One day it looks like China and the US are making progress in trade talks, the next day there is no progress. Just like Brexit — on one day, off another. Then there is the Federal Reserve: will they continue raising their target rate and unwinding their balance sheet? Will the Democrats controlled House try to impeach Trump for putting ketchup on his steaks? And “The Wall.” Same old, same old. So many uncertainities.
Hence it is not a surprise that the US Treasury yield and US Dollar Swaps curve remain “kinked”. That is, inverted in the short-end of the respective curves.
It is difficult to keep one’s head on straight with all the uncertainties in the global markets.
The International Monetary Fund (IMF) has downgraded economic growth for the Eurozone to 1.6 for 2019. weoupdatejan2019. But Japan is even worse at a forecast of 1.1% for 2019.
Russia is also forecast to be sub-2% as 1.6%.
The Eurozone and Japan are drunk as a skunk on global Central Bank zero interest rate policies.
Central banks are like Willy Wonka to markets offering golden tickets.
We have the People’s Bank of China wildly expanding their repo purchases to stimulate their economy and have just announced massive investments.
Then we have Trump administration officials \considering measures to roll back tariffs on Chinese products in order to calm financial markets, the Wall Street Journal reported, a report the Treasury Department quickly denied.
Then we have The Fed taking further rate hikes off the table. It sure looks like it!
Then there is the January effect (not the January Jones effect) where stocks decline at the end of the year only to rise at the beginning of the next year.
My bet is on Jerome Powell, The Fed’s own Willy Wonka spreading golden tickets to Wall Street.
There is a lot of fear and uncertainty in financial markets: the US Federal government shutdown, May’s Brexit defeat, trade anxiety with China, postponement of Nancy Pelosi’s entourage 7-day excursion to Brussels, Egypt, and Afghanistan, the Mexican border wall, etc.
But given all the fear and uncertainty in financial markets, the VIX 1-year implied volatility has actually been declining … and its decline coincides with The Fed’s Quantitative Frightening (QF) or the shrinking of The Fed’s balance sheet.
Quantitative frighening or numbness?
China’s central bank, the People’s Bank Of China, now has the world’s largest balance sheet topping even the European Central Bank (ECB). Only The Federal Reserve is shrinking its balance sheet … for now.
The PBOC has injected almost $1.1 trillion in the market over the past two days.
One of the impacts of the balance sheet expansion and repo injections is a reduction in the volatiilty of Chinese stocks. Better known as “numbing volatility.”
On the sovereign side, China’s yield and swaps curves are kinked.
Central bank interfernce in markets seem to be never ending.
The Federal Reserve’s zero interest rate policy (ZIRP) and quantitative easing (QE) helped to rebuild US household net worth. But it was rebuilt with asset bubbles that invariably burst.
And courtesy of Kevin Smith at Crescat Capitalm here is a chart of asset bubbles and household/corporate debt as percentage of GDP. The most vulnerable? Canada, China and Australia.
Canada, Australia and China represent 3 of the lowest 5 countries in terms of % of stocks with negative annua free cash flows.
Shrimp on the barbie, mate?
In a positive technical sign for bond bulls, the U.S. 10-year Treasury yield has formed a so-called death cross pattern. This occurs when the 50-day moving average crosses below its 200-day counterpart. While many traders are skeptical of its relevance, others argue it presages further weakness in the benchmark yield. “It should indicate long-term yields will continue to head lower as we move through the first quarter,” wrote Miller Tabak + Co. equity strategist Matt Maley, in a note to clients.
As The Fed continues to unwind its balance sheet, 10-year Treasury yields, on average, have been falling (not rising).
Since early November 2018 when the 10-year Tteasury note yield hit 3.24%, both the Treasury yield and 30 year mortgage rate (MBA) have plunged.
Partly to blame is the slowing economies around the globe, particularly in Europe (check out Ford’s announcement of job cuts in Europe: Ford Motor Co. will shed thousands of jobs at its European operations as part of a bid to return the business to profitability with a broad restructuring that could include shuttering factories).
And then there is that 13% YoY decline in China Passenger Car Sales.
So, despite global zero-interest policies (except for the US), global economies are slowing.
It is difficult to push US interest rates higher when the global economy is slowing down.
To be sure, there are a whole host of wild cards that could send interest rates rising again: 1) US-China trade agreement, 2) ending the US government shutdown, 3) resolution of the neverending BREXIT issue, 4) France and Germany’s struggles to raise energy prices (Paris Accord?), etc.
The implied probability of a Fed rate hike in this global environment is pretty low.
And both the US Treasury actives curve and Dollar Swap curve remain kinked.
Will The Fed emulate Frank Booth from “Blue Velvet” and provide more oxygen to markets?