Notes From Underground: An Answer to a Rohr and Chicken

As I noted on Sunday night we FINALLY closed below the 73 basis point level that has held for almost two years after several attempts to flatten through that support. The FED is in a difficult situation. Similar to the central bank openly stating that it doesn’t understand what is going on with the Phillips curve and lack of wage inflation, it doesn’t want to admit that the FLATTENING curve is due to the ECB’s ongoing asset purchases that is compressing yields. Some MOOKS maintain that it is a global savings glut but when you have printing how can you discern what constitutes savings and not just central bank intervention?

A SPECIAL NOTE: While the U.S. curve is flattening, the GERMAN 2/10 curve is steepening. This is defying the logic of the ECB’s debt-buying spree while the FED is shrinking its balance sheet. The German 2/10 curve is pressing up against its 200-day moving average of 109.96 basis points, so imagine that. As the ECB is buying debt, long-term bond holders selling debt over two years and out for fears of inflation and a drop in bond prices once the ECB starts actually shrinking its balance sheet. AGAIN, THE CENTRAL BANKS HAVE BROKEN THE SIGNALLING MECHANISM OF BOND VALUATIONS. (I am posting two charts from Bloomberg: The U.S. and German 2/10 curves, each of a three-year duration.)

As the FED sells, the ECB buys. Along the various curves there are mixed messages. As U.S. economic data improves, Congress is working on a fiscal stimulus program with a 4.1% unemployment rate and the curves are flattening. As Vizzini (Wallace Shawn) says in the Princess Bride: INCONCEIVABLE. The only ways the FED could prevent a flattening is to either cut RATES or increase the rate of SHRINKAGE so as to overpower the ECB‘s plan of halving its purchases beginning in January. Both options would cause major disruptions in the financial markets. We can fondly recall the wisdom of Herb Stein, Chairman of the Council of Economic Advisors under Nixon: “If something cannot go on forever, it will stop.” The problem for the markets is that the world’s central banks have access to an unlimited supply of ink. When the Hunt Brothers tried to corner the silver market in the 1979-80 period they ran out of money and credit, for the worlds central banks we don’t know where the end of their ability to create liquidity ends.

This is the dilemma for global markets. Many traders and hedge fund managers believed the Bank of Japan would not be able to keep Japanese bond yields low through intervention forever. The BOJ won that battle and the short JGB trade became known as the WIDOW MAKER. Four weeks ago, Bridgewater’s Ray Dalio opined on Bloomberg and CNBC that he was shorting Italian bonds because of the terrible fiscal situation confronting the Italian government as their banking system was also saddled with a HUGE overhang of nonperforming loans. Anyone bother to look at a chart of the Italian 10-year BTPs?

Since October 5 the BTP has been rallying and yields have declined nearly 30 basis points. The actions of central banks have succeeded in distorting an entire spectrum of asset classes as designed by Ben Bernanke desired through his Portfolio Balance Channel that was unveiled in Jackson Hole, Wyoming in August 2010. QE 1,2,and 3, which was supported by the similar actions of the Bank of England, Swiss National Bank, Bank of Japan and the ECB have created a liquidity JUGGERNAUT that crushes any financial dissidents in its path. How long can it continue? Ask Herb Stein or visit the PYRES of those financial warriors who were regularly short JGBs.

So how does the FED deal with a flattening yield curve in a time of FULL-EMPLOYMENT and potential massive fiscal stimulus? I don’t know, but I hope Jerome Powell has some sense of what he faces on day one of the job. The easy answer to the QUERY: Start CUTTING SHORT-TERM rates and the U.S. curve will begin the steepen like the German 2/10. But if that were to happen I would look to be LONG GOLD AND SHORT THE MAJOR CURRENCIES AS IT WOULD CONSTRUE A RACE TO THE BOTTOM FOR THE WORLD’S CENTRAL BANKS.

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10 Responses to “Notes From Underground: An Answer to a Rohr and Chicken”

  1. kevinwaspi Says:

    “Never in the history of the planet, has so much been taken from so many, by so few”

  2. Asherz Says:

    Last Friday I pointed out that with the market pricing mechanisms broken, traders and investors could no longer use technical indicators or fundamental analysis. So your US 2/10 73.5 spread offering a trading point had little utility.
    Powell was chosen over his more hawkish peers who might call a halt to the insanity of the last 8 years, and attempt a Sully Hudson River landing. He joins the rest of the Gutenberg gang to keep the dance going . Ultimately Herb Stein is correct . The question is when a Black Swan will swoop in to clog Sully’s jet engines. In the 1987 crash the breakdown of the UAL leveraged buyout was the trigger. In 2008 Lehman and AIG signaled the coming meltdown.
    Until then the sidelines are where prudence dictates ones positioning. As Graham Dodd said long ago,you don’t have to swing at every pitch. There are other places to spend time besides the trading pits, especially when the inmates have taken over what has come to be an asylum.

    • yra Says:

      Asherz–this is a wonderful response and the citation of Graham Dodd from an actual student of theirs is a wonderful addition.Yes,when you wrote the piece Friday I was wondering on to respond and I used last night’s blog post to put perspective to the non-utility view.You are very aware that a theme of NOTES has been the broken signalling mechanism that the Central Banks have created–SANTELLI and harris have duscussed this on CNBC adnauseum and it falls on Bernanke and Draghi’s shoulders far more then others—those two will respond that they were the only game in town as Governments failed to enact the right fiscal and structural policies.Nonsense after the first rounds–they are the classic enablers in a credit addicted world.You should write a response book to Bernanke–The Courage Not to Act–or not swinging at every pitch.As an investor I certainly don’t swing at every pitch but AS A TRADER I HAVE TO TRY TO UNDERSTAND THE CHANGING TERRAIN AND ADAPT–or as Patton would say—Rommel,I read Your Book.

      • Asherz Says:

        Yra- Long term investors like me who are away from the action, look to traders like you to let us know that El Alamein has arrived and signals that they rang the bell, with “Monty” having the Desert Fox on the run.

  3. David Richards (@djwrichards) Says:

    “MOOKS”….gotta love it. I’ve long thought that the “global savings glut” claim was disingenuous because, if true, then why so much printing for so long?

    Finally, some belated kudos for all the outstanding analysis leading up to Mario’s more dovish ECB decision than was widely expected.

    • yra Says:

      David–thanks for the kind words and MOOKS from the great Scorcese Mean Streets and now these streets are mean

  4. Richard H Papp Says:

    Yesterday when one noted newsletter writer went short the UST long bond @154.50 I just smiled, look at TBT, and said “not me”!
    Secondly, to give Ray D. proper credit his major short of ISNPY so far is doing just fine.
    Rock on Yra Harris!

    • yra harris Says:

      Richard–believe me not poking at Ray D. as I have respected him for decades–my point was how badly fundamentals are burdened by the actions of the ECB

  5. Rohr (Alan Rohrbach) (@MacroMeister) Says:

    Hi Yra-
    Thanks for the follow up on the latest US 2-10 curve weakness, and the informed comments it has encouraged from others. In light of the strength of the US equities, the strength of the longer dated US govvies seems very odd except for the still very subdued inflation. And I appreciate your reminder on the central banks breaking the signalling mechanism, as well as the irony of the divergence between the US and Euro-zone curve trends.

    That is of course even more perverse in the context of the ECB plans to continue reinvesting the APP (actually 4 combined QE programs) yield proceeds once net purchases end. That was extended at the last meeting into September 2018, or beyond.) And at the last press conference Constâncio let the cat out of the bag on the APP now being so large that the reinvestment amounts to appr. €10B of additional purchases per month.

    It all seems to relate back to your suspicion the ECB is trying to finesse resisting national powers-that-be (i.e. the Germans and other creditor nations) to allow a Euro-zone finance ministry and budget.

    Am I recalling that correctly, and do you have any further views on the ECB’s next likely moves? Could there be something more than the sheer APP reinvestment endless balance sheet expansion in the works to force the issue? Looking forward to your views on that.


  6. Chicken Says:

    In the real world, “You break it you buy it.”

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