Now that the effects of 3-D and IMAX have worn off, I shared what is becoming a tradition: An interview with Rick Santelli. In the past, Rick has asked me for some of my predictions for the coming year. As a market participant who holds the power of market forces in high esteem and disdains models as all-knowing, it is difficult to find narrow based foreseen outcomes. Last December, Rick and I discussed the Swiss National Bank making some move prior to the January 22 ECB meeting. The SNB did make a move on January 15 but I was certainly not prescient enough to call for a 40 percent overnight move in the EUR/CHF cross. (Though I did warn blog readers that the SNB’s failure to levitate the EUR/CHF cross off the 1.20 floor with massive amounts of euro buying was a cause for concern, so readers of NOTES were not caught short Swiss Francs and certain readers were long the Swiss cross.)
(Click on the image to watch me and Rick discuss yield curves.)
This year’s interview did not include any predictions but I did comment today that a flattening of the yield curves in 2016 may lead to all hell breaking loose. WHAT DID I MEAN BY THIS? Grab a glass of scotch or Chuckie B., or some medicinal California and think about what I am going to say. (And, to paraphrase Danny Devito in the War of the Roses, when a person who charges $5,000 an hour offers free advice you might want to listen [humor intended].) In July 2012–the 24th to be exact–the U.S. 2/10 curve was flattening when it appeared that Europe was in a deep crisis. The two-year yields on EU sovereign debt were rapidly rising as the market feared about the viability of the EU and the EURO currency.
The European 2/10 curves were also flattening and when ECB President Mario Draghi issued his famous, NO TABOOS AND WE WILL DO WHATEVER IT TAKES to preserve the EU and the euro, the two-year yields began dropping and the 2/10 curves reversed course and began to steepen. The July 24 low was 117.25 positive slope. This was also the low made in January 2015 when the ECB and the SNB were busy revealing their plans about the EUR/CHF peg and the ECB‘s new QE policy (again, 117.25). As the year comes to an end, the flattening of the U.S. 2/10 curve continues and today we made an intraday low of 119.80. Now I will warn again that because of the lack of liquidity the last few weeks of the year prices can be easily manipulated and/or distorted.
BUT IF THE MARKETS RESUME FLATTENING IN RESPONSE TO GLOBAL ECONOMIC WEAKNESS AMID CHINESE SLOWING OR SOME GEO-POLITICAL EVENT ALL HELL WILL BREAK LOOSE. WHY? Last time the yield curves dramatically flattened in 2007 or 2012 in Europe the central banks, like John Mayall, HAD ROOM TO MOVE. When the U.S. curve inverted in early 2007, the FED FUNDS rate was at 5.25% so the FED could swiftly cut rates in response to an incipient crisis. In Europe,the yields on the two-year notes of the so-called PIIGS were more than 7.0% and thus a dramatic drop in rates could be a positive signal to the markets.
WITH INTEREST RATES AT ZERO IN ALL THE DEVELOPED ECONOMIES WHAT WILL THE KEY POLICY MAKERS DO? A FLATTENING CURVE AT THIS JUNCTURE WOULD PUSH THE FED INTO NEW TERRITORY AND PUT FEAR INTO THE MARKETS. Thus, “ALL HELL WILL BREAK LOOSE” is an inference that the flattening of the curve at the zero bound will signal that the central banks have lost “control.” Will it be on the first close below 117.25? Most probably not but it is certainly an area for investors and traders to be very aware of. That was my point and it needed explanation beyond the alloted time of the Santelli spot. I await any questions or responses.
December 28, 2015 at 8:13 pm |
Yra- Good interview today with Santelli.
I agree with your analysis of what a flattening 2/10 means, but there are at least two other possibilities.
1) Inflation is going to stay extremely low, for a long period of time, with an OK economy.
2) The credit quality of Treasuries will be in question during the next recession (remember how the Greek yield curve inverted).
That said, I think your interpretation is the most likely.
December 28, 2015 at 8:24 pm |
Yra,
I saw you this morning on Rick’s show. I always enjoy both of you.
It was nice they put the footer on the screen for your firm and that Rick mentioned Notes from the Underground.
From a technical standpoint what do you think the next level of the 2/10 spread would be if it breaks 117.25? Is there any strong support/resistance anywhere or are we on our way to an inverted curve?
Lastly I think the other wild card you touched on this year is the ECB. Neither of the recent Spain or Portuguese elections bode well for German austerity programs. Not much reward for the risk.
Best wishes for the New Year.
December 28, 2015 at 10:34 pm |
By calling attention to the “curve” — can’t say we weren’t warned. Can it be different this time? This ain’t our Father’s Fed. Will Al Gore break into the news cycle, and tell us what should be up is down and what is down should be up?
December 28, 2015 at 11:29 pm |
Forward, into the past!
December 29, 2015 at 4:06 am |
gotcha on zee germans BUT what about our chums in Beijing? They have a few problems of their own and are one bad factory gate price away from devalue and thus hitting the commodities and our beloved $ again.
I am new to this currencies stuff so this is an honest question from a noob.
happy new year trotsky
December 29, 2015 at 4:08 am |
The 31/2 year chart you show has an interesting head and shoulders formation. The neckline is quite pronounced. The head takes place on December 31 2013 and may reflect the thin markets and volatility subject to manipulation in the period running to yearend as you point out. You are certainly on to an important indicator.
I would also suggest another marker, the dollar/yuan FX that are breaking down to recent lows. Watch Shanghai equity markets as well. The global market typhoons may start in the Orient.
January 4, 2016 at 4:12 am |
On 12/29 I wrote:
I would also suggest another marker, the dollar/yuan FX that are breaking down to recent lows. Watch Shanghai equity markets as well. The global market typhoons may start in the Orient.
I meant Hong Kong, not Shanghai which is the market untouched by admitted intervention/.
December 29, 2015 at 5:15 am |
The easy prediction for 2016 is there’s going to be MAJOR volatility across everything and we’ll have more of those moves when prices explode/implode faster and go much further than people think possible (2-3 cent moves in say the Euro within 30-60 mins or $50 up/down Gold within an hour).
The volatility is what will make a trader’s year.
The HARD stops will be what saves a trader’s year.
And our CONCENTRATION will need to be really good because EVERY ONE of these big time moves, either for or against us, will be subtly telegraphed beforehand (that’s where the concentration comes in).
Summary: 2016 should be the biggest trading year of every trader out there. There is no excuse if you know what you’re doing for it not to be. If it’s not then we only have ourselves to blame…
December 29, 2015 at 9:00 am |
Alex–that is a good summation and because of the volatility staying nimble and flexible will be the best strategy–the geopolitical risks are on the boil and so little is discussed in the economics world about them because models don’t factor them in—the unknown unknowns
December 29, 2015 at 3:40 pm |
Yra,
Excellent commentary, and kudos on another great year-end interview with Ricky. Your mention of the 2007 inversion had me think back to the 1999-2000 more pronounced inversion. I temp anyone to review the St. Louis Fed’s FRED charts to plot the effective fed funds vs. the 2-10 spread in April 2000 at 6.02% and -0.41 and respectively. I was out of stocks, and long 15-year strips courtesy of this signal. I agree with Alex and the other Notes cadre, 2016 will be a year of some amazing volatilities with many casualties, and a few fortunate victors. Central Bankers in today’s ZIRP world will be powerless compared to the arsenal they commanded at the turn of the century. Thank you for another year of reminding us all of how 2 + 2 = 5 is such a beautiful world we live in. I wish you all the best in the coming New (and scary) Year.
December 30, 2015 at 8:39 am |
Professor—mind your privilege,provide comfort sounds and announce your triggers—–keep on teaching and opening minds to discourse—you are a gem in the world of academia
December 30, 2015 at 12:27 am |
Thanks for a great year of commentary Yra. Japan showed us that once you have ZIRP you don’t need to invert the curve for a recession, just significant flattening is enough – the move becomes more important than the level in a compressed yield environment. So I think you’re spot on, this is a key thing to watch.
December 30, 2015 at 4:59 am |
for 2016 one of my major concerns is the China International Payment System (CIPS) and it’s replacement of Swift. One of the powers of Swift is the control given by the ability to blacklist a country. Geopolitically it’s a heavy hammer BUT if the “interesting” ones have an alternative whose operators do not share our goals then that’s a smidgen of a problem. Thoughts?
December 30, 2015 at 8:37 am |
Limey–while you make a good point I BELIEVE AND OPINE it is far too early for the Chinese to play that card—-no reason for at this point they have achieved many of their goals—IMF basket,greater waiting at the IMF and the AIIB has gained global exceptance—why rock the boat at this juncture
December 30, 2015 at 9:00 am
when I was at school we were warned by an US ex admiral that the Spratly’s isles would be the trigger point. We keep messing in “their” pond and they’ll certainly rock ALL our boats. Yep more volatility YEEHAW think, my hero, Major Kong.
December 30, 2015 at 12:04 pm |
No doubt we’re missing the bigger picture, my NSA contact warns N Korea is and will remain the primary concern until it isn’t.
Meanwhile new world order stuff, not sure if/how NK fits:
https://www.corbettreport.com/episode-310-rise-of-the-oiligarchs/
December 30, 2015 at 9:11 am |
Hi I am a newbie to this blog and have 2 questions. What are the best instruments to take advantage of the coming volatility and is there are relationship between the curve’s rate of flattening and market volatility?
December 31, 2015 at 10:02 am |
bigman–welcome aboard and because I have covered this over the last four years I didn’t go into any relevant trades but I will cover that in new posts to give readers an idea of the thought process.as I have advised readers over the years—the outcomes from curve moves are predictable but the time periods are never consistent–sometimes a few months to play out sometimes more and with interest rates at zero this time will be vastly different from 2000 and 2007 if the flattening does take place because the FED does not have the traditional tool of lowering the Fed funds rate to turn the curve—this is why 2016 sets up to be so volatile
January 3, 2016 at 1:18 pm |
Just looked at some long term charts on the 2-10 spread.
Flattening of the yield curve typically starts years before a recession starts.
Since 1980, the 2-10 spread has always inverted (at least a little) prior to a recession, and has always steepened just prior to a recession, or just as a recession started.
We are not in a typical economic scenario, and I doubt the yield curve can invert in the current low growth/low inflation scenario.
However, it’s not hard to visualize the yield curve flattening, once a recession Is imminent, as short rates don’t have much room to go down.
10 Year Interest Rate Swaps recently traded thru 10 Year Treasuries, which indicates buy side investors are aggressively
locking in longer term rates (even slightly over 2% 10 Year Swap rates)
However, my guess is that the yield curve will follow past scenarios and steepen(at least initially) once a recession is imminent.
I could be wrong.
December 30, 2015 at 11:05 am |
Oil prices and/or weather are the excuse. I can’t understand the logic of being long banks, but being an exempt insider is the shiz..
December 30, 2015 at 11:22 am |
If the 2-10 breaks 1.17 and closes under where would you look for trades in your “all hell breaks lose” thesis?
December 30, 2015 at 4:08 pm |
It seems the world is headed toward negative real interest rates on a global scale.
http://nymag.com/daily/intelligencer/2015/12/big-short-genius-says-another-crisis-is-coming.html
December 30, 2015 at 6:47 pm |
If you except the Krugman-Summers argument in full he world is in dire need of negative real interest rates—-will the politics sustain it
December 30, 2015 at 7:14 pm |
…and what happens to pensioners, pension funds and insurance companies? Grandpa packing groceries at Winn Dixie?
December 30, 2015 at 7:22 pm |
Asherz—it i amazing that the FED models and some talking heads cannot comprehend that many people my age –in the 55-72 age group are not leaving the labor force because they cannot afford to because of the devastation from financial repression—throw in the wisdom of years on the job and lower health care costs because of medicare –well the unemployment data is as flawed as the models
December 30, 2015 at 7:21 pm |
If the 2-10 breaks 1.17 and closes under what trades/markets would you look at under your “all hell breaks lose” thesis?
December 31, 2015 at 10:04 am |
Trader—-traditionally aflattening curve is negative for equties and positive for the currency and bearish for precious metals in the near term–but at the present state of Zero rates we just don’t know so we will be watching this in the coming time period
December 31, 2015 at 10:31 am |
Yra- The 55-72 or 92 have something else that should be concerning them. How tight have risk managers controls, in retirement funds, life insurance etc., been kept when their assumed ROI has been impossible to meet without going further out on the risk curve? Who bought the billions of junk bonds in the last few years with narrow spreads to high grade? Has the percentage of equity holdings remained constant or increased because of ZIRP in so-called preservation of capital pools?
How many AIGs and Third Ave. Funds are out there?
Malinvestment has run amok because of Fed policy to save the banks without seriously weighing the damage it will have caused.
December 31, 2015 at 1:45 pm |
Asherz–yes to all of course and it is what Jeremy Stein as Fed Governor and now back at Harvard has consistently warned us to be concerned about—that is my problem with the mainstream media,they will only roll out somebody like Stein when it is a full blown crisis but we stop hearing about him as he warns against the voices of complacency
December 31, 2015 at 2:17 pm |
Yra- You would do your readers of this blog a great favor if you would devote a piece to the concept of a “bail-in” which officially begins tomorrow in Europe. In addition, under Dodd Frank derivative creditors of a bank have a superior claim over depositors in the US. Glass-Steagall must be reinstated and banks must be made to stop playing in the casino with depositors money. Too big to fail cannot be allowed to continue.
Otherwise the poor Italian man who recently hung himself when his life savings were bailed-in can become the poster child of our disappearing middle class.
The Draghi Whatever it Takes mentality in this country has included preserving our major banks in their present form by the Fed and Treasury.
December 31, 2015 at 2:47 pm |
aherz–point taken and did you happen to read the latest Larry Summers blog post–pathetic.and just dead wrong and if he wants to debate it I am eagerly available
January 2, 2016 at 12:07 pm |
Not sure if this is off subject but this capital needs a new home soon right?
“The $475bn awarded on Thursday matures on January 4, when markets reopen following the new year holiday, and compares to $277bn taken at an auction on Wednesday.”
January 1, 2016 at 2:37 pm |
Why should we anticipate authorities actually want growth, considering reduced consumption has a net positive correlation with the stated goal of reducing GHG emissions?
Yes we can (halve environmental impact).
January 2, 2016 at 11:17 am |
[…] Legendary trader Yra Harris who we recently interviewed at the Financial Repression Authority has been pounding the table for some time but just issued this warning: […]
January 2, 2016 at 11:20 am |
[…] Legendary trader Yra Harris who we recently interviewed at the Financial Repression Authority has been pounding the table for some time but just issued this warning: […]
January 2, 2016 at 11:24 am |
[…] Legendary trader Yra Harris who we recently interviewed at the Financial Repression Authority has been pounding the table for some time but just issued this warning: […]
January 2, 2016 at 11:41 am |
[…] Legendary trader Yra Harris who we recently interviewed at the Financial Repression Authority has been pounding the table for some time but just issued this warning: […]
January 2, 2016 at 12:02 pm |
[…] Legendary trader Yra Harris who we recently interviewed at the Financial Repression Authority has been pounding the table for some time but just issued this warning: […]
January 2, 2016 at 5:12 pm |
Hi! newbie here – I confess I am not an investor of stocks nor bonds yet I study them and economics out of personal interest — I have focused my portfolio on real estate investments (they never go to zero). With all the volatility that is coming, what will happen with mortgage interest rates ? Trying to figure out if I should refie to fixed yet higher rates than I have now on floating adjustable mortgages… for all my properties. Rents have been insane so it has worked out so far… However, some say we will get a boomerang effect where rates go much higher, then get pulled back … thoughts ?
January 2, 2016 at 5:38 pm |
Summers also said this, I believe. Basically confirming nothing we have read or seen anywhere should be trusted. Thus, there’s no end to the ongoing theft of wealth.
“The fact that a member of Goldman Sachs’ board at the time of the 2008 crisis was the “public interest” Chairman of the New York Fed board is to put it mildly indefensible.”
January 3, 2016 at 9:06 am |
Yes–he did say that but he was probably as responsible as anyone for putting him there.Summers is carving out his desire for the Fed Chairman job again –ss his blog note on Delong-Krugman
January 3, 2016 at 9:15 am |
http://larrysummers.com/2016/01/01/thoughts-on-delong-and-krugman-blogs/
January 3, 2016 at 1:21 pm |
Put my last post in the wrong place.
Just looked at some long term charts on the 2-10 spread.
Flattening of the yield curve typically starts years before a recession starts.
Since 1980, the 2-10 spread has always inverted (at least a little) prior to a recession, and has always steepened just prior to a recession, or just as a recession started.
We are not in a typical economic scenario, and I doubt the yield curve can invert in the current low growth/low inflation scenario.
However, it’s not hard to visualize the yield curve flattening, once a recession Is imminent, as short rates don’t have much room to go down.
10 Year Interest Rate Swaps recently traded thru 10 Year Treasuries, which indicates buy side investors are aggressively
locking in longer term rates (even slightly over 2% 10 Year Swap rates)
However, my guess is that the yield curve will follow past scenarios and steepen(at least initially) once a recession is imminent.
I could be wrong.
January 3, 2016 at 1:58 pm |
shocked–this is a very good post.Again it is difficult to time the fallout from the curve–the question will be how the Fed responds to what you analyze—will the curve steepen because yields on two years drop dramatically?—there is much to absorb in this arena as we move forward
January 4, 2016 at 4:14 am |
asherz Says:
January 4, 2016 at 4:12 am | Reply
On 12/29 I wrote:
I would also suggest another marker, the dollar/yuan FX that are breaking down to recent lows. Watch Shanghai equity markets as well. The global market typhoons may start in the Orient.
I meant Hong Kong, not Shanghai which is the market untouched by admitted intervention/.
January 4, 2016 at 10:43 am |
We weren’t short Yen either, at least I wasn’t. Run for the hills.
January 4, 2016 at 1:05 pm |
Wow, starting to look like CB’s will be tying a few new knots in their Incahuasi khipus this year.
January 4, 2016 at 4:54 pm |
Happy new year to all “mind the gappers” from a VERY smug American Limey, putting my money where my mouth was on shorting the /es on china ( this thread 12/29/15 4:06AM) done about 40% of my 2016 in one, albeit fat fingered, trade. God bless America providing opportunities since 1776 (ish)
seriously
happy new year to all
January 4, 2016 at 6:21 pm |
Limey –we will tax you at the rate of 1775—-see you on the bridge
January 4, 2016 at 7:48 pm |
had to look it up but in 1775, the British government was consuming one-fifth of its citizens’ GDP, while New Englanders were only paying between 1 and 2 percent of their income in taxes SO I take your colonial tax offer PROVIDED you offer protection from the redcoats. Shouldn’t be hard, just offer them crumpets and cream… Easy fix cheaper than bullets…
January 4, 2016 at 8:44 pm |
Now the Yuan has reserve currency status, it seems the FED no longer controls Chinese currency? The mysterious disappearances of certain individuals appears to be increasing about as quickly as Iranian clerics.
January 6, 2016 at 3:42 pm |
[…] Legendary trader Yra Harris who we recently interviewed at the Financial Repression Authority has been pounding the table for some time but just issued this warning: […]
October 11, 2017 at 2:50 am |
[…] hell could break loose as central banks lose control (a must read post in Yra’s excellent blog: http://yragharris.com/2015/12/28/crazy/ ), 4) The market have been distorted by central bank intervention. This may have been needed […]