Tag Archives: interest rates

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

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Who Does America Really Belong To?

Not to Americans…

(Paul Craig Roberts) The housing market is now apparently turning down. Consumer incomes are limited by jobs offshoring and the ability of employers to hold down wages and salaries.  The Federal Reserve seems committed to higher interest rates – in my view to protect the exchange value of the US dollar on which Washington’s power is based.  The arrogant fools in Washington, with whom I spent a quarter century, have, with their bellicosity and sanctions, encouraged nations with independent foreign and economic policies to drop the use of the dollar.  This takes some time to accomplish, but Russia, China, Iran, and India are apparently committed to dropping  or reducing the use of the US dollar.

 https://www.zerohedge.com/sites/default/files/inline-images/The-Dollar-Crash-Is-Coming.jpg?itok=DF5zS-Xy

A drop in the world demand for dollars can be destabilizing of the dollar’s value unless the central banks of Japan, UK, and EU continue to support the dollar’s exchange value, either by purchasing dollars with their currencies or by printing offsetting amounts of their currencies to keep the dollar’s value stable.  So far they have been willing to do both.  However, Trump’s criticisms of Europe has soured Europe against Trump, with a corresponding weakening of the willingness to cover for the US.  Japan’s colonial status vis-a-vis the US since the Second World War is being stressed by the hostility that Washington is introducing into Japan’s part of the world.  The orchestrated Washington tensions with North Korea and China do not serve Japan, and those Japanese politicians who are not heavily on the US payroll are aware that Japan is being put on the line for American, not Japanese interests.

If all this leads, as is likely, to the rise of more independence among Washington’s vassals, the vassals are likely to protect themselves from the cost of their independence by removing themselves from the dollar and payments mechanisms associated with the dollar as world currency.  This means a drop in the value of the dollar that the Federal Reserve would have to prevent by raising interest rates on dollar investments in order to keep the demand for dollars up sufficiently to protect its value.

https://www.zerohedge.com/sites/default/files/inline-images/download%20%283%29_8.jpg?itok=6mgF7kPT

As every realtor knows, housing prices boom when interest rates are low, because the lower the rate the higher the price of the house that the person with the mortgage can afford. But when interest rates rise, the lower the price of the house that a buyer can afford. 

https://www.zerohedge.com/sites/default/files/inline-images/2018-08-01_11-52-53_0.jpg?itok=1zdTfccK

If we are going into an era of higher interest rates, home prices and sales are going to decline.

The “on the other hand” to this analysis is that if the Federal Reserve loses control of the situation and the debts associated with the current value of the US dollar become a problem that can collapse the system, the Federal Reserve is likely to pump out enough new money to preserve the debt by driving interest rates back to zero or negative. 

Would this save or revive the housing market?  Not if the debt-burdened American people have no substantial increases in their real income.  Where are these increases likely to come from? Robotics are about to take away the jobs not already lost to jobs offshoring. Indeed, despite President Trump’s emphasis on “bringing the jobs back,” Ford Motor Corp. has just announced that it is moving the production of the Ford Focus from Michigan to China.  

Apparently it never occurs to the executives running America’s off shored corporations that potential customers in America working in part time jobs stocking shelves in Walmart, Home Depot, Lowe’s, etc., will not have enough money to purchase a Ford.  Unlike Henry Ford, who had the intelligence to pay workers good wages so they could buy Fords, the executives of American companies today sacrifice their domestic market and the American economy to their short-term “performance bonuses” based on low foreign labor costs.

What is about to happen in America today is that the middle class, or rather those who were part of it as children and expected to join it, are going to be driven into manufactured “double-wide homes” or single trailers.  The MacMansions will be cut up into tenements.  Even the high-priced rentals along the Florida coast will find a drop in demand as real incomes continue to fall. The $5,000-$20,000 weekly summer rental rate along Florida’s panhandle 30A will not be sustainable.  The speculators who are in over their heads in this arena are due for a future shock.

For years I have reported on the monthly payroll jobs statistics.  The vast majority of new jobs are in lowly paid nontradable domestic services, such as waitresses and bartenders, retail clerks, and ambulatory health care services. In the payroll jobs report for June, for example, the new jobs, if they actually exist, are concentrated in these sectors: administrative and waste services, health care and social assistance, accommodation and food services, and local government.

High productivity, high value-added manufactured jobs shrink in the US as they are offshored to Asia.  High productivity, high value-added professional service jobs, such as research, design, software engineering, accounting, legal research, are being filled by offshoring or by foreigners brought into the US on work visas with the fabricated and false excuse that there are no Americans qualified for the jobs.

America is a country hollowed out by the short-term greed of the ruling class and its shills in the economics profession and in Congress.  Capitalism only works for the few. It no longer works for the many.

On national security grounds Trump should respond to Ford’s announcement of offshoring the production of Ford Focus to China by nationalizing Ford.  Michigan’s payrolls and tax base will decline and employment in China will rise. We are witnessing a major US corporation enabling China’s rise over the United States. Among the external costs of Ford’s contribution to China’s GDP is Trump’s increased US military budget to counter the rise in China’s power.

Trump should also nationalize Apple, Nike, Levi, and all the rest of the offshored US global corporations who have put the interest of a few people above the interests of the American work force and the US economy.  There is no other way to get the jobs back.  Of course, if Trump did this, he would be assassinated.

https://www.zerohedge.com/sites/default/files/inline-images/ilustra-BolSemanal8.jpg?itok=xd1bMWSN

America is ruled by a tiny percentage of people who constitute a treasonous class. These people have the money to purchase the government, the media, and the economics profession that shills for them. This greedy traitorous interest group must be dealt with or the United States of America and the entirety of its peoples are lost.

In her latest blockbuster book, Collusion, Nomi Prins documents how central banks and international monetary institutions have used the 2008 financial crisis to manipulate markets and the fiscal policies of governments to benefit the super-rich.

These manipulations are used to enable the looting of countries such as Greece and Portugal by the large German and Dutch banks and the enrichment via inflated financial asset prices of shareholders at the expense of the general population.

One would think that repeated financial crises would undermine the power of financial interests, but the facts are otherwise. As long ago as November 21, 1933, President Franklin D. Roosevelt wrote to Col. House that “the real truth of the matter is, as you and I know, that a financial element in the larger centers has owned the Government ever since the days of Andrew Jackson.”

Thomas Jefferson said that “banking institutions are more dangerous to our liberties than standing armies” and that “if the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks . . . will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered.”

The shrinkage of the US middle class is evidence that Jefferson’s prediction is coming true.

Source: ZeroHedge

Top Restructuring Banker: “We’re All Feeling Like It’s 2007 Again”

There is a group of bankers for whom “better” means “worse” for everyone else: we are talking, of course, about restructuring bankers who advising companies with massive debt veering toward bankruptcy, or once in it, how to exit from the clutches of Chapter 11, and who – like the IMF, whose chief Christine Lagarde recently saidWhen The World Goes Downhill, We Thrive– flourish during financial chaos and mass defaults.

Which is to say that the past decade has not been exactly friendly to the world’s restructuring bankers, who with the exception of two bursts of activity, the oil collapse-driven E&P bust in 2015 and the bursting of the retail “bricks and mortar” bubble in 2017, have been generally far less busy than usual, largely as a result of abnormally low rates which have allowed most companies to survive as “zombies”, thriving on the ultra low interest expense.

However, as Moody’s warned yesterday, and as the IMF cautioned a year ago, this period of artificial peace and stability is ending, as rates rise and as a avalanche of junk bond debt defaults. And judging by their recent public comments, restructuring bankers have rarely been more exited about the future.

https://s14-eu5.startpage.com/cgi-bin/serveimage?url=http%3A%2F%2Fprod-upp-image-read.ft.com%2F9eb98cae-36da-11e6-a780-b48ed7b6126f&sp=7a7ec5c1567b57624e3bbad2e33954ca

Ken Moelis

Take Ken Moelis, who last month was pressed about his rosy outlook for his firm’s restructuring business, describing “meaningful activity” for the bank’s restructuring group.

“Your comments were surprisingly positive,” said JPMorgan’s Ken Worthington, quoted by Business Insider. “Is this sort of steady state for you in a lousy environment? Can things only get better from here?”

Moelis’ response: “Look, it could get worse. I guess nobody could default. But I think between 1% and 0% defaults and 1% and 5% defaults, I would bet we hit 5% before we hit 0%.”

He is right, because as we showed yesterday in this chart from Credit Suisse, after languishing around 1%-2% for years, default rates have jumped the most in 5 years, and are now “ticking higher”

https://www.zerohedge.com/sites/default/files/inline-images/default%20rates%20rising.jpg

Moelis wasn’t alone in his pessimism: in March, JPMorgan investment-banking head Daniel Pinto said that a 40% correction, triggered by inflation and rising interest rates, could be looming on the horizon.

These are not isolated cases where a gloomy Cassandra has escaped from the asylum: already the biggest money managers are positioning for a major economic downturn according to recent research from Bank of America. And while nobody can predict the timing of the next collapse, Wall Street’s top restructuring bankers have one message: it’s coming, and it’s not too far off.

However, the most dire warning to date came from Bill Derrough, the former head of restructuring at Jefferies and the current co-head of recap and restructuring at Moelis: “I do think we’re all feeling like where we were back in 2007,” he told Business Insider: There was sort of a smell in the air; there were some crazy deals getting done. You just knew it was a matter of time.”

What he is referring to is not just the overall level of exuberance, but the lunacy taking place in the bond market, where CLOs are being created at a record pace, where CCC-rated junk bonds can’t be sold fast enough, and where the a yield-starved generation of investors who have never seen a fair and efficient market without Fed backstops, means that the coming bond-driven crash will be spectacular.

“Even if there is not a recession or credit correction, with the sheer volume of issuance there are going to be defaults that take place,” said Neil Augustine, co-head of the restructuring practice at Greenhill & Co.

The dynamic is familiar: since 2009, the level of global non-financial junk-rated companies has soared by 58% representing $3.7 trillion in outstanding debt, the highest ever, with 40%, or $2 trillion, rated B1 or lower. Putting this in contest, since 2009, US corporate debt has increased by 49%, hitting a record total of $8.8 trillion, much of that debt used to fund stock repurchases.  As a percentage of GDP, corporate debt is at a level which on ever prior occasion, a financial crisis has followed.

https://www.zerohedge.com/sites/default/files/inline-images/corporate%20debt%20to%20gdp%202.jpg

The recent glut of debt is almost entirely attributable to the artificially low interest-rate environment imposed by the Federal Reserve and its central bank peers following the crisis. Many companies took advantage and refinanced their debt before 2015 when a large swath was set to mature, kicking the can several years down the road. 

But going forward “there’s going to be refinancing at significantly higher rates,” said Steve Zelin, head of the restructuring in the Americas at PJT Partners.

And as the IMF first warned last April, refinancing at higher rates will further shrink the margin of error for troubled companies, as they’ll have to dedicate additional cash flow to cover more expensive interest payments.

“When you have highly leveraged companies and even a modest rise in interest rates, that can result in an increase in restructuring activity,” said Irwin Gold, executive chairman at Houlihan Lokey and co-founder of the firm’s restructuring group.

So with a perfect debt storm coming our way, many restructuring firms have been quietly hiring new employees to be ready when, not if, the economy takes a turn for the worse.

“The restructuring business is a good business during normal times and an excellent business during a recessionary environment,” Augustine said. “Ultimately, when a recession or credit correction does happen, there will be a massive amount of work to do on the restructuring side.” Here are some additional details on recent banker moves from Business Insider:

Greenhill hired Augustine from Rothschild in March to co-head its restructuring practice. The firm also hired George Mack from Barclays last summer to cohead restructuring. The duo, along with Greenhill vet and fellow co-head Eric Mendelsohn, are building out the firm’s team from a six-person operation to 25 bankers.

Evercore Partners in May hired Gregory Berube, formerly the head of Americas restructuring at Goldman Sachs, as a senior managing director. The firm also poached Roopesh Shah, formerly the chief of Goldman Sachs’ restructuring business, to join its restructuring business in early 2017.

“It feels awfully toppy, so people are looking around and saying, ‘If I need to build a business, we need to go out and hire some talent,'” one headhunter with restructuring expertise told Business Insider.

“In our world, people are just anticipating that it’s coming. People are trying to position their teams to be ready for it,” Derrough said. “That was the lesson from last cycle: Better to invest early and have a cohesive team that can do the work right away and maybe be a little bit overstaffed early, so that you can execute for your clients when the music ultimately stops.”

Of course, if the IMF is right (for once), Derrough and his peers will soon see a windfall unlike anything before: last April, the International Monetary Fund predicted that some 20%, or $3.9 trillion, of the total global corporate debt is in danger of defaulting once rates rise.

https://www.zerohedge.com/sites/default/files/images/user5/imageroot/2017/04/19/IMF%20debt%20warning%201.jpg

Although if and when that day comes, perhaps a better question is whether companies will be doing debt-for-equity swaps, or fast forward straight to debt-for-lead-gold-and canned food…

Source: ZeroHedge

***

Fortunately, the Dying Do Die

July 6, 2016 marks the point when the US government’s condition became irretrievably terminal. On that date the US Treasury’s 10-year note yield hit its low, 1.34 percent, and has been trending irregularly higher ever since. Historically, debt has been the life support for regimes in extremis. No regime has ever been more in debt than the US government. Its annual deficit and debt service expense are growing, old-age pension and medical programs face a demographic crunch, and now interest rates are rising. One way or the other, the government walking away from some or all of its promises is as set in stone as anything in this life can be.

Bond Yields And Barbarians

I know Kung Foo, Karate, Bond Yields and forty-seven other dangerous words.

– The Wizard

For forty-four years I have trafficked in the bond markets. I have seen massive inflation, Treasury yields in the stratosphere and risk asset spreads that could barely be included on a chart. At four investment banks I ran Capital Markets, and was on the Board of Directors of those companies, and I have witnessed both extreme anger and one fist fight. It is funny, you know, how people behave when money is sitting there on the table.

One of the things rarely discussed in the Press are the mandates of money managers. Almost no one is unconstrained and virtually everyone is bound by regulations, the tax laws and FINRA and SEC stipulations. Life insurance companies and casualty companies and money managers and Trust Departments and everyone is sidled with something. There are no escapes from the dilemmas.

The markets are a random lottery of meaningless tragedies, a couple of wins and a series of near escapes. So, I sit here and I smoke my cigars, staring raptly at it all. Paying very close attention.

There are two issues, in my mind, to be considered carefully when assessing future interest rates. The first is supply, especially the forward borrowing by the U.S. government. “It’s supply,” Michael Schumacher, head of rate strategy at Wells Fargo (NYSE:WFC), told CNBC’s Futures Now. “When you think about the enormous amount of debt that U.S. Treasury’s got to issue over not just this year, frankly, but next year, it’s staggering,” he said.

Using Michael’s calculations, the Treasury will issue more than $500 billion in notes and bonds in the second to the fourth quarter, pushing the total to around $650 billion for the year. Last year, the total came to just $420 billion. That is approximately a 35% increase in issuance. This raises a fundamental question, who are going to be the buyers and at what levels?

The second issue centers on the Fed and what they might do. They keep calling for rate hikes, like it is a new central bank mantra, and they are increasing the borrowing costs of the nation, corporations and individuals, as a result. I often wonder, in their continual clamor for independence, just who they represent.

You might think that the ongoing demand for higher yields does not exactly help the Treasury’s or the President’s desire to grow the economy as the Fed moves in the opposite direction and tries to slow it down by raising rates. I have often speculated that there might be some private tap on the shoulder, at some point, but no such “tap” seems to have taken place or, if it has occurred, it is certainly being ignored, at least in public.

Here are some interesting questions to ponder:

How much of our U.S. and global growth is real?

How much of it, RIGHT NOW, is still being manufactured by the Fed’s, and the other central banks’, “Pixie Dust” money?

Does the world seem honestly ready to economically walk on its own two feet?

If you answered “No,” to the last question, how do you believe the financial markets will react when they realize that the Central Banks are trying to take away the safety net for the global economies?

Are you really worried about inflation running away from us?

Do you believe that a flat/inverted yield curve has been an accurate predictor of events to come, historically?

Have you run the numbers, can the world’s sovereign nations even afford 4% rates, as predicted by many?

If you answered “No,” do you believe that these nations will suppress yields for as long as they can to push back the “end game?”

Across the pond Reuters states,

Italy’s two anti-establishment parties agreed the basis for a governing accord on Thursday that would slash taxes, ramp up welfare spending and pose the biggest challenge to the European Union since Britain voted to leave the bloc two years ago.

That is quite a strong statement, in my opinion. There are plenty of reasons to be worried about Italy and the European Union now, in my view.

A draft of the accord, reviewed by Reuters, lays out a plan to cut taxes, increase welfare payments and rescind the recent pension reforms. To me, this seems incompatible with the EU’s rules and regulations. These new policies would cost billions of euros and would certainly raise Italy’s debt to GDP ratio, which already stands at approximately 132%.
Reuters also states,

The plan promised to introduce a 15 percent flat tax rate for businesses and two tax rates of 15 and 20 percent for individuals – a reform long promoted by the League. Economists say this would cost well over 50 billion euros in lost revenues.

Ratings agency DBRS has already warned that this new proposal could threaten Italy’s sovereign credit rating. If you have been to Rome, you probably visited the Coliseum. I make an observation today:

The Barbarians are at the Gates!
– Mark J. Grant

Source: by Mark J. Grant | Seeking Alpha

Mortgage Refi Applications Plunge To 10 Year Lows As Fed Hikes Rates

On the heels of the 10Y treasury yield breaking out of its recent range to its highest since July 2011, this morning’s mortgage applications data shows directly how Bill Gross may be right that the economy may not be able to handle The Fed’s ongoing actions.

https://www.zerohedge.com/sites/default/files/inline-images/mortgageinflation1.png?itok=dV-X18sj

As Wolf Richter notes, the 10-year yield functions as benchmark for the mortgage market, and when it moves, mortgage rates move. And today’s surge of the 10-year yield meaningfully past 3% had consequences in the mortgage markets, as Mortgage News Daily explained:

Mortgage rates spiked in a big way today, bringing some lenders to the highest levels in nearly 7 years (you’d need to go back to July 2011 to see worse). That heavy-hitting headline is largely due to the fact that rates were already fairly close to 7-year highs, although today did cover quite a bit more distance than other recent “bad days.” 

The “most prevalent rates” for 30-year fixed rate mortgages today were between 4.75% and 4.875%, according to Mortgage News Daily.

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-16_5-18-48.jpg?itok=JaYsBRcs

And that is crushing demand for refinancing applications…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-16_5-09-36.jpg?itok=6saBh_HY

Despite easing standards – a net 9.7% of banks reported loosening lending standards for QM-Jumbo mortgages, respectively, compared to a net 1.6% in January, respectively.  

According to Wolf Richter over at Wolf Street, the good times in real estate are ending…

The big difference between 2010 and now, and between 2008 and now, is that home prices have skyrocketed since then in many markets – by over 50% in some markets, such as Denver, Dallas, or the five-county San Francisco Bay Area, for example, according to the Case-Shiller Home Price Index. In other markets, increases have been in the 25% to 40% range. This worked because mortgage rates zigzagged lower over those years, thus keeping mortgage payments on these higher priced homes within reach for enough people. But that ride is ending.

And as Peter Reagan writes at Birch Group, granted, even if rates go up over 6%, it won’t be close to rates in the 1980’s (when some mortgage rates soared over 12%). But this time, rising rates are being coupled with record-high home prices that, according to the Case-Shiller Home Price Index, show no signs of reversing (see chart below).

case-shiller home price index

So you have fast-rising mortgage rates and soaring home prices. What else is there?

It’s not just home refinancing demand that is collapsing… as we noted yesterday, loan demand is tumbling everywhere, despite easing standards…

https://www.zerohedge.com/sites/default/files/inline-images/C%26I%20loan%20demand_0.jpg?itok=jkH8NimE

But seriously, who didn’t see that coming?

Source: ZeroHedge

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

T-Minus… Prepare For Much Higher Long-Term Rates

It is late.  We have been crunching data for three days, and won’t bore you with too much prose.

We will be back to fill in the blanks in the next few days but will leave you with some nice charts and data to contemplate.  They may help explain why the stock market is trading so poorly even with, what appears, to be stellar earnings.

Determination Of The 10-year Yield

There will be many posts to come on this topic as we believe it is the most critical issue investors need to grapple with and get right over the next year.

What is the right price for the U.S. 10-year Treasury yield?

Moreover,  how is the yield determined, and how has it been distorted over the past 20 years by central banks, both foreign and the Federal Reserve?

What does the future hold?

Capital Flows

We agree that inflation, growth expectations, and other fundamental factors weigh heavily on determining bond yields but we always maintain, first, and foremost,

“asset prices are always and everywhere determined by capital flows.” 

New Issuance,  Foreign, and Fed Flows Into The Treasury Market

The following table illustrates the new issuance of marketable Treasury securities held by the public and net purchases by foreign investors, including central banks, and the Federal Reserve over various periods.

https://www.zerohedge.com/sites/default/files/inline-images/may2_flow-tables.png?itok=3SjVchCQ(larger image)

The data show since the beginning of the century, foreign investors, mainly central banks, and the Federal Reserve net purchase of Treasury securities, those which trade in the secondary market, is equivalent to 60 percent of all new marketable debt issued by the Treasury since 2000.

We do not suggest all these purchases were made directly in Treasury auctions, though many of the foreign buys certainly were.

From 2000-2010, foreign central banks were recycling their massive build of foreign exchange reserves back into the Treasury market.  During this period, the foreign central banks bought the equivalent of 50 percent of the new issuance.  Add foreign private investors and the Fed’s primary open market operations, and the total equated to 70 percent of the debt increase over the period.

Alan Greenspan blames the foreign inflows into the Treasury market during this period for Fed losing control of the yield curve, a major factor and cause of the housing bubble, and not excessively loose monetary policy.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have “prevented” the housing bubble. – Alan Greenspan, March 2009

Greenspan raised the Fed Funds rate 425 bps from June 2004 to June 2006 and the 10-year barely budged, rising only 52 bps.  More on this later.

Fed Plus Total Foreign Purchases

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_totalforeign_treasuryborrowings.png?itok=9f8p2oHc(larger image)

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_cenbank_treasuryborrowings.png?itok=-BvhQgmP(larger image)

During the Fed’s QE period,  2010-2015,  foreign investors and the Fed took down the equivalent of 80 percent of  the new debt issuance.

The charts also illustrate that for several of the 3-month rolling periods, net purchases were significantly higher than 100 percent of new supply, distorting not only the 10-year yield, but the valuation of all other asset prices.

Interest rate repression also cause economic distortions, which have political consequences.  Most notably, wealth and income disparities.

Rapid Technical Deterioration

Since 2015, flows into the Treasury market have deteriorated markedly, and the timing could not be worse as new Treasury issuance is ballooning with skyrocketing budget deficits.

During the past twelve months, for example,  net foreign and Fed flows collapsed to just 17.6 percent of new borrowings.  Even worse, the net flows were negative (we estimated March international flows) during the first quarter during a record new issuance of Treasury securities of almost $500 billion.

Can we say, “Gulp”?

Stock Of Outstanding Treasury Securities

Given the rapidly deteriorating technicals and fundamentals — rising inflation –, we believe the 10-year yield should be and will be much higher sometime soon.

That is we are looking for a “super spike” in bond yields, and expect the 10-year to finish the year between 4-5 percent.   The term premium, which has been repressed due to all of the above,  should begin to normalize.

Why is taking so long?

Aside from the record shorts and natural inertia of markets, the stock of Treasury securities remains favorable, as the bulk is still held by the Fed and foreign central banks, who are not price sensitive.

Debt Stock Shortage,  Debt Flow Surplus 

Ironically,  there remains an artificial shortage of the stock of  Treasuries but now a huge glut in the flow.   See here for a must read.

The Bund And JGB Anchor?

Treasuries are at almost at record spreads on some  maturities vis-à-vis the German bund, and foreigners are on a buying strike as the above data show.

How can an anchor be an anchor if there are no buyers?   One asset arbitrage?

It is also not normal for the 10-year to be trading in such a tight range with a record short position in the futures market.  The average daily move in the VIX has increased from 0.20 percent in 2016, to 1.37 percent in 2017, and shorts are now hardly spooked by a 500 point flop in the Dow.

Something must be going on beneath the earth’s crust.  We have our ideas.

Dollar Strength

The recent dollar strength may be a signal foreigners are getting yield-hungry again, however.   We are not so sure the rally has legs.

Market concerns over the political stability of the U.S may trump yield-seeking for the rest of the year.

How Foreign Flows Contributed To The Housing Bubble

We are not going to spend much time here but we are starting coming around to Mr. Greenspan’s reasoning.  The lack of response of long-term yields to a 425 bps increase in the Fed Funds rate from 2004-2006  greatly contributed to the housing bubble.  The 10-year yield only moved up 52 bps from when the Fed started their tightening to when they paused.

Take a look at the chart.

https://www.zerohedge.com/sites/default/files/inline-images/may2_mortgage-debt_gdp.png?itok=yzXhWh6T

The Fed’s interest rate hikes didn’t even put a dent in the momentum of the housing bubble. Household mortgage debt continued to rise from 60 to 72 percent of GDP from the first interest rate hike before the market collapsed on itself.

Bubbles are hard to pop.

https://www.zerohedge.com/sites/default/files/inline-images/may2_phases-of-housing-bubble1.png?itok=a2Dis-7Z

Why Long-Term Yields Didn’t Respond

Simple.

As, always and everywhere, capital flows or the recycling thereof.

The biggest economic event in the past 25 years, in our opinion, is the exchange rate regime shift that took place in the emerging markets in the late 1990’s.  These countries now refuse to allow their currencies to appreciate in any significant magnitude as the result of capital inflows.

They learned some hard lessons in the mid-1990’s with Mexican Peso and Asian Financial Crisis, and the Russian Debt Default.

Balance of payments surpluses are now reconciled with dirty float currency regimes, where central banks intermittently intervene if their currency becomes too strong.

The result was a massive build of global currency reserves, much of which were recycled back into the U.S. Treasury market in the mid-2000’s.

https://www.zerohedge.com/sites/default/files/inline-images/may2_cenbank_treasury_purchases.png?itok=imSym7al(larger image)

The chart illustrates that foreign central bank net purchases of Treasury securities, alone, were equivalent to the over 66 percent of net Treasury issuance during the Fed 2004-2006 tightening cycle.

International  Reserves Drive Gold

The gold price also ramped with international reserves during this period.

We believe the global monetary base, mainly international reserves,  is the main driver of gold.  See here.

Reserves have not been growing witness the punk trading range in gold.  This may change as the U.S. current account blows out again.

https://www.zerohedge.com/sites/default/files/inline-images/gold-and-monetary-base.jpg?itok=USqHmoCM(larger image)

Current Account And Trade Deficits

The Mnuchin crowd are wasting their time in China trying to negotiate lower trade deficits.  Trade deficits are the result of internal imbalances where investment exceeds savings.  See here for another must read.

Introducing trade distortions to artificially lower the external deficit will only accelerate stagflaton, which is already starting to take hold.  Then we will all be worse off.   See here.

Besides, where is Mr. Mnuchin going to obtain the financing for his proliferating budget deficits if his goal is to run trade surplus or balances with our trading partners?

We are all for better terms of trade and protecting are intellectual property rights,  but know and understand thy national income accounting before starting trade wars.

Upshot

We have laid out why we believe, and we could be wrong, long-term yields are unlikely to behave as they did during the last monetary tightening.   That is the a further collapse in Treasury term premia and a yield curve inversion until something breaks.

Unless the U.S. blows up its current account again,  credit expansion accelerates significantly, creating another blast of capital flows into the emerging markets, to be recycled back to the U.S,,  the foreign and Fed financing of the U.S. budget deficit is over.  Punto!

We are preparing for a significant move higher in bond yields.

What Is The Right Real Yield?

Do you really think with the deteriorating flows in the bond market, coupled with rising inflation warrant a 0.5 percent real 10-year yield?

Au contraire!   We believe a 2-3 percent real yield is closer to fair value.

Tack on another 2.5 percent for inflation,  generous as shortages seem to be breaking out everywhere,  and that gets the 10-year to at least 4 1/2 percent.

Timing

A little CYA.   Yields could move a little lower, maybe to 2.80 percent (a stretch),  given the dollar strength as Europe slows, and shorts get spooked.

Our suspicions, however, it is going to be a hot summer.  Higher interest rates and lower stock prices.

Disclaimer

Now let us add our disclaimer.

Even if all our facts are correct,  our conclusions may be completely wrong.

If you have been reading the Global Macro Monitor over the years, you have probably seen it several times.

To illustrate our point, we like to tell the story Abraham Lincoln used to persuade juries when he was an Illinois circuit court lawyer.

The story goes that Lawyer Lincoln was worried he had not convinced the jury during the closing argument of a civil case against a railroad.   The jurors had gone to lunch to deliberate.  Lincoln followed them and interrupted their dessert with a story about a farmer’s son gripped by panic,

“Pa, Pa, the hired man and sis are in the hay mow and she’s lifting up her skirt and he’s letting down his pants and they’re a fixin’ to pee on the hay.” “Son, you got your facts absolutely right, but you’re drawing the wrong conclusion.”

The jury ruled in Lincoln’s favor.

Stay Frosty, Oscar Mike!

Source: ZeroHedge