An Occurrence At The Federal Reserve: Increased SMART Money & Equity Volatility, Crushed Bond Volatility

Ambrose Bierce wrote a short story about a man being hanged during the American Civil War and what went through his mind in his final moments. It is called “An Occurrence At Owl Creek Bridge.” Hauntingly similar to today’s plight: overoptimistic expectations before being hung, then …. snap.

In summary., Ben Bernanke and The Federal Reserve entered the markets in 2008 in force. The Fed Funds Target rate was raised once during President Obama’s two terms as President, but eight times since President Trump’s election as President. Plus, The Fed’s Quantitative Tightening (in terms of its balance sheet) begin in earnest in 2019.

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Once The Fed hurled its monetary weight at the economy in 2008, the stock market had an amazing run. but since The Fed started to raise rates and began their balance sheet unwind, the S&P 500 index has increased in volatility as has the SMART Money Flow Index.

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The bond market volatility indices have gotten crushed by central banks.

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On the real estate front, equity REITs, like the small cap Russell equity indices, seemed to be benefit greatly from The Fed’s Zero Interest Rate Policy and QE. Mortgage REITs, on the other hand, kind of died with the financial crisis and never recovered. The RCA CPPI commercial real estate index too off like a missile.

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Like in the Ambrose Bierce short story “An Occurrence At Owl Creek Bridge,” The Fed and other central banks are quitting any attempts at rate normalization (for fear that they might hear that dreaded “snap” at the end of the monetary rope].

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Alarm! Europe’s And US Bond Volatility Grinding To A Halt (Precursor To Recession)

European bond volatility (according to the Merrill Lynch 3-month EUR option volatility estimate) has plunged to the lowest level on record.

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A similar chart for the US bond market is the Merrill Lynch Option Volatility Estimate for 3-months shows exactly the same thing. The US bond market is grinding to a halt.

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Note that the US MOVE 3-month estimate hit a low in May 2007, just ahead of The Great Recession of 2007-2009.

Alarm!

 

The Mummy Returns! ECB’s Draghi Raises Their TLTRO Program From The Dead To Combat Weak Euro Area Growth

The ECB’s Mario Draghi has decided to raise the dead (as in Modern Monetary Theory) by reviving the ECB’s Targeted Longer-Term Refinancing Operations.

Mario Draghi revealed the biggest cut in the European Central Bank’s economic outlook since the advent of its quantitative-easing program as policy makers delivered a new round of stimulus to shore up growth. The ECB president said the euro-zone economy will expand just 1.1 percent this year, 0.6 percentage point less than forecast in December. 

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The central bank will revive its Targeted Longer-Term Refinancing Operations to encourage banks to provide credit to businesses and consumers, and will hold interest rates at current record-low levels at least through the end of the year, several months later than previously indicated.

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The Euro declined on Draghi’s announcement.

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And most Euro area 10 year sovereign yields are down 5 basis points or more.

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Draghi must not read from the Modern Monetary Theory (MMT) book!

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US Real Personal Spending Crashes In Dec, Largest Decline Since 2009 (Core Inflation Declines To 1.7% YoY, Consumer Sentiment Declines)

Bah humbug!

US Personal Consumption Expenditures (PCE) crashed in December to its lowest MoM reading since 2009.

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On the inflation front, core PCE price growth YoY remained steady at 1.9% with the PCE Deflator declining to 1.7% YoY.

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Consumer sentiment declined in February along with ISM New Orders.

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But at least University of Michigan’s Buying Conditions for Houses rose in February, or it is just a blip in a downward trend.

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This looks like the end of The Fed’s Quantitative Tightening.

Global Yield Curve Inversion (Same All Over The World)

An interesting chart of the 30-year sovereign yields less Fed Funds rate reveals that much of the world is in a state of global yield curve inversion. (Graph courtesy of the great folks at Crescat Capital).

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While the US is not in a state of yield curve inversion (except for the 1-5 segment), the US remains (for the moment) is positive territory.

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I prefer using the 10-year Treasury Note for curve analysis rather than the 30-year Treasury Bond.

One might observe that Treasury volatility measures are quite low … again.

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So, yield curve inversion is the same all over the world. The US seems to be on track to invert as well.

Fed Vice Chair Clarida Notes That Yield Curve Is Getting Flatter (But Inverted From 1 Year To 5 Years)

Former Columbia University economic professor and curret Fed Vice President Richard Clarida made one obvious point at a Dallas Fed meeting, and one half-truth.

(Bloomberg) — Federal Reserve Vice Chairman Richard Clarida said that when rates on shorter-dated bonds move above rates on longer-dated bonds, it can be a signal that an economic slowdown is coming.

“Historically in the U.S., inverted yield curves are actually pretty rare — they aren’t black swans, but they don’t happen a lot, and when they do happen that is typically a signal that the economy is either slowing sharply or could even go into a recession,” Clarida said Monday at an event at the Dallas Fed.

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Clarida drew a distinction between flat and actually inverted curves.

“Right now the yield curve in the U.S. is not inverted” but “it is getting flatter,” Clarida said. He noted that the Fed pays a lot of attention to whether the curve is flattening because of a fall in inflation expectations. And he said that monitoring the curve is complicated by the fact that U.S. markets are impacted by global demand for safe assets. “What happens in Europe and Asia can have an impact on our Treasury market, too.”

Well Professor Clarida, your statement is only partially correct. The US Treasury yield curve (green) is actually inverted from 1 year – 5 years. THEN upward sloping after 5 years. The US Dollar Swaps curve is inverted from 3 months to 4 years then upward sloping.

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Now, if you want to talk about a downward sloping yield curve, take Venezuela. Please!

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Another curve that is shaped like a rollercoast at King’s Dominion is the US Dollar Overnight Indexed Swaps curve.

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So Professor Clarida is only semi-correct about curve shapes. There is inversion from 1 year to 5 years, possibly signalling a slowdown (or recession) in the 1-5 year period.