Notes From Underground

You put your left poll in, you take your left poll out, you put your right poll in and you shake it all about … and that is how you get the hokey POLLKEY. The markets are moved by the cacophony of polls, both private and public. Couple that with the ability to broadcast any and all results via social media in an immediate fashion, the markets get high frequency volatility. This is why I keep advising to trade with FERVOR, invest with FEAR. Brexit is keeping everyone on edge but the most confusing variable is the BETTING LINES at the London bookmakers. Always deemed the smart money, the odds are favoring a REMAIN vote while the markets are pricing in a higher probability of BREXIT. It’s a great arbitrage opportunity. Global equity markets are certainly fearful as investors are leery of being caught in the downdraft of a BREXIT vote.

Today’s EUROPEAN BOND MARKETS are pricing in a vote to LEAVE as the BUND/FRENCH, BUND/ITALIAN and BUND/SPANISH have considerably widened out over the last two days. The BUND/ITALIAN differential has widened by 12 BASIS POINTS as investors are searching for the safest haven. BUT I WARN ALL TRADERS: The ECB seems to be sitting on the sidelines as it doesn’t want to use up its buying power in case it has to intervene post-BREXIT to smooth markets. Currently, the global speculators seem to be pushing yields without much resistance from the ECB trading desk. At the end of last week, the ECB had purchased an estimated 25 billion euros of assets. So with half the month gone the ECB still has 55 billion euros of paper to buy. The market took the BUND yields through zero today as investors were clamoring for the highest rated debt as fears about a BREXIT vote increase. Just one positive poll away from the shift in sentiment. It is the summer of the HOKEY POLLKEY.

***Tomorrow Janet Yellen will deliver the FOMC decision and will be followed by a press conference. I BELIEVE THE FED WILL HOLD RATES BUT WILL ADD HAWKISH TONE TO KEEP JULY IN PLAY. The most important outcome of the FOMC will be the VOTE. Will it be 9-1 again or will some of the “big talkers” actually vote their words rather than seek consensus? Esther George has been the regular dissenter, but what if the vote is 10-0 as President George shifts, or if it becomes 7-3 as Rosengren and Mester of the Boston and Cleveland Feds actually follow their previous speeches and vote to increase rates? In today’s Washington Post Larry Summers has an op-ed piece titled, “The FED Is Making the Same Mistakes Over and Over Again.” Summers posits that the Fed is missing the point about the need to raise rates and OUGHT to let inflation run hotter because the recovery is long-in-the-tooth and the probability of a recession is increasing. “Given lags, raising rates now would increase the chances of recession, along with likely severity.”

Summers believes that the global headwinds from weak demand and political uncertainty demands the FED be cautious. The Professor also notes, and in this I certainly agree, the LABOR MARKET CONDITIONS INDEX is flashing a weakening overall jobs picture to match the recent weakness in the U-3  non-farm payroll data. “While last month’s  highly disappointing employment report was a jolt to most observers, the Fed’s summary employment conditions index has been flashing yellow since the beginning of the year.” The other indicator pushing on Summers is the yield curve’s recent bout of flattening. While the 2/10 has been making eight-year lows, I am not as certain as Larry Summers that it is signaling a looming recession. Until the 2/10 curve settles below 75 basis points I am assuming the recent move in the 10-year note is more a relative value phenomenon, but the Summers op-ed piece certainly raises the bar for the Yellen Fed.

I will be taking the next few days off as I gear up for the high anxiety of the Brexit week, plus the Spanish elections and Italian regional elections providing ever more uncertainty for the EU. But if something extraordinary takes place I will try to put out my thoughts and possible trade ideas. Trade with fervor, invest with fear. Put one leg in and take it out as we follow the hokey pollkies.

Tags: 2/10 Curve, Brexit, Bund, ECB, Fed, FOMC, Janet Yellen, Larry Summers

This entry was posted on June 14, 2016 at 4:03 pm and is filed under Debt Market, ECB, Fed. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.