Notes From Underground: Is The FED Afraid of Inversion?

Last week, NOTES FROM UNDERGROUND left off asking, WHAT IS THE FED AFRAID OF? The most ostensible fears are of a global slowdown coupled with a potentially too strong DOLLAR, which would create the possibility of a new global financial crisis. The world has borrowed heavily in dollars because of the FED‘s zero interest rate policy. Rates were too low for too long.

Stan Druckenmiller cautioned against this DOUBLE-BARRELED BLITZ OF HIGHER INTEREST RATES AND TIGHTER LIQUIDITY. There is no doubt in my mind that Chairman Powell used the March FOMC meeting to respond to the concerns of one of the great global macro minds. In December, Powell didn’t want to be perceived as pivoting because of the political pressure pouring out of the White House. However, March empowered Powell to genuflect in the direction of Druckenmiller. Every part of the new dovish manifesto was a response to the Druckenmiller’s critical analysis: First, the Fed announced it would start tapering the balance sheet unwind in May, ending the normalization experiment in September. This possibly addresses the tighter liquidity issue. Second, putting off additional rate hikes in 2019 removes the threat of higher interest rates.

The U.S. DOLLAR is an issue for the FED because the White House is adamantly opposed to a stronger currency given its impact on U.S. exports. The recent action by the ECB and BOJ forced Powell into a position where any tightening of U.S. monetary policy would push the DOLLAR higher. This is because every major central bank is trying to reflate their economies and are actively depressing the value of the domestic currencies.

Immediately following the March 20 FOMC decision, the Swiss National Bank met and ultimately decided to leave their rate unchanged at -75 BASIS POINTS, while pledging to remain active in the FX market as necessary. The SNB also said the negative interest rate and its willingness to intervene in the market as necessary “remain essential.” The FED is locked into a passive policy by the aggressive attempts of foreign central banks to keep downward pressure on their currencies through the active use of monetary policy.

So, what is the FED afraid of?

The recent bout of dovishness has failed to steepen the yield curves in the U.S. The PIVOT OUGHT TO HAVE lowered short-term rates while sending yields on longer duration instruments HIGHER as the FED is deemed to be reticent to raise rates and thus allow the economy to run hotter for longer. The 5/30 curve has steepened in response, but the 2/10 has actually flattened and made lows on March 22.

Some pundits maintain that what really scares the FED is that the 3-month/10-year curve, which has inverted and has been labeled by the San Francisco Fed as the true harbinger of a coming economic slowdown. If the San Fran Fed is correct about the importance of the 3-month/10-year curve, then the FED has a very serious problem for even in the face of a dramatic dovish pivot the curves have not reacted in an appropriate fashion.

THERE IS ONE WAY FOR THE FED TO OVERCOME ITS FEARS: An immediate cut to short-term interest rates. Now, many of those I talk to say an inter-meeting cut would shock the STOCK MARKET as the FED was fearing something. But the PIVOT already sends a message and the failure of the YIELD CURVES to respond makes the situation even more critical. The last time the FED cut in an emergency meeting was in January 2008 as the EUROPEAN stock market was down more than 5 percent and investors were aggressively selling European bank shares were being aggressively sold in response to rumors about the solvency of SocGen.

A trader at the French bank, Jerome Kerviel, had sustained huge losses in a trade gone wrong and in an effort to support global markets the Bernanke FED cut rates by 75 basis points. The FED just admitted it was wrong by the swiftness of its pivot but if it is truly fearful of the message emanating from the shorter term curves more action is needed. If for Jerome Kerviel, why not for [INSERT EXCUSE HERE]?

***On March 21 I did an hour interview with Morad Askar of Convergent Trading. We discussed many issues so readers may find it worth a listen. There were several queries from the thousands of listeners about books to read in an effort to learn about the BOND market. I suggest reading articles by Lee Buchheit but I also hope that Professor Kevin Waspi of the University of Illinois Business School will provide some sources that he utilizes at the University of Illinois. A link to the discussion is below. Thank your for your indulgence.

Click here to for Convergent Trading interview.

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21 Responses to “Notes From Underground: Is The FED Afraid of Inversion?”

  1. kevinwaspi Says:

    Excellent one-hour chat with Morad Askar. I encourage readers of Notes to give it a listen if they have not done so already.
    As for recommended reads on fixed income, here you go:
    Suggestion #1 for the starter is the old standard, “Inside the Yield Book”, Sidney Homer and Martin Leibowitz. I have the sixth printing, dated January 1997 and still refer to it.
    Suggestion #2 for those who like math, “Bond Markets, Analysis and Strategies”, Frank J. Fabozzi. Once you get past Frank’s love for his own brilliance, there is some good relational mathematics that fixed income demands people understand. I have the fourth edition, dated 2000, still relevant, although with the 2008-09 experience, certainly more entertaining examples exist.
    I cannot agree more with Yra’s view on the importance of the markets for borrowed money. They are the tail that wags the dog of all markets, financial and real.

  2. Trader1 Says:


    If the FED did an immediate cut to interest rates and the yield curve stayed flat/did not steepen, then what??

    What I’m trying to ask is: Have the Central Bankers around the world using years of zero/negative interest rates just messed up the whole yield curve – would the ‘shock’ of the cut get the yield curve to respond??

    • yraharris Says:

      Trader 1–yes the central banks have destroyed the signaling mechanism of the bond markets.If the shock failed the Fed would have an even bigger problem then they can admit but as Rabbi Hillel asked–if I am not for myself who will be for me;if I am only for myself what am I;and if not now ,when?

  3. Michael Temple Says:

    Very perceptive analysis. I would add the following thoughts to your analysis.

    1. With a bow to Sherlock Holmes and “Why The Dog Didn’t Bark”, you are spot on in highlighting how utterly frightening it should be to Powell (and all of us) that the UST yield curve (I am ignoring the 30yr) is FLATTENING when the Fed just announced an incredibly
    ACCOMMODATIVE stance by announcing the halving of current QT with an overall end to it by September. Why isn’t the yield curve barking/widening?

    2. If Wednesday’s actions/words actually caused the curve to invert dramatically in the immediate days following, then perhaps only a SURPRISE cut is left to hammer home the message that the Fed has pivoted and begun to heed
    the wise words of Drunckenmiller and others.

    3. I know you watch the RED EDs….Sadly, too few others do. It is
    ASTONISHING to me that the spread between EDM19/EDM20 gapped out to 41ish bps this past week (now at 39).

    This is HUGE….Mr Market is pricing in nearly TWO 1/4 point rate CUTS.
    If stocks go a little bit wobbly from here (I am not even predicting
    a big collapse) and simply fall back to 2600ish on S&P, I would not
    be surprised to see that spread widen to 60ish bps.

    The ONLY WAY the Fed can attempt to “catch up” with the markets
    is, in fact, to SHOCK everybody with YOUR inter-meeting rate cut of 50 BPs. Heck, Powell may still be “behind the curve” after doing that, but the RED EDs are telling Powell that even his bold QT pullback last week ain’t enough to steepen the yield curve.

    Continued USD strength and the still muted gold price action offer another piece of the puzzle that seem to go hand in hand with the still inverting yield curve after the Fed action last week. They both
    seem to indicate that things are still “okey dokey” with no big rate cuts looming.

    This, too, should be quite puzzling/upsetting to the Fed….Dollar should be softening and gold should be getting a far better bid.

    I think you are on the right path….Just 3-4 months ago, “nobody” could have predicted that the dot plots would melt away and that
    Powell would do a complete “about face” about the QT autopilot.

    Tonight, “nobody” could envision a Fed rate cut any time soon.

    I am willing to wager that if you could sit with Powell for an “off the record” conversation, he would be very very worried that the markets
    have inverted on him after he just said he would begin to wheel back out the punch bowl, or at least indicate that it is on the sidelines and ready to be served up again soon.

    I think you may get your rate cut by Memorial Day…..4th of July by the latest.



  4. David Richards Says:

    As the excellent Ben Hunt piece “Fiat World “recently posted by Kevin Waspi showed, true US inflation is significantly higher than stated and higher than US interest rates. Thus should the Fed cut already-negative US real rates and/or engage in other dovish policy (it already has), it could bear more unintended consequences (worsening real inflation, even worse wealth inequality, impoverishment of the middle and lower classes, and active civil unrest). USD has already been generally weak since at least last summer, especially against most EMFX, down significantly from where it was 2 years ago, and down 43% in DXY since 1985.

    A falling dollar combined with falling real interest rates will exacerbate capital flight from US, which capital analysis shows has gathered pace since last August. The last time that combination happened to this extent was in 1987. Does policy hint at being hell bent on repeating that mistake?

    • David Richards Says:

      The investment implication is, Fed policy is intent on reversing asset prices higher since last year’s mild disinflation (the millennials will balk at my use of the word “mild” but they’re inexperienced), but this sunny effect could be temporary as regardless of Fed policy, US growth is slowing significantly, an earnings recession seems likely, and US equity prices could follow lower after this temporary spike higher. Rather similar to the last final price pushes up in 2007, 1973, post-911, pre-1987, etc. It’s all so damn cyclical and these government monetary masters trying to break the business cycle with their interventions only wind up exacerbating the inevitable cyclical down move later.

      Talk about a policy “mistake”. These tend to happen when the choir isn’t singing so. Hopefully, this Fed policy mistake will be its undoing and bring about the end of the Federal Reserve System as we know it, a monster and distortion of its original design.

  5. Michael Temple Says:

    Meanwhile, in overnight action, Red EDs have exploded higher, again. EDM19/EDM20 is now at 47 BPs.

    Expect to see gold stocks begin to rise decisively this week, even if gold remains muted. Miners generally lead the metal. This morning’s ED explosion is DEAFENING, to those who are watching.

    While 3Mo/10 yr remains inverted at -7, the 2/10 spread is beginning to widen, sitting now at 19 bps. Talk about cross currents.

    We know 5/30s has been widening, and now 2/10s bears watching closely.

    Again, back to Red EDs this morning.

    Stocks are NOT collapsing today to cause this up move. Powerful
    powerful trends are now set in motion.

    Once again, Powell must be plotzzing upon seeing this freight train
    move in the Red EDs.



    • yraharris Says:

      Mike—your comments tonight off the chart –very good support to the thesis and as you aptly analyze and the Who sang—-‘No one had the guts to leave the Temple”

  6. Michael Temple Says:

    And while we were sleeping, RED EDs soared in the overnight. And, there wasn’t even a stock market “risk off” event to spark it.
    EDM19/EDM20 is now at 47 bps as EDM20 is up another 9ish tics today.

    I think your rate cut prediction is now simply a matter of when, not if, even though no mainstream WSJ or BBG analyst is picking up on this EXTRAORDINARILY TECTONIC shift in the ED market.

    While gold still remains muted, most of the major miners tacked on solid 1%ish gains yesterday. I will be watching those miners quite
    closely today/rest of the week. Some interesting breakouts on key BIG BOY stocks, such as GOLD (the old Barrick), and WPM.
    RGLD and FNV don’t look so bad, either.

    How can Powell possibly ignore the message of EDM19/EDM20 now at 47 BP!!! Talk about “bitch” slapping. “Whose your Daddy?”

    Stay tuned

    • TraderB Says:

      If Powell waits and market proves him right, stocks rally. If he is wrong and has to cut 75-100 basis points, stocks rally. I don’t see where the bearish scenario is for stocks. Is there one?

      • David Richards Says:

        Maybe a significant earnings recession? It’s perhaps a reasonably probable event ahead?

  7. David Richards Says:

    Maybe Treasury should simply peg USD and monetary policy to TRY cuz they’re both 3rd world “shitholes” now with tinpot dictators. Sad.

    • yraharris Says:

      David—-you are wound up.You know as well as any reader that the FED is in a trap of its own making.Bernanke and Yellen trapped them,ok Greenspan by his misconceived bail-out of LTCM creditors,and Kuroda and Draghi have taken over but the trap is certainly set.If I hear another pundit talk about the greatness of Super Mario I will go ballistic—Mario is to banking as Neville Chamberlain was to peace in our time

      • David Richards Says:

        Yra, I last wrote rather rather tongue in cheek. But yes, I’m also wound-up some, so apologies if I blog-bombed your current post.

        Some of us are getting upset at this Fed sham. Re-enriching the vocal few who’ve done very well for a decade while repressing the unprotected, vulnerable majority who’d finally been seeing some small real gains in the value of their savings, work wages and purchasing power. Most of whom don’t care nor are directly affected much when credit spreads gap up or the S&P moves 50%.

        And I can’t excuse Powell on the basis of considering his immediate predecessors or other central bankers. He knew in advance the situation he was getting into, so if he couldn’t handle the job, then he shouldn’t have pursued it over Warsh & Taylor (who might’ve been a better 1-2 punch than Powell & Clarida, which I know isn’t saying much), or else Powell should’ve resigned with dignity rather than cave to the dictator-wannabe. So instead of admirably working to painfully but necessarily try to unwind the big ugly bubble that reportedly kept him up awake at night, Powell will now apparently instead douse bubbles with gasoline ensuring a worse explosion eventually later.

        Their “more cowbell” policy doesn’t hurt me as I can financially protect myself against the bastards and possibly even thrive with our TA, risk mgmt and a bit of luck. But the ordinary majority face both a slowing US economy and higher prices (rising substantially faster than claimed by gov’t per Ben Hunt’s piece Fiat World), while being financially repressed and unable to save in ways that keep up with the understated price inflation for life essentials like like rent & food, especially the millennials and middle-to-lower classes who unsurprisingly will thus vote in marxist-socialist extremists (and have the numbers to do so) intent on massively taxing both wealth and investment income/gains at high tax rates (per Elizabeth Warren, if you’ve much wealth then you’re going to pay it back – and she’s more moderate than some others).

        Thus the Fed-driven wealth inequality that I mentioned above as an unintended consequence, about which I’m sure you and most readers are already aware. Inequality which might worsen as Powell et al resume doubling-down on their excessively easy monetary policy, rate cuts, financial repression and QE. Blowing a yet bigger financial bubble and yet bigger income inequality, it’s an unnatural market trend being re-imposed by policymakers that is giving free markets a black eye in the court of public opinion. Indeed, to quote Ryan McMaken recently from the Mises Institute, “It looks like we should expect a continuation of the policies which have coincided with both an unimpressive economy and rising inequality. If that’s not evidence of the Fed’s failure, it’s hard to imagine what is.” Bingo!

        So, rising civil unrest and an extreme marxist-socialist government on the horizon? Brought in part by the Fed as more unintended consequences of its unintended consequence of wealth inequality?

        The US is *not* Japan, in many ways, so that relatively pleasant social outcome is unlikely for the US. Gotta read some books and live in the East awhile to help comprehend why. A large and separate discussion.

      • Chicken Says:

        I can help with the cowbell….

      • David Richards Says:

        How appropriate. From the last stagflation era, which will be making a comeback. And again “after a series of staggering defeats”, also more cowbell this time from jerome powell.

      • Chicken Says:

        With apologies to Yra, it’s just not complete without bag pipes…

    • yraharris Says:

      david Richards—there is so much here but let me respond to your last comment which I concur with as Japan and the US are vastly different.The Japanese have weathered the two lost decades because they went into it with massive savings all along the wealth and income spectrum.Secondly,the Japanese had actual defaltion which rewarded its savers who owned 97% of the Japanese sovereign bonds—even at zero interest rates the Japanese savers were earning a positive real yield.The sociological aspects are a whole different matter.The US has no savings and have been financially repressed through the use of negative real yields for a decade and more.The silliness or laziness of the pundit class in making the US into Japan is as badly flawed as the FED models

      • David Richards Says:

        Yra, great reply about Japan in support of mine. But I also like comments that challenge me in case I’m wrong (like so many times). An example I found elsewhere:

        That commonly-held narrative I echoed above that “Powell caved into Trump” given the Fed’s stunning policy U-turn (everyone has heard about “the white house dinner” in late December) might be a false narrative after all. Even though I, many serious managers and others bought into the “Powell caved” story.

        Danielle DiMartino Booth, formerly of the Dallas Fed, has been making the rounds on MacroVoices and Hedgeye, publicly claiming that “cave” story is just nonsense and wrong. She’s in a better position than most to know, I think. She cites that Powell, who has a private equity background, was instead moved by credit markets starting to freeze.

        If so, then maybe I was too harsh on Powell. But if Danielle is right, then why did Powell as recently as December 19 still hike and say that balance sheet runoff was on autopilot, even after credit spreads had spiked and credit markets were seizing? Hmm.

        Anyway, it is what it is and the Fed is uber-dovish. Grants reports US credit is very loose everywhere with borrowers of all merit having unprecedented access again and dollars are in high supply globally. Party on?

  8. Michael Temple Says:

    Good Morning.

    Following up after the weekly close, I am struck at how other markets seem to confirm the strangeness of the yield curve flattening AFTER the Fed’s big pivot.

    Notwithstanding the pullback in USTs and Red EDs, the curve is sitll
    flatter than before the Fed.

    But, consider these two other MAJOR developments, which should
    further buttress the argument that the Fed is still too tight and that a 50 bp cut is probably far closer than anybody can imagine (excluding, of course, Stephen Moore and now Larry Kudlow, who continue to shill for such a cut, but for reasons that don’t necessarily
    match with what I am about to write).

    1. Gold got monkey hammered this week. Generally speaking, that
    is a deflationary event, which seems to dovetail with inflation downgrade expectations.

    2. USD stubbornly refusing to weaken and actually gaining. A stronger dollar is a de facto tightening.

    Add that to a flattening yield curve, and it is quite astonishing to realize that even AFTER a full dovetard turn by Powell, Mr Market
    chose to rise up and SCREAM, “Jerome, you are still too tight”.

    While the Fed may not be able to spy where any domestic crisis might lie, you hit the nail on the head that the Black Swan that probably lights the fuse comes from overseas, much like the SocGen
    disaster in 2007 that forced Bernanke’s hand.

    Hard Brexit?
    Failed China trade deal?
    Spill over from Turkish lira?

    Who knows….But the fact that USD is stubbornly strong while gold got pushed back down dovetails (ha ha) with the flattening curve.

    The only thing left for Powell to do is to cut rates. Unless, of course, he wants to buy some gold. But, that is the call of the Treasury, and
    probably only happens sometime in 2022 and beyond.



    • yraharris Says:

      Mike—my answer is in tonights blog–thanks as always for your very informed analysis—the discourse puts us in the vanguard of seeking potential profits from the policies we are forced to absosrd as citizens and market denizens

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