Notes From Underground

The jobs report on Friday was the antithesis of May’s poor data, which was actually revised downward by 27,000 to a very meager 11,000 NFP gain for May. The June report brought an unexpected increase of 287,000 jobs, although the average hourly earning (AHE) showed a weak 0.1% gain. The market closes revealed a well known fact: ULTRA-LOW INTEREST RATES ARE THE KEY ELEMENT TO THE REACTION FUNCTION OF TRADERS AND INVESTORS.

The S&Ps settled above the high made on the June 23 when the market was convinced that the “REMAIN” camp had prevailed in the Brexit referendum (per Nigel Farage). It is now clear that Brexit is not the market key that the pundits declared it to be. The driving FORCE is the ECB‘s and BOJ‘s continuous asset purchase policy, which pushes all sovereign bond yields lower. The pressure is forcing global investors to purchase bonds that have increased risk because of minuscule yields. The compression of Japanese and European rates is steering investors into U.S. and corporate debt that is not adjusted to its actual risk. So let’s survey market outcomes following the unemployment report:

1. The SPOOS rallied as the report was deemed positive for the U.S. equity markets. The market has accepted the negative view on Brexit, which means that the FED will be reticent to raise rates until there is clarity about the British decision on Article 50, which is what officially begins the U.K.’s process for exiting the EU. Therefore, strong economic data therefore becomes more supportive for stock prices because the FED is on hold, making dividend yielding stocks ever more desirable.

2. A confirmation of the ECB‘s impact of its QE program on all asset classes is the fact that the GOLD, SILVER and YEN rallied in response to the surprise increase in U.S. jobs. At first the GOLD sold off as some algos are programmed that strong data increases the possibility of a FOMC move to raise interest rates. But on further review, the precious metals and YEN said that the risk-on market profile is not one-dimensional as the ECB’s negative rates are a more powerful element. The news from the European banks continues putting pressure on European equities as the ECB’s large-scale asset purchases provides upward pressure while European sovereign debt yields are FORCED lower. (A classic case of the ECB’s influence is that the Italian BTP yields continue making record lows even as the situation for Italian banks deteriorates every day.)

The GOLD‘s rise is  a signal that money is searching for haven status for fear of negative outcomes from the destruction wrought by central bank policy. In a risk-on matrix GOLD and YEN are supposed to be sold. The recent market action signifies a change in previously held algo logic.

3. Brexit is not what has been foretold by soothsayers. There was an article in Friday’s Financial Times website titled, “Swiss Bankers Propose Alliance With London to Negotiate EU TERMS.” This is an important for the negative nabobs of the Brexit outcomes. The pundits predicting dire outcomes for the future of the U.K. are stuck in the morass of static analysis. Capitalism is at its best when free to act in a dynamic fashion. The FT article stated: “The Swiss banker’s association first suggested a ‘F4’ financial centers group in 2012. It is now time to relaunch the initiative Mr. Odier said.”

Odier, Chairman of Swiss Association and the F4, a linked group consisting of Switzerland, London, Hong Kong and Singapore. London’s demise is greatly exaggerated and can only come about if the EU and Jean-Claude Juncker set out policies that attempt to punish the Brits at a great cost to the EU economy. Practice static analysis at your own detriment.

***I am linking a previous blog post from August of 2013 titled, “COO COO for CoCos.” After Mario Draghi’s market-stabilizing “Whatever It Takes” speech in July 2012, European banks increased their issuance of COCO bonds, or contingent convertibles. These bonds yield higher rates than standard bank debt but they come with a caveat: If a bank’s Tier 1 equity ratio falls below a certain level the bank could increase its equity by converting the debt to equity. I warned investors to avoid this debt at all cost because the covenants of the COCOs gave the issuing banks far too much discretion in BAILING IN debt holders. Different banks were constantly soliciting me to purchase CoCos to enhance my interest rate returns.

Even as Draghi keeps pushing borrowing rates lower the situation becomes more uncertain. ECB policy has pushed many investors into high risk investment in the search for some needed income.

***The ECB’s insanity has also pushed the U.S. 2/10 yield curve into severe flattening mode. Friday’s close of 74.8 basis points is causing a test of  2007 support. Normally, this move in the yield curve would portend a signal of ominous economic trends. Because the central banks–especially the ECB–have so badly distorted the yield curve’s signalling mechanisms, I WILL BE CAUTIOUS IN JUMPING ON THIS CURVE  PLAY. One of the interesting outcomes from Friday’s unemployment report is that typically the 2/10 curve would have steepened as the FED remaining on hold until stronger data would cause traders to sell the long-end of the curve.

The June 14-15 FOMC minutes even noted the recent flattening of the 2/10 curve: “The nominal Treasury yield curve flattened, on net, over the intermeeting period, mainly reflecting declines in longer-term rates; the flattening left the spreads between yields on 2- and 10-year Treasury securities near its lowest level since 2007. Although a significant portion of the  declines in yields occurred following the release of the May employment report, yields at longer maturities has begun drifting down earlier in the period, consistent with an apparent deterioration in global risk sentiment.” This is nonsense from the FOMC. Why didn’t the long-end yield rise post-unemployment report? Because the market is suffering from Stockholm Syndrome, or capture bonding. When it comes to the impact of the ECB “bond capture,” coo coo for COCO’s is a product of the central bank’s insane policy. Brexit is a mosquito on an elephant’s ass.

Tags: BOJ, CoCo bonds, ECB, Fed, FOMC, nonfarm payrolls, QE, U.S. 2/10 Yield Curve

This entry was posted on July 10, 2016 at 6:42 pm and is filed under Central Banks, Debt Market, Europe, United States. 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.