a follow up note, Panigirtzoglou highlights that this inversion has gotten worse over the past week following Wednesday's hawkish FOMC meeting. As shown in the chart below which updates the 1-month OIS rate, the difference between the 3-year and the 2-year forward points has worsened, falling to a new low for the year of -5bp.

 

But in an unexpected development - because as a reminder we already knew that the market had priced in an inversion in the short-end of the curve - something remarkable happened last week: the entire global bond curve just inverted for the first time since just before the financial crisis erupted.

As JPM notes, while the Fed's hawkish move was sufficient to invert the short end further, it was not the only central bank inducing flattening this past week: the ECB also pressed lower on the curve via its "dovish QE end" policy meeting this week. And as a result of this week’s broad-based flattening, the yield curve inversion has spilled over to the long end of the global government bond yield curve also.

In particular, the yield spread between the 7-10 year minus the 1-3 year maturity buckets of our global government bond index (JPM GBI Broad bond index) shifted to negative territory this week for the first time since 2007. This can be seen in Figure 2.

But how is it possible that the global government bond yield curve can be inverted when most developed 2s10s cash curves are still at least a little steep? After all, as seen below, After all, the flattest 2s10s government yield curve is in Japan at +17bp and although the 2s10s US government curve - shown below - has been collapsing, it is still 35bp away from inversion.

The answer is in the unequal weighing of US duration in the JPM global bond index: specifically, as Panigirtzoglou explains, the US has a much higher weight in the 1-3 year bucket, around 50%, than in the 7-10 year bucket, where it has a weight of only 25%.

This is because in terms of the relative stocks of government bonds globally, there are a lot more short-dated US government bonds relative to longer-dated ones as the US has lagged other countries in terms of the duration expansion trend that took place over the past ten years.

This is shown in Figure 3 which shows the average duration of various countries’ government bond indices over time. It is very clear that the US has failed to follow other countries in the past decade’s duration expansion race and as a result there are currently a lot more non-US government bonds in longer-dated buckets which are typically lower yielding than the US. And a lot more US government bonds in short-dated buckets which are typically higher yielding.

What are the practical implications? Well, in a word, global investors - those for whom Treasury flows are fungible and have exposure to the entire world's "safe securities" - now find themselves in inversion.

In other words, with the Fed having pushed the yield on short dated 1-3 year US government bonds to above 2.5%, global bond investors who, by construction, hold more US government bonds in the 1-3 year bucket and more non-US government bonds in the longer-dated buckets, finds themselves with a situation where extending maturities at a global level provides no extra yield compensation.

And the punchline:

This means that while at the local level bond investors are still demanding a premium for longer-dated bonds, at an aggregate level – abstracting from segmentation and currency hedging issues – bond investors globally are no longer demanding such a premium.

Needless to say, although JPM says it anyway, "this is rather unusual as can be seen in Figure 2."

As for the timing, well it's troubling to say the least: it did so just before the last two bubbles burst. In fact, the last time the 7-10y minus 1-3y yield spread of JPM's GBI Broad bond index turned negative was in 2007 ahead of an equity correction and recession at the time. Before then it had turned very negative in late 1990s also, after the 1997/1998 EM crisis but also in 1999 ahead of a burst in the equity bubble and a reversal of Fed policy.

And if that wasn't enough, here are some especially ominous parting thoughts from the JPM strategist:

In other words, in normal times, bond investors demand a premium to hold longer-dated bonds and to tie their  money for a long period of time vs. investing in lower risk short-dated bonds. But when investors have little confidence in the trajectory of the economy or they think monetary policy tightening is overdone or they see a high risk of a correction in risky markets such as equities, they may prefer to buy longer-dated government bonds as a hedge even though they receive a lower yield than short-dated bonds. This is perhaps why empirical literature found that the slope of the yield curve is such a good predictor of economic slowdowns and/or equity market corrections.

In other words, contrary to all those awed but naive interpretations of the short-term market reaction invoked by Powell or Draghi, according to the market, not only the Fed but the ECB engaged in consecutive policy mistakes. And, as JPM confirms, "this week’s central bank meetings exacerbated this flattening trend."

As a result the yield curve inversion is no longer confined to the front-end of the US curve, but has also emerged at the longer end of the global government bond yield curve.

What this means is that a decade after the last such inversion, bond investors globally no longer require extra premium for holding longer-dated bonds vs short-dated bonds, something that happens rarely, e.g. when investors have little confidence in the trajectory of the economy, or they think monetary policy tightening is overdone or they see a high risk of a correction in risky markets such as equities.

Comments

JRobby gmrpeabody Sat, 06/16/2018 - 14:24 Permalink

I laugh when they apply pre-ZIRP/QE tools to the current economic - monetary "situation."

"Where's the $$$$ gonna go?"

"We can't really forecast that. We just want a crash before mid-terms. This is our assignment. We need to predict it beforehand so our clients think we are amazing."

"Your handlers must be very nervous about mid-terms?"

In reply to by gmrpeabody

Klassenfeind BigCumulusClouds Sun, 06/17/2018 - 06:03 Permalink

The headline for this article should be:

"PUT OPTIONS FOR SALE, EXTRA CRISPY PUT OPTIONS FOR SALE! Get your put options here today! The world is going to collapse, so get your put options here quick! PUT OPTIONS FOR SALE, EXTRA CRISPY PUT OPTIONS FOR SALE!" 

Edit: by the way, what is the definition of "imminent?" Within the next 24 hours? The next 48 hours? By the end of next week? And what if this "market crash" doesn't materialize? Will they finally SHUT THE FUCK UP and stop pretending that they know what they're talking about?!

In reply to by BigCumulusClouds

Giant Meteor BigCumulusClouds Sun, 06/17/2018 - 10:42 Permalink

Number one bullet point of my primary thesis, "it's all bullshit folks." If one is not "skeptical" in these times, they just aren't paying attention.

Here is a pretty good read on the matter at hand ..

https://www.fxstreet.com/analysis/inverted-yield-curve-its-definitely-n…

"Objective market strategists understand that the yield curve will soon invert and the ramifications of such an event will be the same as they always have been in the past. The only difference being that this next financial crisis will bring about a protracted global recession/depression. This is because the bursting of the gargantuan bond bubble is occurring in the context of aggregate debt levels and asset valuations that are far greater than at any other time in history."

There is no question the globe is straining under a shit load unpayable debt, and of course, hubris. So, being perhaps the cleanest dirty shirt for now, while offering advantage in regards to reserve currency and printing press, will not be left indefinitely untouched as multiple black swans gather simultaneous.

All roads lead to collapse ..

Uncharted territory, in other words, literally nothing is as it appears .. or rather, as is MADE to appear. Not a question of IF, only a question of when. Perhaps this time both cynicism, AND complacency, will destroy the worlds economies, with equal effectiveness, and zeal .. .. .. One day (in example) Gartmen will be correct. At that time you can expect the end. ..

By the way, happy father's day to all you dad's out there ..

In reply to by BigCumulusClouds

Government nee… TBT or not TBT Sat, 06/16/2018 - 18:01 Permalink

The signal for a global crash will be nation-states descending into Venezuela or Brazil style economic/political chaos.  In other words, when the Western Central Banks can no longer prop up markets.  I dont think we are close, and the fact that the front end of the yield curve is inverted after a 2% reduction in aggregate QE doesnt necessarily mean what it used to (pre-QE).

In reply to by TBT or not TBT

I am Groot 666D Chess Sun, 06/17/2018 - 02:25 Permalink

But if the Fed pulls the football out from under Trump and a major catastrophic crash happens, everyone will be chasing him with pitchforks, and him alone for the disaster. Nobody will be smart enough to open the door to the Fed and go after those motherfuckers with a chainsaw. Why would he put himself in the position of being a whipping boy for the Rothschilds ? That makes no sense at all.

Trump is a total wild card. And whatever his malfunctions are, he actually keeps his word, good or bad vs the other three previous POTUS douchebags. And he gets shit done, which is nothing short of fucking totally miraculous and probably should be knighted or recommended for sainthood by the Vatican. Anyone that manages to get anything done in Washington should get their dick sucked every day by Playboy Playmates. He is the total opposite of our totally impotent Congress who can't unzip their own short dicks without it turning into War and Peace. The only thing they do very well with extreme efficiency is fuck this country up more and more everyday.

In reply to by 666D Chess

666D Chess I am Groot Sun, 06/17/2018 - 08:31 Permalink

He knows he will be the escape goat and he will be paid handsomely for doing so. Trump is a Rothschilds' long term project. He is good friends with Hillary and he job is to make the American public believe that they are free while the elites do the last money grab before the final crash. 

As to what you say about him keeping his promises, is Hillary in jail? Nope, MAGA? What the fuck is he doing get involved in Syria again? Draining the swamp? Yeah, probably by filling his cabinet with ex-Goldman Sachs crooks... How on Earth can you be so blind? Or are you in denial?

Do you want some evidence, I've got plenty of it:

https://www.investopedia.com/articles/insights/121616/wilbur-ross.asp

http://articles.chicagotribune.com/2004-10-28/news/0410280265_1_donald-…

https://www.youtube.com/watch?v=iM8S0ePjPPg

https://www.youtube.com/watch?v=ams4BMa9A6c

https://www.youtube.com/watch?v=utD_8cRBXbM&t=36s

https://www.youtube.com/watch?v=Exjx3Ij7VWs

You are also aware that Ivanka Trump was dating Nathaniel Rothschild before marrying Kushner, right? Google it up. Wake up already, you are not doing this world a favor by being stupid. 

In reply to by I am Groot

666D Chess dark pools of soros Sun, 06/17/2018 - 19:05 Permalink

dark pools of soros Hey you fucking inbred, so according to you, anyone that is against the orange swine is a pedophile, well, I could easily argue that anyone who supports the orange swine actually supports Hillary and therefore is a fucking pedo like yourself. Looks like your mother passed on syphilis to you when you were a baby and it damaged your brain. Bonus video just for you pedo:

https://www.youtube.com/watch?v=iM8S0ePjPPg&t=2s

In reply to by dark pools of soros