Tag Archives: bond market

Where The Next Financial Crisis Begins

https://macromon.files.wordpress.com/2010/09/cropped-currency11.jpg?w=621&h=131

(Global Macro Monitor) We are not sure of how the next financial crisis will exactly unfold but reasonably confident it will have its roots in the following analysis. Maybe it has already begun.

The U.S. Treasury market is the center of the financial universe and the 10-year yield is the most important price in the world, of which, all other assets are priced. We suspect the next major financial crisis may not be in the Treasury market but will most likely emanate from it.

U.S. Public Sector Debt Increase Financed By Central Banks 

The U.S. has had a free ride for this entire century, financing its rapid run up in public sector debt,  from 58 percent of GDP at year-end 2002, to the current level of 105 percent, mostly by foreign central banks and the Fed.

Marketable debt, in particular, notes and bonds, which drive market interest rates have increased by over $9 trillion during the same period, rising from 20 percent to 55 percent of GDP.

Central bank purchases, both the Fed and foreign central banks, have, on average, bought 63 percent of the annual increase in U.S. Treasury notes and bonds from 2003 to 2018. Note their purchases can be made in the secondary market, or, in the case of foreign central banks,  in the monthly Treasury auctions.

In the shorter time horizon leading up to the end of QE3,  that is 2003 to 2014, central banks took down, on average, the equivalent of 90 percent of the annual increase in notes and bonds.  All that mattered to the price-insensitive central banks was monetary and exchange rate policy. 

Stunning.

Greenspan’s Bond Market Conundrum

The charts and data also explain what Alan Greenspan labeled the bond market conundrum just before the Great Financial Crisis (GFC).   The former Fed chairman was baffled as long-term rates hardly budged while the Fed raised the funds rate by 425 bps from 2004 to 2006, largely, to cool off the housing market.

The data show foreign central banks absorbed 120 percent of all the newly issued T-notes and bonds during the years of the Fed tightening cycle, freeing up and displacing liquidity for other asset markets, including mortgages. Though the Fed was tight, foreign central bank flows into the U.S., coupled with Wall Street’s financial engineering, made for easy financial conditions.

Greenspan lays the blame on these flows as a significant factor as to why the Fed lost control of the yield curve.  The yield curve inverted because of these foreign capital flows and the reasoning goes that the inversion did not signal a crisis; it was a leading cause of the GFC (great financial crisis) as mortgage lending failed to slow, eventually blowing up into a massive bubble.

Because it had lost control of the yield curve, the Fed was forced to tighten until the glass started shattering.  Boy, did it ever.

Central Bank Financing Is A Much Different Beast

The effective “free financing” of the rapid increase in the portion of the U.S debt that matters most to markets, by creditors who could not give one whit about pricing, displaced liquidity from the Treasury market, while at the same time, keeping rates depressed, thus lifting other asset markets.

More importantly, central bank Treasury purchases are not a zero-sum game. There is no reallocation of assets to the Treasury market in order to make the bond buys.  The purchases are made with printed money.

Reserve Accumulation

It is a bit more complicated for foreign central banks, which accumulate reserves through currency intervention and are often forced to sterilize their purchase of dollars, and/or suffer the inflationary consequences.

Nevertheless, foreign central banks park much of their reserves in U.S. Treasury securities, mainly notes.

Times They Are A Chang ‘en

The charts and data show that since 2015, central banks have on average been net sellers of Treasury notes and bonds to the tune of an annual average of -19 percent of the yearly increase in net new note and bonds issued. The roll-off of the Fed’s SOMA Treasury portfolio, which is usually financed by a further increase in notes and bonds, does not increase the debt stock but, it is real cash flow killer for the U.S. government.

Unlike the years before 2015, the increase in new note and bond issuance is now a zero-sum game and financed by either the reallocation from other asset markets or an increase in financial leverage. The structural change in the financing of the Treasury market is taking place at a unpropitious time as deficits are ramping up.

Because 2017 was unique and an aberration of how the Treasury financed itself due to debt ceiling constraint, the markets are just starting to feel this effect. Consequently, the more vulnerable emerging markets are taking a beating this year and volatility is increasing across the board.

The New Market Meta-Narrative 

We suspect very few have crunched these numbers or understand them and this new meta-narrative supported by the data is the main reason for the increase in market gyrations and volatile capital flows this year.   We are pretty confident in the data, and the construction of our analysis. Feel free to correct us if you suspect data error and where you think we are wrong in our analysis. We look forward to hearing from you.

Moreover, the screws will tighten further as the ECB ends their QE in December.  We don’t think, though we reserve the right to be wrong, as we often are, this is just a short-term bout of volatility, but it is the beginning of a structural change in the markets as reflected in the data.

Interest Rates Will Continue To Rise

It is clear, at least to us, the only possibility for the longer-term U.S. Treasury yields to stay at these low levels is an increase in haven buying, which, ergo other asset markets will have to be sold. If you expect a normal world going forward, that is no recession or sharp economic slowdown, no major geopolitical shock, or no asset market collapse,  by default, you have to expect higher interest rates.  The sheer logic is in the data.

Of course,  Chairman Powell could cave to political pressure and “just print money to lower the debt” but we seriously doubt it and suspect the markets would not respond positively.

Stay tuned.

https://macromon.files.wordpress.com/2018/10/central-bank_2.png?w=620&h=412

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https://macromon.files.wordpress.com/2018/10/central-bank_10.png?w=621&h=437

Source: Global Macro Monitor

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From Russia With Love?

Russia Dumps US Treasuries As Rates Climb

As predicted, Russia has reduced its holdings of US Treasuries as US rates continue to rise.

https://confoundedinterestnet.files.wordpress.com/2018/10/russiawithlove1.png?w=624&h=449

But Russia is a relatively small player in the US Treasury market (unless they are using proxies like postage-stamp sized Luxembourg, Ireland or the Cayman Islands).

https://confoundedinterestnet.files.wordpress.com/2018/10/fedholdings.png?w=621&h=447

As The Federal Reserve SLOWLY unwinds its balance sheet, the Confounded Interest blog is surprised that Japan and China have not unloaded MORE of their Treasury holdings.

Source: Confounded Interest

Bonds Experienced Biggest Bloodbath Since Trump’s Election

Yields spiked by the most since Nov 2016 (the day of and following President Trump’s election).

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-28-06.jpg?itok=9ksI3vBw

NOTE – After 1430ET, bond were suddenly bid (and stocks sold off).

30Y yields spiked to the highest since Sept 2014…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-28-57.jpg?itok=EQdN9mnQ

10Y yields spiked to the highest since June 2011…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-20-38.jpg?itok=CJftSC_v

5Y yields spiked to the highest since Oct 2008…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_12-21-26.jpg?itok=WPeoecA9

The yield curve steepened dramatically…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_11-06-13.jpg?itok=_YVCE3Zz

All of which is fascinating given that Treasury Futures net speculative positioning is already at record shorts…

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_7-51-10_0.jpg?itok=1clcbFN-

The entire global developed sovereign bond market saw yields surge

https://www.zerohedge.com/sites/default/files/inline-images/2018-10-03_11-20-58.jpg?itok=8o6Ynw1W

…observations and serious concerns from a trader.

JGB Market Enters “Uncharted Territory” As Bond Rout Goes Global

“Monster Move” In Treasuries Unleashes Global Market Rout

https://www.zerohedge.com/sites/default/files/inline-images/10y%20tsy%20yield%2010.4.jpg?itok=Y8eDvwh3

Fed Chair Powell Hints He May Soon Crash The Market

Source: ZeroHedge

Emerging Markets Continue to Slide as Dollar Pressures $3.7 Trillion Debt Wall

Emerging Markets Continue to Slide as Dollar Pressures $3.7 Trillion Debt Wall

Emerging market stocks extended their declines Friday as investors continue to pull cash from some of the world’s biggest developing economies amid concerns that the greenback’s recent rally will pressure the cost of servicing some of the $3.7 trillion in debt taken on in the ten years since the global financial crisis.

Argentina has been at the forefront of the recent emerging market pullback this week, with the peso suffering its biggest single-day slump in three years — including a fifth of its value yesterday — before the central bank stepped in with a move to lift interest rates to an eye-watering 60% amid concerns that President Mauricio Macri’s efforts to cut spending and stave off a looming recession in South America’s third largest economy will ignite social unrest that could toppled his government.

“We have agreed with the International Monetary Fund to advance all the necessary funds to guarantee compliance with the financial program next year,” Macri said Wednesday in reference to a $50 billion support plan in the works. “This decision aims to eliminate any uncertainty. Over the last week we have seen new expressions of lack of confidence in the markets, specifically over our financing capacity in 2019.”

Those moves shadow a similar concern for the Turkish Lira, which resumed its slide against the dollar Thursday following a warning from Moody’s Investors Service earlier this week as the ratings agency downgraded its outlook on 20 domestic banks owning to the country’s slowing growth and their exposure to dollar-denominated debts.

The Turkish lira recovered from yesterday’s decline, but was still marked at 6.57 against the dollar, near to the weakest since the peak of its currency crisis in early August. Larger emerging market economy currencies were on the ropes Thursday, with the Indian rupee hitting a lifetime low of 70.68 against the dollar this week and falling 3.6% this month, the biggest decline since August 2015, while the Russian ruble bounced back from a two-year low to trade at 68.06.

The sell-off has also affected emerging market stocks, which continue to lag their advanced counterparts, with most major EM benchmarks either in or near so-called ‘bear market’ territory, which defines a market that has fallen 20% from its recent peak.

The benchmark MSCI International Emerging Markets index, for example, is down 0.4% today and more than 3% this month alone, extending its decline from the high it reached on January 29 to nearly 17%, while Reuters data notes that 20 out of 23 emerging market benchmarks are trading below their 200-day moving average, a technical condition that investors use as a signal for further selling.

Each of the three major emerging market ETFs, which collectively hold around $143 billion in assets — Vanguard’s FTSE EM (VWOGet Report) , and iShares’ Core MSCI EM (IEMGGet Report) and MSCI EM (EEMGet Report)  — have seen net asset values fall by an average of 15.3% since their January 26 peak.

The Bank for International Settlements, often described as the ‘central bank for central bank’s, estimates that emerging market countries are sitting on $3.7 trillion in dollar-denominated debt, all of which must be serviced in increasingly expensive greenbacks.

And while the dollar index is sitting at a four-week low of 94.60, it has risen more than 5% since the start of the second quarter and is expected to add further gains as the Federal Reserve signals future rate hikes amid a surging domestic economy, which grew 4.2% last quarter and is on pace for a similar advance in the three months ending in September, according to the Atlanta Fed’s GDPNow estimate.

“We look for the dollar to stay bid particularly against the emerging market FX segment where a meaningful decline in risky currencies is spilling over into the wider risk sentiment,” said ING’s Petr Krpata. “

Debt service costs aren’t the only concern, however, as many emerging market economies rely on the export of basic resources, such as oil and gas and other commodities, to fuel their growth.

With China’s economy showing persistent signs of a second half slowdown amid its ongoing trade dispute with the United States, many of those countries are seeing slowing demand, which is pressuring dollar-denominated revenues at exactly the time their needed to both support the value of their currencies in foreign exchange markets and make timely payments on the estimated $700 billion worth of debt that is set to mature over the next two years.

Source: by Martin Baddarcax | TheStreet.com

Are Bonds Sending A Signal?

Michael Lebowitz previously penned an article entitled “Face Off” discussing the message from the bond market as it relates to the stock market and the economy. To wit:

“There is a healthy debate between those who work in fixed-income markets and those in the equity markets about who is better at assessing markets. The skepticism of bond guys and gals seems to help them identify turning points. The optimism of equity pros lends to catching the full run of a rally. As an ex-bond trader, I have a hunch but refuse to risk offending our equity-oriented clients by disclosing it. In all seriousness, both professions require similar skill sets to determine an asset’s fair value with the appropriate acknowledgment of inherent risks. More often than not, bond traders and stock traders are on the same page with regard to the economic outlook. However, when they disagree, it is important to take notice.”

This is an interesting point given that despite the ending parade of calls for substantially higher interest rates, due to rising inflationary pressures and stronger economic growth, yields have stubbornly remained below 3% on the 10-year Treasury.

In this past weekend’s newsletter, we discussed the current “bullish optimism” prevailing in the market and that “all-time” highs are now within reach for investors.

“Currently, the “bulls” remain clearly in charge of the market…for now. While it seems as if much of the “tariff talk” has been priced into stocks, what likely hasn’t as of yet is rising evidence of weakening economic data (ISM, employment, etc.), weakening consumer demand, and the impact of higher rates.

While on an intermediate-term basis these macro issues will matter, it is primarily just sentiment that matters in the short-term. From that perspective, the market retested the previous breakout above the March highs last week (the Maginot line)which keeps Pathway #1 intact. It also suggests that next weekwill likely see a test of the January highs.

https://www.zerohedge.com/sites/default/files/inline-images/SP500-Chart3-080318%20%281%29.png?itok=aOPYMJ1K

“With moving averages rising, this shifts Pathway #2a and #2b further out into the August and September time frames. The potential for a correction back to support before a second attempt at all-time highs would align with normal seasonal weakness heading into the Fall. “

One would suspect with the amount of optimism toward the equity side of the ledger, and with the Federal Reserve on firm footing for further rate increases at a time where the U.S. Government is about to issue a record amount of new debt, interest rates, in theory, should be rising.

But they aren’t.

As Mike noted previously:

“Given our opinions on the severe economic headwinds facing economic growth and steep equity valuations, we believe this divergence poses a potential warning for equity holders. Accordingly, we thought it appropriate to provide a few graphs to demonstrate the ‘smarter’ guys are not on board the growth and reflation train.”

In today’s missive, we will focus on the “price” and “yield” of the 10-year Treasury from a strictly “technical”perspective with respect to the signal the bond market may be sending with respect to the stock market. Given that “credit” is the “lifeblood” of the Government, corporate and consumer markets, it should not be surprising the bond market tends to tell the economic story over time.

We can prove this in the following chart of interest rates versus the economic composite of GDP, inflation, and wages.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-GDP-Composite-080618.png?itok=lcRcPHyd

Despite hopes of surging economic growth, the economic composite has remained in an elongated nominal range between 40 and 60 since 2011. This stagnation has never occurred in history and is a function of the massive interventions by the Government and the Federal Reserve to support economic growth. However, now those supports are being removed as the Federal Reserve lifts short-term borrowing costs and reduces liquidity support through their balance sheet reinvestments.

As I said, credit is the “lifeblood” of the economy. Think about all the ways that higher rates impact economic activity in the economy:

1) Rising interest rates raise the debt servicing requirements which reduces future productive investment.

2) Rising interest rates will immediately slow the housing market taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

3) An increase in interest rates means higher borrowing costs which leads to lower profit margins for corporations. 

4) The “stocks are cheap based on low interest rates” argument is being removed.

5) The massive derivatives and credit markets are at risk. Much of the recovery to date has been based on suppressing interest rates to spur growth.

6) As rates increase so does the variable rate interest payments on credit cards. 

7) Rising defaults on debt service will negatively impact banks.

8) Many corporate share buyback plans and dividend issuances have been done through the use of cheap debt, which has led to increases corporate balance sheet leverage.

9) Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs lead to lower CapEx.

10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

I could go on, but you get the idea.

So, with the Fed hiking rates, surging bankruptcies for older Americans who are under-saved and over-indebted, stumbling home sales, inflationary prices rising from surging energy costs, what is the 10-year Treasury telling us now.

Short-Term

On a very short-term basis, the 10-year Treasury yield has started a potential-topping process. Given that “yield” is the inverse of the “price” of bonds, the “buy” and “sell” signals are also reversed. As shown below, the 10-year yield appears to be forming the “right shoulder” of a “head and shoulder” topping formation and is currently on a short-term “buy” signal. Such would suggest lower yields over the next couple of months.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Weekly-080618.png?itok=astGcYCm

The two signals above aren’t a rarity. The chart below expands this view back to 1970. There have only been a few times historically that yields have been this overbought and trading at 3 to 4 standard deviations above their one-year average.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Weekly-Crisis-080618.png?itok=8OuknfhB

The outcome for investors was never ideal.

Longer-Term

Even using monthly closing data, which smooths out volatility to a greater degree, the same message appears. The chart below goes back to 1994. Each time yields have been this overbought (remember since yield is the inverse of price, this means bonds are very oversold) it is has signaled an issue with both the economy and the markets.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Monthly-SP500-080618-Crashes.png?itok=8bs9_JzH

Again, we see the same issue going back historically. Also, notice that yields are currently not only extremely overbought, they are also at the top of the long-term downtrend that started back in 1980.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Monthly-SP500-080618.png?itok=gJpuxCHG

Even Longer Term

Okay, let’s smooth this even more by using quarterly data closes. again, the picture doesn’t change.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Quarterly-SP500-080618-Crashes.png?itok=32JtcmDe

As I noted yesterday, the economic cycle is extremely advanced and both stocks and bonds are slaves to the full market cycle.

https://www.zerohedge.com/sites/default/files/inline-images/Historical-Recoveries-Declines-080518.png?itok=qWOsFTAd

“The “full market cycle” will complete itself in due time to the detriment of those who fail to heed history, valuations, and psychology.”

Of course, during the late stage of any market advance, there is always the argument which suggests “this time is different.” Mike made an excellent point in this regard previously:

“Given the divergences shown between bond and equity markets, logic says somebody’s wrong. Another possibility is that neither market is sending completely accurate signals about the future state of the economy and inflation. It is clear that bond traders do not buy into this latest growth narrative. Conversely, equity investors are buying the growth and reflation narrative lock, stock and barrel. To be blunt, with global central banks buying both bonds and stocks, the integrity of the playing field as well as normally reliable barometers of market conditions, are compromised.

This divergence between bond and equity traders could prove meaningless, or it may be a prescient warning for one or both of these markets. Either way, investors should be aware of the divergence as such a wide gap in economic opinions is unusual and may portend increased volatility in one or both markets.”

While anything is certainly possible, historical probabilities suggest that not only is “this time NOT different,” it will likely end the same way it always has for investors who fail to heed to bond markets warnings.

Source: ZeroHedge

Why You Should Care About The Narrowest Yield Curve Since 2007

Money manager Michael Pento is sounding the alarm because we are getting very close to something called a “yield curve inversion.” Pento explains, “Why do I care if the yield curve inverts? Because 9 out of the last 10 times the yield curve inverted, we had a recession… The spread with the yield curve is the narrowest it has been since outside of the start of the Great Recession that commenced in December of 2007… The last two times the yield curve inverted, we had a stock market drop of 50%. The market dropped, and the S&P 500 lost 50% of its value.”

For those who don’t have enough money to require professional management, consider storing water and food because that will never go out of style.

Source: by Greg Hunter | USAWatchdog.com

Bond Bear Stops Here: Bill Gross Warns Economy Can’t Support Higher Rates

Having thrown in the towel on his bond bear market call two weeks ago, Janus Henderson’s billionaire bond investor Bill Gross now believes that the most recent bearish bond price (rise in yields) will stop here as the economy cannot support higher yields.

As Gross said two weeks ago, yields won’t see a substantial move from here.

“Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV.

“I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-03_7-29-30.jpg

Since then, yields have tested the upper-end of his channel and are breaking out today to their highest since 2011 (10Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-48-50_1.jpg?itok=fFNyLeBx

and back to their critical resistance levels (30Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-50-55_0.jpg?itok=s6Hc1rhv

And now Gross is out with a pair of tweets (here and here) saying that the record bond shorts should not get too excited here…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-13_9-26-13.jpg?itok=hqAROAA1

Bill Gross thinks they won’t be right. He highlights the long-term downtrend over the past 30-years, which comes in a 3.22%.

“30yr Tsy long-term downward yield trend line for the past 3 decades now at  3.22%, only ~4bps higher than today’s yield.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-39-58.jpg?itok=aNdSRwTH

“Will 3.22% be broken to upside?” he asks.

“I don’t think so. The economy can’t support yields higher than 3.25% for 30s and 10s, nor 3% for 5s.

Continuing hibernating bond bear market is best forecast.”

Asa ForexLive also notes, if he’s right it doesn’t necessarily mean the US dollar will reverse right away but it would be a good sign for stocks and would limit how far the US dollar might run.

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-44-38.jpg?itok=MS3UBYGJ

So, will Gross be right? Is this latest spike all rate-locks on upcoming IG issuance? And will this leave speculators with a record short position now wondering who will be the one holding the greatest fool bag by the end of the year…

Well worth your time to hear what geo-economic consultant Martin Armstrong has to say.

Source: ZeroHedge