The U.S. unemployment data released on Friday was extremely positive on two measures: Nonfarm payrolls increased by 288,000 and the unemployment rate dropped from 6.7 to 6.3 percent. The soft side of the numbers was that the average hours worked remained flat and the all-important average hourly earnings also stayed flat, undermining the robustness of the headline figure. The U.S. dollar and U.S. bond markets initially performed as expected as the DOLLAR strengthened and bond yields rose in response to positive news. However, by day’s end the DOLLAR was LOWER and the yields on the long end of the CURVE had also dropped while the SPOOS and DOW failed to hold gains on what was a very strong employment picture. The reason given by analysts was that the Ukraine situation was becoming more volatile and caused investors to be cautious over the weekend.
I POSE THIS QUESTION: If the Ukraine/Russia geopolitical news was unnerving the market, WHY DID THE EURO CURRENCY RALLY? Europe has far greater exposure to Russia and the blowback should negatively impact European energy companies and banks with large loan exposure to the Russian economy. WHAT HAPPENED TO THE SAFE HAVEN STATUS OF THE U.S. DOLLAR? The movement of the dollar on Friday seemed to me to be more about the softness in the underlying data rather than the Ukraine.
The potential problem with this analysis was the drop in the 2/10 yield curve, which closed at a new low for the last five months, 216.5 basis points. Although far from being flat, if the bond market was worried about the FOMC erring on the side of keeping rates ultra-low until there was some sign of wage inflation the YIELD CURVES OUGHT TO STEEPEN. The steepening would be an indication that there was a lack of confidence in Chair Yellen and as of now that scenario doesn’t exist. The LONG END of the curve is one giant conundrum. Does it smell an economic slowdown or are the SHORTS still being squeezed? And the U.S. Treasury curve may be being supported by the continued rally in European peripheral debt. The market will soon provide the answer.
In tomorrow’s FT there is an article titled, “IMF’s Jose Vinals Warns on Eurozone Bond Market.” (Mr. Vinals is the director of the IMF‘s Monetary and Capital Markets Department.) He notes that the peripheral bond markets are behaving in a manner that Fed Governor Jeremy Stein has warned about. “We are seeing a lot of what I would call ‘pricing to perfection’ in financial markets, by which I mean pricing outcomes which are really quite good. There is a danger that if outcomes are not perfect, there is room for disappointment.” It seems that one area of disappointment will be the FED raising rates and driving the spreads between U.S. and European debt wider. It is rare that I concur with the IMF, but in this instance I believe Vinals is on target.
***Something to ponder. The Ukraine-Russia situation is not going to calm any time soon for there is much at stake for Mr. Putin. This situation has been simmering for many years. The Russians believe that the U.S. and NATO have been duplicitous in their treatment of Russia and agreements that were made going back to the early 1990s and maybe even earlier. Russian President Gorbachev asked for assurances from the U.S., France, Germany and Britain on the issue of eastward expansion of NATO if the Soviet Union collapsed. To allow for Russia’s acquiescence to German unification it was promised that the Russian sphere of influence would be respected. In a Der Spiegel piece from November 26, 2009, the issue arises about what German foreign minister Hans-Dietrich Genscher promised to the USSR and foreign minister Eduard Shevardnadze. Genscher is reported to have told Shevardnadze: “We are aware that NATO membership for a unified Germany raises complicated questions.”
However, for us one thing is certain. NATO will not expand to the east. Also, on February 10, 1990 Genscher said in a policy speech in Tutzing: “… there would not be an expansion of NATO territory to the East, in other words, closer to the borders of the Soviet Union.” Mr. Gorbachev also maintains that these promises were made to him in the four-plus-two meetings by Secretary James Baker, Francois Mitterand and Helmut Kohl. Vladimir Putin was certainly aware of the promises and although Russia has been too weak to prevent continued eastern expansion of the EU, it seems that Georgia and now the Ukraine were just too close to home.
The west may apply sanctions in the hope of preventing Russian aggression but the stakes may have gotten to high for the Russians to remain complacent. Putin will push to see how deeply the Obama White House and Chancellor Merkel will wish to get involved in actual intervention. Again, Russia has much at stake and has short supply lines. This geopolitical tension will not ease anytime soon.
Tags: 2/10 yield curve, Dollar, Dow, Euro, Fed, FOMC, IMF, Jeremy Stein, Jose Vinals, nonfarm payrolls, Russia, S&P, Ukraine
May 5, 2014 at 4:06 am |
So, if growth fails to emerge in the months ahead, we´ll see an ah-ha moment in which investors say, “Is that all there is?”
May 5, 2014 at 5:44 am |
Yuan and dollar weak, Euro and yen firm, Spanish long bond powerful, Putin continuing to heat things up making European economic forecasting uncertain…2+2=5. Anyone who can put all these puzzle pieces together ought to get some sort of prize.
May 5, 2014 at 5:50 am |
US 10y yield has dropped to 2.57%, its lowest since February 3. Taper? What taper?
May 5, 2014 at 10:10 am |
Yra- Great analysis.
There are a number of other things that I believe can precipitate curve flattening……..sufficient anticipated FED tightening to hold down inflation, buying of bonds by investment funds that need to lock in yield, tapering of QE (which should slow the growth of money supply and inflation), and even an impending credit crisis (as I recall the yield curve flattened dramatically in sovereign debt for Greece during the crisis).
When I look at Fed Funds futures, they are predicting tightening of about 1% two years out. I have read (but don’t actually know) that there is good structural demand for long-dated paper. Tapering of course means, less FED buying of the long end, but the effect on holding down inflation may be more important. I don’t see any signs of near term credit problems for Treasuries, BUT the condition of both the the FED and Treasury balance sheets is significantly worse that entering the 2008 crisis. I would argue that we only got through the 2008-9 crisis, because these balance sheets were not in too bad a shape.
That said, I believe that if the market begins to believe that inflation will rise significantly, the long end will get demolished.
May 5, 2014 at 2:27 pm |
Shocked–I totally concur with each point and the conclusion is what we will pay attention to especially as a barometer on the market’s view of janet yellen—-i lived thru the period of G.William Miller and as I will repeat—a central bank’s credibility is the KEY variable in the world of FIAT MONEY