March 12. Summers’ wisdom

I am not a big fan of Larry Summers and his secular stagnation thesis, “…an excess of savings over investment.”  It sounds a bit like re-heated Keynes, who my old college prof Robert Eisner distilled with this summary: “Investment doesn’t necessarily equal intended investment.”  That was Keynes breakthrough, though it’s now all been bastardized to the simplistic idea that government should spend more to support the economy.  Not to worry, I am not going to try to recite my lame college memories.  Instead, I am going to quote Summers with, for me at least, his most interesting and endearing quote:

“One of the things you learn as a college president is that if an undergraduate is wearing a tie and jacket on Thursday afternoon at three o’clock, there are two possibilities. One is that they’re looking for a job and have an interview; the other is that they are an as$hole. This was the latter case.” 

He was referring to the Winklevoss twins.  The reason I bring up the twins is that they suffered a large setback Friday when the SEC denied their application for the Bitcoin Trust ETF.  After the news late Friday, bitcoin immediately plunged to nearly 1000, having been at 1300 early in the day.  This is actually a minor event for the world of global finance and rates, however, there were other large and significant moves which also occurred this past week, which may have big implications in the near future.

While bitcoin isn’t all that important, the price of oil is clearly a centerpiece of the reflation trade.  Other commodities like iron ore and steel rebar also posted declines.  Copper, which like other industrial metals, appeared to be breaking out of its three month range to the upside in February, has now slipped below the old highs and is back in the middle of the range.  For now, the BBG Commodity index is still about 13% higher than a year ago.  It’s just above 84, having been between 80 and 90 since Q2 2016.  It’s also worth noting that the Atlanta Fed GDP Now Q1 forecast has dwindled from 2.5% in late February to just 1.2% currently.

The above items would be considered headwinds in the march to higher rates.  However, a rate hike is now completely priced into the very near part of the US interest rate curve for the FOMC meeting on Wednesday.  Given the ‘new’ libor/ois spread of 22-23 bps, and the Fed’s year-end 2017 dot projection of 1.40 for the FF target (3 hikes), one might expect EDZ7 to be around 1.73%, and indeed EDZ7 settled 9835.5 Friday. Jan 2018 Fed Funds (FFF8) settled 98.675 or 1.325%, just 7.5 away from the Fed’s year-end projection.  In my opinion it’s not very likely that the 2017 dot will change much from December, and for that matter, the year end 2018 median of 2.1 probably won’t change much either.  So it’s all transparent and steady sailing for the US….right?

Not so fast.  It was April 21, 2015 when Bill Gross termed German 10 year bunds the ‘short of a lifetime.’  In fairly short order, the yield went from 6 bps to a bit over 100, only to grind back down in the middle of last year to a new low of -19. Since then it’s been up.  The bund yield is now 48.5, a jump of 13.5 bps this week.  Even more impressive was the surge in euribor yields.  Net changes on the week in reds, greens, blues and golds were +7.125, +13.875, +18.375 and +20.25.  The greens (3rd year out), for example, went from just above a yield of zero (99.96) to 18 bps (99.82125).  In the US, five, ten and thirty year treasury yields rose just over 9 bps, at or through old highs.  These moves are the strongest signal I have seen in terms of a global change in sentiment regarding rates.  Even the 30 year JGB (I watch 30 year rather than 10 as the BoJ is targeting the 10 yr yield), has gone from just above zero in the middle of last year to 86.5 currently.  There is a global change in sentiment.  Are the central banks leading or following?  The Fed would seem to be the leader, but as Jim Bianco says, CB interventions are fungible across markets, and the underlying theme now is cessation or withdrawal of stimulus.

Certainly there are many factors that could arrest or reverse a move to higher rates.  For example, there are continuous warnings about China’s unbalanced credit growth which could lead to an abrupt shock. “Non-financial corporate leverage is too high” according to PBOC Governor Zhou Xiaochuan.  European elections loom.  In the US, C&I loan growth has decelerated sharply of late, with the last reading at a rate of -1.1%, vs 6.6% in Q3 2016 and 4.7% in Q4.*   The last revolving credit number was also negative.  The CEO of Target says he hasn’t seen this many distressed retailers since the crash in 2009.  On top of that, the flow of funds report released Friday shows that the ratio of household wealth to income has never been higher and is at 6.5x.  Of course, much of that wealth is comprised of stocks, and the total market cap to GDP ratio is now just over 130%, the highest since the tech inspired peak of 148% in 2000.

However, it appears as if fear of higher rates and possible inflation acceleration has now gripped both central banks and investors.  It might just be a simple case of rates having been too low, too long.  On a technical basis, I compare the current move in bunds to JPY in 2012 [chart below]

 

 

 

 

 

 

 

 

 

 

 

 

 

Of course, the two charts above might have exactly nothing to do with each other.  It’s just that markets are sometimes susceptible to large and unexpected moves, and, as I have said before, the current US interest rate structure has entirely dismissed the concept of an ‘overshoot.’

Bonds are counted as valuable assets due to their income streams, derived from disaffected taxpayers or from over-indebted corporations.  Occasionally, generally accepted facts (‘housing prices only go up’) get up-ended.

 

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3/3/2017 3/10/2017 chg
UST 2Y 131.0 135.5 4.5
UST 5Y 201.0 210.3 9.3
UST 10Y 249.0 258.0 9.0
UST 30Y 307.5 316.8 9.3
GERM 2Y -83.0 -83.1 -0.1
GERM 10Y 35.0 48.5 13.5
JPN 30Y 85.0 86.4 1.4
EURO$ M7/M8 57.0 58.0 1.0
EURO$ M8/M9 40.5 44.5 4.0
EUR 106.23 106.74 0.51
CRUDE (1st cont) 53.73 49.03 -4.70
SPX 2383.12 2372.60 -10.52
VIX 10.96 11.66 0.70

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https://www.bloomberg.com/news/articles/2017-03-10/mnuchin-said-to-focus-on-currencies-as-g-20-girds-for-trump-era

https://www.federalreserve.gov/releases/h8/Current/

http://www.zerohedge.com/news/2017-03-10/household-wealth-has-never-been-higher-relative-income

Posted on March 12, 2017 at 3:33 pm by alexmanzara · Permalink
In: Eurodollar Options

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