EconMatters: Bond

Showing posts with label Bond. Show all posts

Friday, June 24, 2016

Markets Gone Risk-off After Brexit

The shocking news that the UK voted to leave the European Union has triggered a new phase of risk-off sentiment around the world. It�s anyone�s guess how this all plays out, but the initial reaction is deeply bearish. Yes, it could all be overblown, but the crowd is inclined, once again, to run first and ask questions later. �This is the biggest shock to European politics since the fall of the Berlin Wall,� Rob Ford, professor of politics at Manchester University, tells Bloomberg.
World equity markets are tumbling today, but the real test will probably come next week, after the world digests the news over the weekend. Meantime, the appetite for safety has soared.

The 10-year German Bund yield is back in negative territory, dipping to -0.08% (as of 6am NY time), as investors rush back to a safe haven. Futures trading for US stock indexes are down sharply in early trading, following routs in Europe and Asia on Friday. Suffice to say, the notion of a Fed rate hike is dead in the water for the foreseeable future.

The main question is what impact will all of this have on the real economy? No one knows, although the initial view is that Brexit comes with a price tag. Exactly how much a macro haircut awaits, if any, is to be determined. Ground zero, of course, is Britain. Economists have been warning that a vote to exit the EU would take a bite of Britain�s GDP, perhaps leading to a mild recession in the months ahead. Europe, too, would suffer a degree of blowback. The bigger unknown is whether there are ramifications for the US and elsewhere?

Lots of questions, but few answers at the moment. For the moment, it�s all about sentiment, which has turned sharply negative. Markets are discounting trouble, and there�s sure to be no shortage as the ugly details of how the UK will disentangle itself from the EU emerge in the months ahead.

As for the US stock market, the crowd as recently as yesterday (Thurs., June 24) was feeling jovial. The S&P 500 surged 1.3%, approaching its highest level in months. But if the rally this week was predicated on Britain staying in the EU, a major attitude adjustment is scheduled for Friday.

In the short run, nothing much, if anything, will change in terms of fundamental adjustment of regulations, trade, etc. Implementing Brexit will take time, several years, in fact. But it�s coming and because markets are forward-looking machines there will be a constant discounting process underway for some time, perhaps with turbulent results.

The blowback from Brexit probably won�t be as bad as the pessimists think, but it won�t be trivial either. As the markets struggle to find out where equilibrium lies, there will be substantial risk and opportunity� and lots of volatility. Separating the wheat from the chaff isn�t going to get any easier, and it may be a whole lot tougher. But for good or ill, it seems that regime change has arrived� again. Now comes the hard work of figuring out what it means, or doesn�t.

About the Author - James Picerno is a veteran financial journalist since the early 1990s at Bloomberg, Dow Jones, etc. before becoming an independent writer/analyst/consultant in 2008. James is also the author of Dynamic Asset Allocation (Bloomberg Financial, 2010) and he writes at The Capital Speculator. (Author Archive here)

The Brexit Carnage from a Trader`s Perspective (Video)

By EconMatters

The surprise Brexit event made for some fun trading with great price action opportunities last night - sort of like being in a hurricane without getting your house destroyed - there is something "energy" in the air.

Thursday, June 23, 2016

An 85 Percent Probability of Black Swan Event in Bond Markets (Video)

By EconMatters

This is one of the Few times in financial market history that analysts could with high probability predict a black swan market event. The Federal Reserve is going to lose a lot of money on their Bond Portfolio Holdings over the next 10 years.

Friday, June 17, 2016

Core Inflation Rate 2.2 Percent and Rising (Video)

By EconMatters

The Fed Propaganda regarding Inflation is similar to Russia`s Propaganda techniques, and the financial media is brain dead to the entire media manipulation campaign.

Thursday, June 16, 2016

The Fed is Cherry Picking Inflation Numbers (Video)

By EconMatters

The real inflation rate is 2.2% year over year, the Fed is just committing economic dishonesty to justify not normalizing rates. Frankly, the mainstream financial media buy this crap as if it is real, i.e., that we have a below trend inflation problem in the United States.

This is just not true as once the poor food and energy comps and the effects of a strong dollar on a year over year basis come out of the numbers, the inflation numbers are really going to jump well above average inflation trends.

The Fed will definitely become schizophrenic again, and be forced to raise rates twice the remainder of this year due to above trend inflation as energy spikes after markets rebalance for the second half of the year as many analysts expect. The EIA Oil report was actually pretty good, and illustrates that oil markets are rebalancing.

But beyond this the core inflation rate will still rise the remainder of 2016 even if energy prices just stay trading within their current range. The Fed has through slight of hand like a magician changed from using core inflation in the past when it was convenient, to now ignoring it when the artificially lower inflation metric that includes the cyclical downdraft in food and energy prices which are temporary comps makes the inflation numbers appear below their 2% target, when in fact the real inflation rate is already above 2%, standing at 2.2% - basically the Fed is lying about inflation!

Moreover, the intellectuals in the financial media bought this magician`s trick hook, line and sinker. The mainstream financial media are blatantly incompetent, and plays right into the Fed`s hand in lying about the real inflation metric that they have used for decades. Inflation is already above the Fed`s stated 2% target! This is academic dishonesty to say the least by Janet Yellen, and highly unethical in my opinion.

People should call her out on this crap! Janet Yellen acts like an innocent grandma so nobody calls her out on anything in the financial media, she is actually a wolf in sheep`s clothing. She has lost all credibility in my book, and is going to look real stupid when forced to raise interest rates by inflation the back half of 2016, when she could have raised rates at a much more gradual pace while the food and energy comps were still in her favor.

The Bond Market Bubble is the Next Black Swan Event (Video)

By EconMatters

Central Banks are encouraging excessive risk taking in the Bond Markets, setting the stage for the next financial crisis. Bill Gross is right, Bonds are a systemic risk bubble right now. Conditions are ripe right now around the globe for an absolute crash in the bond market similar to a prolonged drought setting the stage for a forester fire that does such damage to become a natural disaster. Once the preconditions are set, it just takes one small match or event to kick start the entire natural disaster or financial crisis black swan event.

Central Bankers are the most irresponsible we have ever witnessed, the current irresponsible risk taking makes subprime lending look like child`s play. Just wait until the budget entitlements hit the balance sheets of the Federal Government in 2018. The Fed is so focused on the Micro, they are completely missing the big picture of 19 Trillion in debt, and an entitlements cost curve coming down the pike where bond yields are going to spike to epic proportions. You can just imagine what happens when the "New Normal" is the other way around in much higher interest rates because no investor wants to be caught holding the bag on this unsustainable and onerous debt.

The short termism by the Fed and other Central Banks is astounding for what are supposed to be conservative economists, not rogue traders going out on a limb. They literally have become extreme versions of rogue, irresponsible Central Bankers! This is never ending well, and the more they encourage excessive risk taking in the bond markets, sets the stage for an even bigger reversion to the historical mean market crash - the essence of a Black Swan Event. However, this one is so predictable, it is telegraphed a mile away, sort of like playing with fire in a chemicals plant.

Tuesday, June 14, 2016

There Needs to be a Chinese Wall between Monetary Policy and Markets (Video)

By EconMatters

The Paul Krugman if we only do more ZIRP model has officially and finally been proven a failure with absolute certainty. Anybody asserting this economic nonsense should be embarrassed by the Academic community writ large. New legislation is required for restricting Central Bank Authority going forward.

Central Banks are doing the exact opposite of what they should be doing, causing the very conditions they are trying to fix through continued policy methods of ZIRP and Asset Purchases. Not only are Central Banks the initial cause of the existing deflationary growth spiral around the world, they are exacerbating the problem by doubling down on ineffectual policy and thereby causing additional downward impetus to the negative feedback loop of inefficient capital allocation choices by investors and capital markets.

If you want to spur growth around the globe start respecting capital, pay a respectful interest rate for capital, positively reinforce investors to put capital to work in the actual economy with real growth projects and not stuck chasing low margin yield strategies in bond markets further reinforced by Central Bank Asset Purchases - this is the definition of Capital Hoarding and Deflationary for Global Growth from a capital allocation standpoint.

The Japan Economic Model has failed and the closer other Central Banks come to emulating this model the more their economies will resemble Japan`s slow growth economy. I realize this is a hard concept for economist`s to get because it is slightly counter intuitive to economics in general, but makes sense when talking about setting incentives for financial markets and capital investment choices. If you want to incentivize positive investment strategies and get this money out chasing real growth opportunities you don`t do this with negative interest rates but the exact opposite you do it with higher interest rates. You don`t effectuate this change in investor behavior by charging interest on deposits this is backward thinking policy, you just raise interest rates dramatically around the world and watch what happens to all this hoarded capital in storage around the globe in the banking and financial market system.

Because we are just not talking about the banking system but financial markets as well which have become inexorably linked and meshed with the banking system even more so with the advent of ZIRP. A low interest rate has negative consequences that reverberate throughout the entire financial market system and eventually resulting in what we have now - a capital hoarding bubble just on the verge of a tipping point of absurdity reflected in the German 10 Year Bund today finally going negative in one of the best performing economies in Europe.

Forget about providing the necessary conditions for the next financial market instability black swan event, ZIRP and Asset Purchases just plain don`t work on any extended time frame past an emergency liquidity shortage phase of 6-8 months. Where is the academic community in all this as well, we have over 30 years of documented evidence that ZIRP fails miserably, it has been proven an incorrect strategy in promoting economic growth. It has actually been proven to stimulate and stoke deflationary pressures in an economy through poor incentives from a capital hoarding and capital allocation perspective. Furthermore, it provides massive disincentives throughout the price discovery function that financial markets were originally intended for.

I am in favor of new legislation restricting the influence and authority of central banks at least in the United States to meddle in financial markets. They should never be allowed to purchase any financial assets period, this interferes with the market structure from both a price discovery process and risk profile.

I think they have slowly been allowed more influence into financial markets over the years and have finally completely destroyed financial markets pricing ability which is abundantly clear with the German 10 Year Bund being negative in an economy that is actually not in a once in a lifetime recession. The ECB buying Corporate Bonds is just absurd, and not the role for any central bank period.

We have proper checks and balances for every part of the government, at least that is the stated goal with the legislative, executive and judicial branches. But the Federal Reserve originally just providing economic guidance for fiscal policy measures and setting the Fed Funds Rate has slippery sloped all the way into buying Financial Market Assets and if not "Walked Back" who knows what else they would try from an extreme policy experimental standpoint! It is normal from a business cycle standpoint, and even healthy for economies to actually go into recessions.

You do more long term harm to an economy as witnessed in Japan`s Monetary Disaster to address normal and healthy economic weakness with extreme Central Bank solutions to try and artificially prop up an economy on a short term basis and prevent the cleansing and healing process of the economic business cycle which is crucial to promoting an upward trending long term growth profile.

As a long time market participant I respectfully want the Fed out of Financial Markets period. No more Financial Asset Purchases period, and normalize interest rates to non-recessionary conditions - start respecting financial capital. It sets a bad precedent when you have absurdly low interest rates for any period of time, let alone 2 years to a decade, and in Japan`s case 30 years!

Frankly, what Central Banks have done to financial Markets is criminal in nature, and why should we be surprised as a PhD in economics is not a PhD in Financial Markets, this distinction has played out in broken market structure. At this point if the Federal Reserve as an unelected body isn`t scaled back in their influence and effect on financial markets, then we would be better off with the establishment being discontinued altogether.

Bond Futures: Smart Money Holds The Largest Net Short in 18 Years

For years, most pundits believed that interest rates had nowhere to go but up; now, with rates near all-time lows, it seems everyone has shifted to the bullish camp.

Another day, another 52-week low in the 30-year U.S. Treasury Bond Yield (TYX). As we mentioned at the beginning of June, the break below the post-2015 Up trendline in the TYX suggested lower yields to come, so we are not surprised by this move. However, the depths to which the TYX has fallen should not be glossed over. To say that yields are at a 52-week low severely downplays how low they are. At 2.43%, as of today�s close, the TYX has only been lower during 2 months (January and February of last year) � ever.

As we recounted in our post from earlier in the month, it�s going on perhaps a dozen years now that we�ve been hearing a similar and nearly unanimous refrain when it comes to the bond market: interest rates have nowhere to go but up. Yet, here we are a dozen years later with the 30-year yield near all-time lows. And judging solely by the technical price action, the TYX looks as if it is likely to continue to go lower still.

As recently as early this year, it seemed as though the consensus opinion was that interest rates were poised to begin that long-awaited trek higher. Once again, of course, that view ended up being misguided. For some reason though, during this first half of the year downdraft in rates, something seems different to us. Perhaps it is our instinct fed by many decades of experience. Or perhaps we are succumbing to the same persuasions that have caused others to expect interest rates to rise for many years now. However, as we mentioned in that early June post, ��there are some ancillary factors that have recently begun to lessen our conviction of indefinitely lower rates��.

Some of these factors are anecdotal. For instance, while �zero interest rate policy� (ZIRP) globally seemed unsustainable for many years, it appears as though the masses have become quite comfortable with it. Indeed, with the move to �negative interest rate policy� (NIRP) across a not-insignificant swath of the globe, the idea of lower (rates) for longer has become the accepted, and expected, path.

It is not just subjective factors that feel different, though. There is quantitative evidence to back it up as well. One such piece of evidence comes from today�s Chart Of The Day pertaining to 30-Year T-Bond Futures. It shows that according to CFTC Commitment Of Traders data, Commercial Hedgers (i.e., those on the other side of commodity funds, hedge funds, etc.) are now holding a net short position of more than 100,000 contracts. This is the first time that milestone has been hit, and their largest net short position, since 1998.

As we have mentioned many times before, Commercial Hedgers have been given the moniker of �smart money�. This typically brings about plenty of questions and confusion when we discuss this topic. It is not that these Hedgers are always right, or smart. They do what their name implies, i.e., hedge. They are, again, taking the other side of positions held by Non-Commercial Speculator firms, e.g., commodity funds, hedge funds,etc.

These Speculators are typically trend-followers so they will generally add to longs as prices rise and add to shorts as prices fall. Therefore, the Hedgers will build up positions counter to the prevailing trend. Thus, during a long trend, Hedger positioning can be on the wrong side for a long time, and to a great extent. However, the reason for their �smart money� reputation is that at critical turning points or junctures in an underlying contract, they will most often be positioned correctly for the turn. And the more significant the juncture, often times, the more extreme their (correct) positioning will be.

In this case, these, so-called �smart money�, Commercial Hedgers have their largest net short position in bond futures in 18 years (meaning Speculators are at their most bullish). Incidentally, the last time Hedgers were net short more than 100,000 contracts was in September 1998, just as bond yields were breaking below a 5-year floor to plumb 30-year lows. Within days, the TYX would form a low around 4.10% that would hold for the next 4 years.

Of course, as we always caution when discussing COT data, using it as a timing tool is tricky. What marks an extreme in one cycle may not be the case in the next. I.e., while Hedgers� current net short position of 117,505 contracts mark an 18-year high, there is nothing to say the position cannot get more extreme. Indeed, in the past few years, we�ve seen COT data go to unprecedented extremes in contracts like crude oil, the U.S. Dollar and others.

Furthermore, while the extreme may indeed wind up nearly marking the cycle low in rates, it doesn�t mean that a substantial rise in rates is imminent. As we�ve pointed out, after Hedgers set an all-time record short position in the Dollar last spring the currency did indeed top out. However, it has generally moved sideways over the last year while the extreme COT positioning has been unwound. Therefore, as always, it still pays to track prices first and foremost, with ancillary factors serving as supplementary analysis.

And prices continue to trend higher � and rates lower. Therefore, we have little reason, so far, to fight that trend. However, for the first time in a long time, it feels as though the sentiment pendulum has begun to shift. No longer, it seems, does the investment community view rising rates as an inevitable and imminent path. And perhaps it will be just that widespread shift in expectations to the bullish side of the bond boat that will allow for the long-awaited bottom in interest rates�eventually.

Courtesy Dana Lyons' Tumbler (More Articles Here) More from Dana Lyons, JLFMI and My401kPro.

The End Game of the PhD Tyranny

By David Stockman

Sad to say, you haven�t seen nothin� yet. The world is drifting into financial entropy, and it is going to get steadily worse. That�s because the emerging stock market slump isn�t just another cyclical correction; it�s the opening phase of the end-game.

That is, the end game of the PhD Tyranny.

During the last two decades the major central banks of the world have been colonized lock, stock and barrel by Keynesian crackpots. These academic scribblers and power-hungry apparatchiks have now pushed interest rate repression, massive monetization (QE) and relentless rigging of the financial markets to the limits of sanity and beyond. Honest, market-driven price discovery is dead as a doornail.

No more proof is needed than the �matrix� below. The very thing that history proves, above all else, is that governments can�t be trusted to honor their debts. In fact, modern welfare state democracies have a veritable fiscal death wish.

What else can you call Japan�s announcement to defer yet again an increase in the consumption tax? Its public debt is already at 240% of GDP, even as its tax-paying population is rapidly streaming toward it�s national old age home.

At a 135% debt-to-GDP ratio, Italy is not far behind. It�s economy is still smaller than it was in 2007, its banking system has more than $200 billion of bad debt, its public sector squanders more than 50% of GDP and its politically fractured and corruption-ridden government is paralyzed.

Yet these are only advanced cases of the universal fiscal condition of the world�s sovereigns. With $80 trillion of public debt and unfunded entitlement liabilities, the US government is hardly more solvent than the socialist basket cases of Europe.

Once upon a time, the tendency of politicians to bankrupt the state was at least partially held in check by the fear of bond vigilantes, and the prospect of soaring interest costs on the public debt. I happened to be there during one such episode, when the 10-year treasury note required a 15% coupon.

It was enough to cause even Democrats to denounce deficits!

That is, at least until the GOP took a powder on social security and other entitlement reforms. At length, a tax-cut bidding war and DOD war spending spree supplanted most of the old-time fiscal religion, and Greenspan finished the job when he throw in the towel on monetary discipline in 1994.

Once upon a time, too, the interest rate on debt reflected compensation for credit risk and inflation�-and a real return to boot.

At the moment, however, �investors� aren�t getting paid for any of these costs. Instead, thanks to the mad-men running our central banks they are actually being forced to pay governments to borrow.

Moreover, that�s not an aberrant condition in the far recesses of the global bond market. There is now $10 trillion of sovereign debt securities with negative yields��and that figure is growing by the week as it cascades across government bond markets and out the maturity spectrum.

There could be nothing more perverse than for the central banking branch of the state to destroy the very government bond market on which modern state finances ultimately depend. But that�s exactly what they are doing, and the end-game could not have been expressed more colorfully than in the recent musings of the once and former bond king, Bill Gross:

Bill Gross, the manager of the $1.4 billion Janus Global Unconstrained Bond Fund, warned central bank policies that pushed trillions of dollars into bonds with negative interest rates will eventually backfire violently.
�Global yields lowest in 500 years of recorded history,� Gross, 72, wrote Thursday on the Janus Capital Group Inc. Twitter site. �$10 trillion of neg. rate bonds. This is a supernova that will explode one day.�

To be sure, a supernova at least has a basis in physics. It an end-of-life star that suddenly increases in brightness owing to a catastrophic explosion that ejects most of its mass.

Not NIRP. There is nothing natural or scientific about it.

It�s an economic mutant confected by arrogant Keynesian economists who inhabit a puzzle palace of fantasy. Not only do they have the nerve to believe that a tiny posse of monetary central planners has the capacity to price money, debt, capital and risk more correctly than the millions of agents that once populated free financial markets, but they do so in the name of invisible measuring sticks and prompts.

Thus, a recent piece in the Wall Street Journal

Chart Source: WSJ

Courtesy David Stockman at David Stockman's Contra Corner, check out Mr. Stockman's book The Great Deformation on Amazon.

Monday, June 13, 2016

Why 60/40 Stock & Bond Portfolio Won�t Survive the Next 10 Years

By Alex M., Founder of Macro Ops:

Everyone�s familiar with the classic 60/40 investment portfolio. If you�ve ever dealt with financial advisors, this is the standard allocation they�ll recommend. 60% of your money in the stock market, and 40% in bonds.

There�s no doubt this has been a great strategy the past few years. Check out the statistics from Jan. 1 2010 to Jan. 1 2016 below:

The standard 60/40 portfolio grew an average of 9.88% per year. And not only that, but the Sharpe ratio was at a stellar 1.33!

The Sharpe ratio is a standard industry measure for calculating risk-adjusted return.

Sharpe ratio = (Mean portfolio return - Risk-free rate) / Standard deviation of portfolio return

It takes the average return, subtracts the risk free rate, and then divides that difference by the standard deviation. The result is the excess return per unit of volatility. It basically tells you how much risk and volatility you had to endure for that extra return.

A high Sharpe ratio means you�re getting more excess return for less risk. So the higher this ratio is, the better.

Most quantitative hedge funds shoot for a Sharpe near or above 1. So 1.33 is really something. Especially considering that it�s coming from a simple 60/40 portfolio�

Now take a look at that portfolio�s statistics from 1946 to now:

See the Sharpe ratio? It�s only 0.45� much lower than our current period�s ratio of 1.33.

So our 70 year average is .45, but our current ratio over the last 6 years is 1.33.

What do you think will happen next? Do you believe we�ve reached a new era of permanently higher Sharpe ratios? An era where the new normal is high returns with low volatility?

Definitely not�

What goes up must come down. It�s a pretty good bet that the current 1.33 Sharpe ratio will revert back to the .45 long term average. Now you can do the math to find out what level of Sharpe ratios we need to print over the next decade to get back to this average, but long story short, it�s not pretty. Investors are in for a lot of pain as this number reverts back to the mean.

The worst part is that everyone has gotten used to this high return, low volatility environment. They aren�t prepared for the pendulum to swing back the other way. They never are. And that�s why we get boom/bust cycles and all the joy and misery that comes with them.

Going forward there are two possible scenarios that can play out which will send us back to our long-term average Sharpe ratio. The inflation scenario and the deflation scenario.

In the inflation scenario, bonds get killed.

Bonds as an asset class are very asymmetrically skewed right now. There�s a lot of downside, with not much upside.

As you know, when interest rates go up, bond prices go down. And at this point we�re near the zero bound in interest rates. There�s not much room for the Fed to maneuver to the downside. But the upside is wide open.

In general, longer term bonds (like the ones in a 60/40 portfolio) are more sensitive to interest rate changes than shorter term bonds. This is explained through the concept of �bond duration�, a rabbit hole we won�t get into right now.

What you do need to know is that there�s a lot of risk to the price of these bonds if interest rates move higher from here.

The Wall Street Journal has a tool you can use to test the effect of various interest rates on different dated bonds. It includes a variety of countries� bonds with different terms, from Italy�s five-year, to the US 10-year, and even France�s 50-year.

If you take a look at the US 10-year, you can see that decreasing rates by half a percent will cause a 5% rally in the bond price. On the other hand, raising rates by 2% will cause the bond�s price to drop 17%.

This is what we mean by asymmetry. The risk-to-reward is skewed for long term bond holders. There�s a lot more downside risk than upside reward.

Inflation will come back. And when it does the Fed will be forced to raise rates. Once they do, we�ll see long term bonds get dumped. The rout in bond prices will be detrimental to the standard 60/40 portfolio and will effectively bring our current Sharpe ratio back down to earth.

The second possible scenario is the deflationary scenario. This is where the entire global system deleverages to reach a manageable debt to income level. Cash becomes king in this environment. People will start hoarding their money, refusing to spend. This will in turn cause a deflationary loop where lower spending leads to lower corporate profits, meaning lower incomes for employees, which again leads to even less spending. Stocks will face huge price declines as corporate profits deteriorate and investors get rid of their shares. Risk assets in general will fall as investors find higher (and safer) returns in holding cash. The standard 60/40 portfolio will suffer as the equity decline plays itself out.

We believe the deflationary scenario has a highest possibility of occurring. But in either case, we see major problems brewing for those holding the standard 60/40 portfolio. As this portfolio reverts back to its long term average Sharpe ratio, these investors will take a beating.

Courtesy of Alex M., Macro Ops via Wolf Street