The yield curves were the star performers after the FOMC statement and the Bernanke press conference. The 5/30 (bottom) curve was the most volatile but the 2/5 (top) and 5/10 curves also provided great volatility. It seems that while everybody parked money in the FIVE-YEAR NOTE as the safest place to be during the FED’s non-tapering act, the FIVE-YEAR NOTE has become a bastard child and is being orphaned. Why? In my opinion the FREE PARKING place that the fives provided for curve players has now been placed under the microscope and it seems that it is not as safe in a world of “LESS” Fed asset purchases. The FIVE YEAR has a flat to negative real yield. This means that if you expect inflation to be running at 1.6% and the yield on the five-year is 1.65% you are breaking even on a real return basis. The 10-year at 2.95% provides you with a real yield of 1.3% over the inflation rate. The problem is that you run TERM RISK by going out further on the curve.
The question that BOND TRADERS ask is: “Am I being compensated enough by the premiums offered further down the time line or duration?” The FIVES have said no to the question but the 10s and 30s have found some buyers, or at least shorts are being forced to cover. As I have warned for four years, the FED has caused great harm in the BOND market through its massive large-scale asset purchases or, QE. Year end and the thin holiday markets will exaggerate any moves so tread cautiously into the credit markets. The FIVES though will be the keystone of the price movements for the very near term so be attentive. Put in charts I sent –{if we have a shorter term 5/30 that might be better}.
***In Monday’s Financial Times, columnist Wolfgang Munchau has an article criticizing the newest agreement coming out of Brussels on the creation of a EU Single Resolution Mechanism (SRM). Munchau is a Europhile, who has until recently been a cheerleader for all things emanating from Brussels. When a member of the privileged cast heaps criticism on a major decision, I advise paying attention. The article, “How To Prolong A Banking Credit Crunch,” and it takes the EU finance ministers to task for proclaiming a major victory in their efforts to create a unified financial system throughout the EU,which means a major backstop is in place to rescue any banks or financial institution that is in trouble. The key to the SRM is that it requires Germany to be the co-signer for all the legacy debt presently on the books of European banks from Greece to Portugal.
In listening to news reports on Friday, the spin was that Germany has bent and agreed to finance basically what would be a FDIC. Munchau writes: “Some of the finance ministers tried to put a brave face on this humiliating defeat, pretending that Wolfgang Schaeuble, the German finance minister, had given ground on an important principle. But that is not the case at all. The banking union that was agreed was the banking union Mr.Schaeuble always wanted. He does not want German taxpayers to pay for the restructuring of banks in other countries. And he does not want the European Commission, or anybody else, to close down a German Bank. If ever there was a game, set, match victory in EU history, this was it.”
As we enter 2014, the European financial crisis is far from resolved for it will only reach some certainty of outcome when the Germans, Dutch and others accept the concept of a EURO BOND backed by the full faith and credit of the economically strong European nations. If the Germans do agree to such an instrument, what will be the cost extracted from the rest of Europe? The German push for austerity is the effort to get the budgets of the peripherals under control so the German policy makers can at least provide German voters with an improving situation. But as we have seen, AUSTERITY sets into motion NEGATIVE FEEDBACK LOOPS. Less spending means slower growth, which means less tax revenue with increased unemployment. Yes, the EURO currency continues to strengthen but that is a function of liquidity flows as the ECB’s balance sheet shrinks while the U.S. Fed’s continues to grow. Now that the German’s have blocked any immediate hope of a SRM to backstop the banks, will Mario Draghi become more assertive in his efforts to provide the liquidity that will be needed to forestall an EU financial crisis?Welcome to 2014.
***I want to wish all my readers a very Merry Christmas and a happy and healthy New Year. I deeply appreciate the feedback and conversation that takes place within the bounds of Notes From Underground. All the best for the New Year — Yra Harris
As we await the outcome of the German elections in September, we at Notes From Underground would like to point out a few posts in which we alluded to the German elections. The first one is from June 2010, after the defeat of Chancellor Merkel’s candidate for German President, Christian Wulff.
The revelation: she leaves a sour taste in the mouths of Germans.
Chancellor Merkle’s hand-picked candidate for German president, Christian Wulff, did not receive a majority of votes in the 1,244-member assembly of federal lawmakers–similar to the electoral college in the U.S.–and will have to go on to further ballots. Wulff had 600 of the needed 623, thus keeping the opposition candidates alive. If any of the candidates fail again to achieve the needed majority, then the process goes to a third ballot in which the candidate with most votes wins.
We believe that Merkel’s candidate will prevail but the failure on the first vote is a slap at the chancellor. The meaning of this slap is that it makes the German Government bailouts of the PIIGS that much more problematic as the German public is growing tired of sending its money to the profligate. The internal opposition to further bailouts is the real threat to sovereign solvency within the EU. It is not the strikers in the peripherals, as significant as that may be, but the rise of opposition in Germany to sustained money transfer. We continue to say that the real TEA PARTY people are in Germany and there in lies the rub. We also note that the EURO has held up very well today in spite of this news. However, one day on month-end/quarter-end doth not make a trend but does reflect on the U.S. DOLLAR. The problems in the developed world are immense –no nation seems to have escaped. It’s just a matter of what seems to be the flavor of the day.
In a more recent post from April 28, we said, “the question that is framing the most recent debate in European circles is the one asked by Bernard Connolly for the last 18 years: Whose currency is the euro and who controls its outcome?” Click the link below for a refresher while we wait for the listless markets to wake.
First, the unemployment report offered no surprises as the market was close to the actual release. The real surprise was in the upward revisions to the February and March numbers. The negative surprise was the average work week shrinking by 0.2% of an hour. The shorter work week may be an aberration but it may mean that employers are cutting workers hours so as to keep under the Affordable Care Act mandates, but I caution it is far too early to say that this is definitely occurring. The BOND markets reacted negatively to the “stronger” jobs data and the 10-year note future fell as yields rose by 10 basis points. Investors bought stocks and seemingly sold bonds in a performance of risk-on/risk-off. Again, one day’s action does not a trend make. The pure risk-on/risk-off paradigm has been dormant for quite a while and let’s hope it stays that way.
It seems that the European debt markets are rallying in response to the end of ADVERSE FEEDBACK LOOPS. In a mind-numbing thought, it appears that the implementation of austerity budgets actually had the effect of increasing deficits as economies slowed as austerity began to bite. (The outcome of the adverse feedback.) The more austerity, the larger the deficit, which is compounding the debt problems of peripheral nations. Greece is the poster child of austerity gone awry. So as the threat of AUSTERITY diminishes, the more a nation’s bonds rally. The ITALIAN BTPs (10 years) saw its yields drop precipitously as a new government was formed over the weekend. But the rally in the BTP futures had begun well before the new government was actually crafted, as I noted last week. The BTP FUTURES had closed over the February 25 high–that was made before the failed election was a reality.
The fiscal crisis came and went and yet the Potemkin village remains. So much was made about the looming fiscal calamity and its dire consequences that the probabilities of a compromise were overwhelming. Not only did fiscal sanity fail to show, the final package was beyond my comprehension. As the nation’s focus was supposedly on Congress, these purveyors of fiscal rectitude passed a BILL that was laden with pork. NASCAR, Hollywood, alternative energy et. al. were the recipients of CONGRESSIONAL LARGESSE IN THE TIME OF FISCAL AUSTERITY. There is no shame in the payment of political favors even in the full view of the MIDDLE CLASS.
Yes, the U.S. Presidential election is finally here. After the POLITICAL-INFO COMPLEX has spent the $6 billion on various political campaigns, we are left wondering why anyone would contribute money to feed the monster and prolong our agony. I know the answer and the “road to political hell is not paved with good intentions.” There are so many polls predicting a very tight race that I care not for the popular predictions. As an investor/trader I am much more concerned about the outliers. First, the most significant result would be for the Democrats to retake the house. The 2010 Republicans claiming the majority in the House by such a wide margin was not predicted. If the Democrats were to undo 2010 it would mean a landslide victory for President Obama as well as the continued control of the Senate. The triple crown for the Democrats would be a negative for the markets as there would be no movement on the “fiscal cliff” as the Democratic leadership would be empowered with a mandate.
First, the equity markets continued this week’s rally as better data in the U.S. (housing) following upon the Monday retail sales report provided more fuel for the bulls and is causing great angst for portfolio managers that are underinvested and badly underperforming their benchmarks. These investment advisers must go to sleep and pray for the U.S. to bomb Iran so that they will have some type of opportunity to buy into the global equity rally. It’s tough to chase this one. As I wrote on Sunday, the IMF “volte face” on the impact of austerity budgets was a game changer as it will mean that austerity inspired programs, like the U.S. fiscal cliff, will force policymakers to be cautious in pushing for too much austerity in times of a balance sheet recession. The pushback from Spain, Italy and others is allowing the forces for unrestrained growth to gain ascendancy over the voices of austerity led by the Bundesbank.
The tale of the first quarter tape is in and evidenced by the large gains of the equity markets, global investors have benefited from the sea of liquidity provided by the CENTRAL BANKS OF THE DEVELOPED WORLD. Global stock markets have been calmed by the massive liquidity injections provided by the BOJ, ECB, FED and BOE.The German DAX closed the quarter up more than 15%. The long dormant NIKKEI was up almost 20% powered, by the new inflation mandate of the BOJ/MOF; and, of course, the S&Ps were up almost 12%, while the tech-ladened NASDAQ climbed more than 20%.
Yes, I know Athens is burning as some of the more violent demonstrators threw some Molotov cocktails and the media was given some photo ops so the situation can be understood by those too involved with life’s challenges to read. If that sounds acerbic it is because I have been writing about the Greek debt crisis since December of 2009 when the Chinese investment funds reneged on a promise to purchase $25 Billion of Greek bonds and the debt crisis was in full swing. Again, Athens may be the present battleground but the political and financial games are being played out in Paris and Berlin and of course in the offices of the IMF.
The release of the FOMC minutes today revealed that the FED plans to be more transparent as it will “publish forecasts of its own interest rates for years into the future.” Previous FED forecasts have proved to be very poor at predicting the path of the economy over the near term or yet for any longer period of time. On first read, this attempt at transparency ought to be labeled the VOLUME ENHANCEMENT FOR THE CME EURODOLLAR CURVE. FED prognostications will move the 3-5 year part of the curve all over the place and be very productive at increasing futures and options volume.
