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