Notes From Underground: Draghi is Laughing All the Way To the Bank

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.

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7 Responses to “Notes From Underground: Draghi is Laughing All the Way To the Bank”

  1. asherz Says:

    Yra- Good post. The 2/10 curve has lost some of its historical significance because of the 80 billion monthly Euro bond purchases which has obliterated market pricing mechanisms. The equity market’s irrational exuberant reaction to an employment number that has more adjustments than Kardashian’s backside is also not rational, as we have had five quarters of declining earnings. Q2 should see a 5% decline. If hiring is so good wouldn’t we see rising revenues, greater capex and higher GAAP earnings (without the financial engineering)?
    COCOs are to the bond market as bail-ins are to banks as you point out. The theme song for that dance should be “Co-co Cabana” and you can choose either the Barry Manilow or Carmen Miranda (for the old-timers) to sing the lyrics.
    The Yen as a safe haven is also silly as a 230% debt/gdp ratio and an aging population demographic has poor long term outcomes. But the one eyed man is king in the world of the sightless.
    Gold and silver will be the last men standing when the history books are written about this insane period.

  2. Blacklisted Says:

    The implications of Brexit is much more influential on markets than the jobs report. I assume the elephant’s ass is the lawless end of govt.

  3. Arthur Says:

    Interesting, …

    “Brexit is a mosquito on an elephant’s ass.” (Yra Harris)

    “Brexit is the most significant political risk the world has experienced since the Cuban Missile Crisis.” (Ian Bremmer)

    • yra Says:

      Arthur–Bremmer is a smart person but resides in the echo chamber of “great” thinkers and he gets paid handsomely for it–i stick with my present analysis but as always will adjust through dynamic analysis

  4. Dustin L. Says:

    Yra- While it’s impossible to deny the yield curve has been very distorted by CB policy, I still see it as a meaningful gauge of the markets expected growth and inflation potential across different periods as well as a gauge of sentiment (diverging far from historical norms in either direction warning of overconfidence either way). Thus, I am currently viewing it more directionally than based on particular levels because of CB distortion but, still hold it up as a useful indicator. Given my view, since you are the yield curve maestro and I started down the path of analyzing global yield curves largely because of your guidance, I would appreciate your opinion on this? We have touched on this several times but, in this piece you seem to be implying you are doubtful of the yield curves message of declining expected growth potential and the seeming acceptance (especially in the US, UK, Canada, AUS) that super-low rates could be here to stay for quite sometime (which I am less inclined to jump on this band wagon this late in the game but it seems to be what the market is pricing in.)

    • yra Says:

      Dustin–of this I have been thinking so when I have a concrete answer I will repsond in an intelligent and hopefully profitable way

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