The Beach Boys sang it best: Shutdown!
The Dow Jones Industrial Average has risen 12.8% since The Federal government’s partial shutdown starting just before Christmas 2018. But since December 26th (the day after Christmas), the Dow has shot up 12.8%. And the S&P500 volatility index, the VIX, has declined by 50%.
Its fun, fun, fun for investors. But for nonessential Federal employees, Don’t Worry, Baby because you will receive back pay as soon as the shutdown is over.
Meanwhile, “Help Us Nancy and Chuck” and end the shutdown.
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?
Global uncertainites abound. And with them, the US TReasury yield curve, the US Dollar Swaps curve, and the 1-month LIBOR curves are all kinked.
These curves are kinked all day and all the night.
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?