Notes From Underground: Let’s Look at Global Yield Curves

One of the most important indicators for financial markets is yield curves. They are predictive as they have historically shown coming economic turmoil, or, more importantly, the end of a business cycle. The severity of any recession depends on the amount of debt that has preceded the onset of an economic slowdown. I will remind readers that before the 2007-08 financial crisis, the U.S. 2/10 curve actually INVERTED to NEGATIVE SIX BASIS POINTS. Some financial pundits like to cynically advise consumers that the STOCK markets have predicted 10 of the last 5 recessions, but that is not so with yield curves. The difficulty with the signalling mechanism of yield curves is predicting the time for even during the GREAT RECESSION equity markets continued to rally even as the curve flattened.

After the FED cut rates in late-2007 the SPOOS rallied to new highs (1578), but the onset of more aggressive rate cuts in 2008 could not prevent the massive stock market selloff as the piles of debt proved too great a burden while the financial system was being liquidated. Currently, global yield curves are actually steep as central banks keep the short-end well supported with QE programs but nervous investors and astute speculators are shorting the longer end as political fears weigh on economic outcomes. An example is the recent steepness in the French 2/10, which at 166 basis points, but all of Europe’s yield curves have steepened except ONE: GREECE.

The 2/10 Greek curve is signalling new dangers for Greece as the curve is now a dangerously inverted at NEGATIVE 200 BASIS POINTS. It seems that the 2-year Greek note is yielding 9.85% as people fear a massive debt restructuring because the IMF is searching for a way out of its commitment to Greece. DANGER PREVAILS AS MANY INVESTORS ARE THUMBING THEIR NOSES AT 9.85% as FEAR IS TRUMPING GREED. The IMF made a critical error when it got involved in the Greek bailout. Since it’s part of the euro, transfers from the Germans, Dutch and French could have easily sustained Greece. But the IMF involvement provided political cover for Sarkozy and Merkel.

The IMF provided funds while the EUROCRATS in Brussels demanded austerity through tax increases, budget cuts, and, of course, a squeeze on wages. This policy is what economists refer to as an internal devaluation and the citizens of Greece have borne the full impact of  a TROIKA-imposed depression. During the last six years the internal devaluation has resulted not in a contraction of the debt/GDP ratio, but actually an expansion. The IMF wants out of this failed program but if it walks the German taxpayers are going to absorb large losses. Former Greek Finance Minister Yanis Varoufakis has battled with Prime Minister Tsipris as he advises forcing a Greek debt restructuring so that Greece can unshackle itself from the chains of debt bondage. But if the Greek crisis explodes, the political situations in the Netherlands, France and Germany take on a heightened level of uncertainty.

The GREEK 2/10 curve is a very important barometer for measuring investor sentiment. NORMALLY THE STEEPENING YIELD CURVES IN THE OTHER EUROPEAN NATIONS WOULD BE A POSITIVE FOR EQUITY VALUES AS THE ECB WOULD BE DEEMED TO BE TO EASY FOR ECONOMIC CONDITIONS. But with the massive QE program it is difficult to discern the significance of current valuations. Patience is required, but I warn that the fallout from a European crisis will be GLOBAL and not regional. And yet, U.S. equities are stable. Don’t be deaf to the rising global uncertainty.

***Today, Italian and French debt were bid as ECB bond buying forced shorts to cover. As the yields on 10-YEAR Italian and French debt fell, BUND yields actually rose. But at the conclusion of the trading day the Italian yields rose and German yields retraced and actually closed lower on the day. Just a sign of the power of the ECB to affect prices intraday.

***Something to think about as we go forward: In a world where the U.S. dollar is the global reserve currency the impact from the enactment of a BORDER TAX has far greater ability to disrupt the global economy than a VAT tax at the Mexican border. The FED’s QE program resulted in a massive debt binge from emerging market countries and corporations. The proponents of the BORDER TAX note that the import tax will result in a 15-20% increase in the DOLLAR and will be neutral for the U.S.-based consumer as the stronger DOLLAR will result in lower prices for goods.

The damage of a rapid rising DOLLAR will bankrupt foreign concerns with DOLLAR-VALUED LIABILITIES. The world rotates on 2+2=5 (thank you, Fyodor Dostoyevsky). Do not be trapped by the myopic thoughts of the tweeting crowd. And yet we are so stable as to make me jump to Hyman Minsky.

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12 Responses to “Notes From Underground: Let’s Look at Global Yield Curves”

  1. JTC Says:

    again the wait of world on U.S

  2. Angelo Gallo Says:

    Wouldn’t surprise me if Brussels uses duck tape to hold the Greece debt situation together until after German elections in September.

  3. Dustin L. Says:

    Yra- Your thoughts have been very thought provoking of late and for that I would like to say thanks. On that note, I have been wondering has the market over simplified USD reactions to VAT or other “America first” trade adjustments? The fact that it is the world’s reserve currency certainly will complicate the dollars reaction to policy change. As we all learnt in college Econ, protectionist policies increase the domestic currency ceteris paribus: But, 1) Things are never ceteris paribus, especially in trade policy; 2) With USD playing such a large role in facilitating global trade and as the reserve asset of choice, could capital implications, that is a global dumping of dollar reserves as the falling supply of dollars forces the world to find alternatives (for instance all those bilateral swaps being utilized at least short term) puts pressure on the USD offsetting some portion or perhaps all of the price impact from protectionism? Additionally, how much of the “America first” policy objectives is already priced into the pricing of the USD? Additionally, how hedged are those exposed to USD liabilities in emerging markets? (Something we can’t confirm and I presume quite hedged at this point, they have been shorts on the run.)

    Anyways, some food for thought to add some complications to the scenario you laid out. I have to admit, I’m feeling more contrarian on USD and UST all the time.

    Kind Regards,

    • yra Says:

      Dustin L–as usual a very solid contribution.And we can’t asume hedges are on because a zero to negative rate environment breeds complacency and maany few the hedges as an a waste of potential return—there are mny unanswered questions and as usual Prof Waspi has raised the issue of when genius failed or maybe it is all artificial intelligence cloaked in math

  4. frank c Says:

    Another new round of “kick the can down the road”?

    The EU, ECB, IMF haven’t fixed any problems. They just continue
    to buy more time.

    They have failed to take/give the strong medicine.

    The history lessons from the past deadlines, restructurings, and bailouts all lead to the same answer: the Central Banks idle threats and then printing more money and buying up bad paper.

    The market participants seem to be complicit in this charade.

  5. kevinwaspi Says:

    Frank, Interesting point on the market participants complicit in the charade. I have wondered how much of our “market participants” are really only robots, buying what goes up, selling what goes down because that is the way “passive management” has to play to the market bogey today. A little like “dynamic hedging” being all the rage in the 1980s, until we saw what could happen when the tail wags that dog in 1987. I’m wondering what today’s hyper-robots do with a 22% one-day swoon. That was just a warm-up to 1998 “when genius failed us”, so again, i wonder how all of the physics majors managing economic equilibriums will react this time, when all correlations go to 1.0. (Ancient Chinese curse: “May you live in interesting times”)
    We do.

    • Joe Says:


      Great comment and insight. These “market participants” will be AWOL if they sense anything like a 22% swoon, unlike the Specialists and spreaders they replaced under the guise of democratizing markets, making the claim they are providers of “liquidity” absurd. They bring unquantifiable risk to the process and the market itself.

      ” I have wondered how much of our “market participants” are really only robots, buying what goes up, selling what goes down because that is the way “passive management” has to play to the market bogey today.”

      Me too, and more than we likely know, and much more than the market’s infrastructure wants to admit. In an age of cutting the penny into hundredths of a unit – (and ongoing efforts to eliminate the red cent in cash accounting) – I can’t help equate these robots to the fellows who used to skim the take in Vegas count rooms.

  6. Kevin Says:

    Interesting comments re the yield curve’s signalling power, Yra. I must make the point that an inverted curve is a powerful signal, but not a precondition. I have seen many articles saying there cannot be a recession given the shape of the curve. Those commentators need to glance east, where Japan has had 3 recessions since the start of their de-facto ZIRP in 1996. In each case, while the curve flattened sharply, it did not invert. I used to think this was because of the constraints of the zero bound, but we know what happened to that! But when the short end is not far from zero, I focus on steepening or flattening rather than shape.

    @kevinwaspi: 1987’s portfolio insurance = 2017’s risk-balanced mandates, where equity allocations must be reduced as volatility rises. They may have looked very good in back testing (bar the Taper Tantrum), but these are an accident waiting for a simultaneous bond and equity bear market to happen. Huge amount of institutional assets in these mandates.

    • yra Says:

      Kevin–certainly a fair point about flattening and not necessarily inverting .But we are all searching for understanding the impact from the central banks and not all counterfactuals are created equal–which is what Draghi and Yellen are going to Max Planck maintained—Science advances one funeral at a time as does good investment.

  7. Rob Syp Says:

    Is everyone noticing all the cranes being used for new building projects? I only had time to count 10 on a quick trip through Chicago yesterday and there has to be many more. South Florida is also experiencing a major build out boom as probably everywhere else. Dare I say zero % fueled this? Bigger question is where are all the people coming from to occupy the new parcels and when higher interest rates get here than what?

    • David Richards (@djwrichards) Says:

      Scarier thought is that it seems to be a common phenom. It was the “ghost cities” of China and spread to Canada, Australia & NZ, Germany and southeast Asia where I now live. Scary because the motivation behind much of this recently is cash buying by rich folks getting off the financial grid due to insolvent banks & governments. Europeans and Asians know from history that government bonds, currency and banks can go to zero.

  8. Fearless Rick Says:

    Excellent reading as always. I get Yra’s posts via email and they never fail to inspire new and challenging concepts in the macro environment. Many thanks and great comments as well.

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