Notes From Underground: The Yield Curves Were Crowded (Nobody Goes There Anymore)

The yield curves were the star performers after the FOMC statement and the Bernanke press conference. The 5/30 (bottom) curve was the most volatile but the 2/5 (top) and 5/10 curves also provided great volatility. It seems that while everybody parked money in the FIVE-YEAR NOTE as the safest place to be during the FED’s non-tapering act, the FIVE-YEAR NOTE has become a bastard child and is being orphaned. Why? In my opinion the FREE PARKING place that the fives provided for curve players has now been placed under the microscope and it seems that it is not as safe in a world of “LESS” Fed asset purchases. The FIVE YEAR has a flat to negative real yield. This means that if you expect inflation to be running at 1.6% and the yield on the five-year is 1.65% you are breaking even on a real return basis. The 10-year at 2.95% provides you with a real yield of 1.3% over the inflation rate. The problem is that you run TERM RISK by going out further on the curve.

The question that BOND TRADERS ask is: “Am I being compensated enough by the premiums offered further down the time line or duration?” The FIVES have said no to the question but the 10s and 30s have found some buyers, or at least shorts are being forced to cover. As I have warned for four years, the FED has caused great harm in the BOND market through its massive large-scale asset purchases or, QE. Year end and the thin holiday markets will exaggerate any moves  so tread cautiously into the credit markets. The FIVES though will be the keystone of the price movements for the very near term so be attentive. Put in charts I sent –{if we have a shorter term 5/30 that might be better}.

U.S. 2/5 Yield Curve 5-30chart3yr-gif

***In Monday’s Financial Times, columnist Wolfgang Munchau has an article criticizing the newest agreement coming out of Brussels on the creation of a EU Single Resolution Mechanism (SRM). Munchau is a Europhile, who has until recently been a cheerleader for all things emanating from Brussels. When a member of the privileged cast heaps criticism on a major decision, I advise paying attention. The article, “How To Prolong A Banking Credit Crunch,” and it takes the EU finance ministers to task for proclaiming a major victory in their efforts to create a unified financial system throughout the EU, which means a major backstop is in place to rescue any banks or financial institution that is in trouble. The key to the SRM is that it requires Germany to be the co-signer for all the legacy debt presently on the books of European banks from Greece to Portugal.

In listening to news reports on Friday, the spin was that Germany has bent and agreed to finance basically what would be a FDIC. Munchau writes: “Some of the finance ministers tried to put a brave face on this humiliating defeat, pretending that Wolfgang Schaeuble, the German finance minister, had given ground on an important principle. But that is not the case at all. The banking union that was agreed was the banking union Mr.Schaeuble always wanted. He does not want German taxpayers to pay for the restructuring of banks in other countries. And he does not want the European Commission, or anybody else, to close down a German Bank. If ever there was a game, set, match victory in EU history, this was it.”

As we enter 2014, the European financial crisis is far from resolved for it will only reach some certainty of outcome when the Germans, Dutch and others accept the concept of a EURO BOND backed by the full faith and credit of the economically strong European nations. If the Germans do agree to such an instrument, what will be the cost extracted from the rest of Europe? The German push for austerity is the effort to get the budgets of the peripherals under control so the German policy makers can at least provide German voters with an improving situation. But as we have seen, AUSTERITY sets into motion NEGATIVE FEEDBACK LOOPS. Less spending means slower growth, which means less tax revenue with increased unemployment. Yes, the EURO currency continues to strengthen but that is a function of liquidity flows as the ECB’s balance sheet shrinks while the U.S. Fed’s continues to grow. Now that the German’s have blocked any immediate hope of a SRM to backstop the banks, will Mario Draghi become more assertive in his efforts to provide the liquidity that will be needed to forestall an EU financial crisis?Welcome to 2014.

***I want to wish all my readers a very Merry Christmas and a happy and healthy New Year. I deeply appreciate the feedback and conversation that takes place within the bounds of Notes From Underground. All the best for the New Year — Yra Harris


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11 Responses to “Notes From Underground: The Yield Curves Were Crowded (Nobody Goes There Anymore)”

  1. thl Says:

    and a blessed and prosperous new year to you.

  2. Steve O Says:

    Thank you Yra, your blog has been a tremendous place to learn & interpret markets, I do very much appreciate this site. All the best in the New Year.

  3. Shocked to Find Gambling Says:

    Yra- Your Euro analysis looks right to me. Shouldn’t the Euro start discounting what will likely happen next year, and start moving lower.
    Thinking very generally, if the world economy tanks, Europe is in huge trouble, and if the world economy takes off, Europe should lag. II have not traded a lot of Forex the last few years, but I believe there is a strong seasonal in January for the USD to rally. What say you?

  4. kevinwaspi Says:

    Thank you for all that you do in this blog bringing the discussions to the front & center. Have a safe week, a Happy New Year, and many more to come.

  5. yra Says:

    Shocked —there may be a seasonal to the Dollar trade but when I sell the Euro it will be for a bigger reason and that is that the clock has run out on Mario Draghi and Europe will finally have to come up with a new QE TYPE program—we will keep vigilant and I showed a few months ago—many were early selling the Euro as the ECB was shrinking its balance sheet through the paydown of LTRO borrowings but as where the FED has bought all the debt it is the private banks in Europe that have loaded up on sovereign debt because there is no hit to the capital ratios as sovereign debt requires no haircut—let the games begin

  6. Shocked to Find Gambling Says:

    Yra- you said

    “the private banks in Europe that have loaded up on sovereign debt because there is no hit to the capital ratios as sovereign debt requires no haircut”

    A lot of this debt could wind up near worthless. So you would think the ECB will have to backstop (or buy) this debt, at some point.

    At least the FED (theoretically) only buys Treasury and Agency bonds.

    You also said

    “Many were early selling the Euro as the ECB was shrinking its balance sheet through the paydown of LTRO borrowings but as where the FED has bought all the debt.”

    What’s your critical point on this…..that they are controlling their money supply, or the banks have been profitable enough to pay back the LTRO debt, or the ECB balance sheet is improving?

  7. yra Says:

    Shocked–as the LTRO was being repaid to the ECB the liquidity in the system was contracting which has been the opposite in the U.S. Fed system—when the ECB finally has to monetize the sovereign debt load as the banks struggle that will begin the long awaited sell off of the Euro—that was my point.The “healthier ” banks have been able to return cashfrom the LTRO in anticipation of appearing healhier for the stress tests so hoping to avoid the capital raises–Italian and Spanish banks are loaded upwith their sovereign debts as the recent European Banking Authority[EBA] has revealed—no haircuts as of now on that sovereign debt–so what is the feedback loop is that the debt yields in the PIIGS has dropped because their banks have been buying the bonds of the sovereign they are depending upon to bail out the banks—which is why Germany continues to maintain that all bank bailouts should be done on a national basis over the next ten years.

  8. Shocked to Find Gambling Says:

    Yra- Thanks for the clarification.

    We’re talking about timing, on shorting the Euro. You think there is currently a relative shortage of Euros and a surplus of USD, so we should wait.

    I’m also guessing that you think that if the world economy improves, the Euro can rally for a while, as too much bad news is built in. Kind of like buying junk bonds (currencies), as the economy improves.

    I’m thinking that there is a lot of concern about what will eventually happen in the EU (and to the Euro), and that Euro asset holders will start moving into to USD, CHF, and Gold soon.

  9. Marc Goodman Says:

    Yra, must read piece comissioned by Roubini (the gold basher) on killing the oil for gold trade which if left unchecked would drive up gold prices; report penned in May 2013 at same time he was out bashing gold…. note how all this relates to the ongoing situation in Turkey directly related to this gold trade. Personally I think this is all about preserving the petrodollar monopoly and has very little to do with a supposed Persian threat ; but very interesting that Roubini comes out publicly bashing gold while his organization is penning a major research expressing deep concern about massive gold purchases to settle this oil trade

  10. Notes From Underground: The Yield Curves Were Crowded (Nobody Goes There Anymore) | owngoldllc Says:

    […] See on […]

  11. yra Says:

    Marc –interesting post but celebrity has gotten to Roubini.His work through the credit crisis was top notch but since the Fed’s massive QE programs the Roubini has been struggling to put it together.Must be janging out with Bill Dudley and struggling to demystify the QE programs.

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