The Crazy World Of Libor, Swaps And Treasury Yield Curves (Fire? or Ice Axe Cometh?)

Financial markets are experiencing “The Crazy World of Libor, Swaps and Treasury Yield Curves.” 

In other words, all three curves have a downward sloping section, all at different times, but all short-term (less than 6 year maturities).

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What uncertainties are in financial markets and the unlying economies, you may ask? How about trade (e.g., US and China trade flows), Brexit, China’s recession, Japan’s ongoing stagnation (despite negative interest rates), Italy and Germany’s slipping into darkness, not to mention uncerainty about The Fed’s path for balance sheet unwind.

The Fed’s balance sheet is a particular concern since the 10-year Treasury Note yield began to rise when the unwind began, but rates have gone DOWN when the unwind got serious in 2018. Or is Fed Chair Jerome Powell really “The Iceman”?”

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Here is a photo of Fed Chair Jerome Powell weiliding his “ice axe.”

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Former Fed Chief Yellen Says Rates Could Next Move Up or Down (Implied Rate Forecast Is Down, US Treasury Curve Downward Sloping From 1-3 Years)

My favorite Bloomberg headline of all time is: “Former Fed Chief Yellen Says Rates Could Next Move Up or Down.” Wow, how insightful. But of course, she was refering to The Fed Funds Target rate which she kept at 25 basis points seemingly forever. However, current Fed Chair Jerome Powell could either raise, lower of keep rates constant, depending on the state of economy.

But then again, both the ECB and Bank of Japan are currently at zero (ECB) and below zero (BOJ). The US Fed is headed in a direction that differs from other central banks.

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While Powell has been increasing The Fed Funds Target rate AND shrinking The Fed’s balance sheet, Europe is drowning in negative target rates (Eurozone, Switzerland, Sweden, Denmark) as is Japan.

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But in terms of central bank balance sheets, only the US is shrinking their balance sheet.

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There are currently around $9 trillion of bonds trading at negative interest rates.

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As we stand today, the US Treasury yield curve is downward sloping at tenors 1-3 years.

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The current implied policy curve for The Fed is declining (meaning Fed Fund rate cuts are implied in 1-3 years.

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So, former Fed Chair Janet Yellen thinks rates could go up or down.

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The Average Adjustable-rate Mortgage Is Nearly $700,000! (Misleading Because Mortgage Refis Are Essentially Dead)

MarketWatch has the tantalizing headline of “The Average Adjustable-rate Mortgage Is Nearly $700,000.”

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True, the average loan size for ARMs (adjustable-rate mortgages) is substantially higher than for FRMs (fixed-rate mortgages).

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But here is a catch. Mortgage refinancing applications are virutally dead.

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Mortgage purchase applications are relatively sedate but rising following the financial crisis with new rules governing bank lending such as QM (Qualified Mortgage) and other Consumer Financial Protection Bureau (CFPB) rules.

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A more relevant chart that the one posted by MarketWatch is a comparison of average loan size by purchase applications and refi applications. Note that following the financial crisis, average loan size for purchases is higher than for refi applications.

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For the week ending 02/01/19, mortgage purchase applications SA declined 4.58% while mortgage refis were up 2.6% from the preceding week.

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The bottom line is that the MarketWatch piece, while tantalizing, is fundamentally misleading. Mortgage refi applications are nearly dead and mortgage purchase applications are rising again, but are no where near the 2000-2007 levels.

So, who killed mortgage refinancing applications?

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These guys! (Paul Volker can be excluded from the blame list).

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