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.