Remember when the curve was getting steeper each day? Remember when we started warning that the steepness was going to catch a lot of net interest margin (NIM) players flat footed when it finally turned? Well, it might be turning. Even if it goes back to the former steepness levels, I’m not sure it will surpass what we saw at the end of 2010. Here’s the 2-30 spread. Sure it can double dip, but the real issue is that 2 year bonds are being sold quicker than 10 year bonds. That’s not inflation – that’s stagflation, it’s deflation, or it’s bi-flation. Whatever it is, it’s not pretty for the long only managers.
Bill Gross loudly got out of treasuries, and just as loudly started shorting them earlier this month. Now, others are coming out of the woodwork on the trade (Jim Rogers, Michael Steinhardt, etc.). I’ve been there for a while, with a flawed implementation vehicle, but not bad given the magnitude of the move I anticipate and some challenges with shorting TLT. An even better way would be to structure the outcomes with options given the binary nature of the current environment. I’ve also been researching the newer ETN’s, FLAT and STPP, flattener and steepener respectively. Both are flawed and not my cup of tea, but I see the appeal and the use. Here’s a WSJ article about them. I think there are other ways to play the beneficiaries rather than ETNs on derivatives (a credit product which is a derivative to begin with, on derivative underlyings – definitely not for me at this point).
Relevant ETFs: FLAT, STPP, TLT, TBT
I have to admit that the title is not mine, although oh I wish it were. Peter Hooper at Deutsche Bank just came out with a report (h.t. ZeroHedge.com) sporting this title. Not surprisingly, Hooper is trying to figure out the end game (aren’t we all) and concludes that if nothing else, the market is underpricing the possibility of a Minsky moment, namely a point in time where US debt faces a dramatic drop in prices as investors stampede out.
Our bottom line finding is that the relatively low risk the market attaches to US public debt belies a substantially higher degree of riskiness (indeed one about on a par with the euro periphery)indicated by standard measures of internal and external deficit and debt. While the debt ceiling hurdle will likely be jumped with only moderate disruption to the Treasury market, the challenges to a much needed fundamental reworking and redirecting of US fiscal policy are great. Failure of US political leadership to make substantial progress in this area in the next few years will substantially raise the risk of a bond market crisis.
Read the full report here.
The idea of a Minsky moment for treasuries is nothing new for our readers, but 2 things struck me. The first, is that there aren’t a lot of sell-side analysts discussing it. The second, is the focus on 2013, mainly because I anticipate that we might face a crisis sooner. Hooper’s analysis made another great point: if Obama is NOT re-elected, the US will face a situation with a president that will want to be re-elected, which in turn implies a limited ability to address the entitlements and taxes that will need to be reduced and increased, respectively. In that light, Obama’s re-election is a necessary condition for change, as a second term president will have the capacity to implement more far-reaching changes. Very interesting.
In the early 1990’s, as a first term president, George Bush Sr., sacrificed his second term by increasing taxes and ensuring the US was on stronger economic footing. As the US faced the remnants of a war, the S&L crisis, etc. Bush’s move set us up for the following seemingly golden era of the Clinton/Rubin team. I don’t anticipate that Obama will sacrifice his second term in the same way, so Hooper is probably right that we might have to wait until 2013. On the other hand, as a discounting mechanism, the markets might start to foresee just that moment and move earlier.
Relevant ETFs: TLT, TBT
Turns out that lowering the outlook from stable to negative IS still legal, and surpringly S&P actually did it. I thought it would never happen, but lo and behold, they did it. Here’s from their statement:
The negative outlook on our rating on the U.S. sovereign signals that we believe there is at least a one-in-three likelihood that we could lower our long-term rating on the U.S. within two years. The outlook reflects our view of the increased risk that the political negotiations over when and how to address both the medium- and long-term fiscal challenges will persist until at least after national elections in 2012.
Some compromise that achieves agreement on a comprehensive budgetary consolidation program–containing deficit reduction measures in amounts near those recently proposed, and combined with meaningful steps toward implementation by 2013–is our baseline assumption and could lead us to revise the outlook back to stable. Alternatively, the lack of such an agreement or a significant further fiscal deterioration for any reason could lead us to lower the rating.
Standard & Poor’s will hold a global teleconference call and Web cast today–April 18, 2011–at 11:30 a.m. New York time (4:30 p.m. London time). For dial-in and streaming audio details, please go to www.standardandpoors.com/cmlive.
It makes sense. Can’t fault them for stating the obvious, even if they are a bit late. Moody’s probably feels pretty foolish right now, and the administration is scrambling, but this is no surprise to many investors. Bill Gross is feeling like a genius right now.
I’ll write more on the topic, but the markets are moving pretty fast. Gold is bid. Everything else…well, not.
Slowly and quietly spreads of the 2-10 year treasuries decided not to blow out and instead have started coming back. What does it mean that in a world of increasing rates, we’re getting a flattening yield curve?
Here’s the 10 year yield:
Edging up slightly recently, and certainly not contracting. On the flip side, look at the 2-10 spread:
A few short months ago, hyper-inflationists were warning that this spread, which hit high after high, would blow out as inflation took hold, became rampant, and we’d be back to the middle ages. I was never in that camp, and while we see some inflationary pressures building, I think the main risk remains deflation as real estate, unemployment, etc. will drag down the consumer. Regardless, the 2-10 spread has come back from the brink and the curve is now flattening. I don’t know which way we go from here, but my analysis is still that rates are headed higher on an absolute level and the flattening yield curve supports my view that a recession or worse could be on the way. It’s a bad combination to have higher rates, deflation of stores of wealth, and a government with no ability to provide future fiscal and monetary stimulus.
Relevant ETFs: TLT, TBT, AGG, SAGG
This is from the Atlanta Fed:
March 24, 2011
Longer-term deflation probabilities move up slightly
Prices of Treasury Inflation-Protected Securities (TIPS) with similar maturity dates in 2015 can be used to measure probabilities of a net decline in the consumer price index over the five-year period starting in early 2010. One measure of the deflation probability was11 percent on March 23, up slightly from10 percent a week earlier. An alternative lower bound on this deflation probability ticked up from 0 percent on March 16 to 1 percent on March 23.
Link is here.
This is a very short time frame and can fluctuate easily (as you can see from the time series). That being said, it’s tough for the probability of deflation to get any lower, which to me says that it might be a good time to check out www.intrade.com or, if you’re an investor, just find who are the winners and losers from deflation materializing. It just needs to materialize more than the market expects for it to make a significant impact.
Relevant ETFs: TLT, VNQ, RWR, REK, GLD, SLV, XLF
A bit later than usual…
As always, MacroView is produced in collaboration with MacroMan. To show the extent of our need to SEEK conflicting data, today’s MacroView has a number of charts showing support/resistance for inflation triggers. I’m not in the inflation camp for the time being. I see no wage pressures, a consumer slowdown, increased savings rate, lower velocity, lower housing, excess capacity, etc. That being said, one must always let the data lead, and I’m open to re-interpretation…
macroviewmarch17
I have been negative on a lot of asset classes for a long time, but it was always part of a larger process of getting back to some normalization (earnings, geopolitics, etc.). I have been hesitant to call a top, because quite honestly, I am not sure anyone can do that effectively. With that in mind, I feel like we are close to a breaking point on multiple levels. Walk with me through today’s news, none of which is actually new to our readers, but the combination may finally hit investors in a new light:
- All’s NOT well in Libya. Pictures of burning oil fields, a lot of misinformation, etc. If nothing else, oil supplies are threatened. Not new, but a piece.
- Meanwhile, in Iran, Reuters had this headline: “U.. OFFICIAL EINHORN SAYS BELIEVES IRAN SEEKS TO REACH THRESHHOLD OF NUCLEAR WEAPONS CAPABILITY”. Iran is testing the waters, maybe even provoking a little. How will the world respond? Again, nothing new, but coming with Libya and the rest of the Middle East turmoil it might finally make sense to investors.
- Finisar (FNSR) is down 35% as I write this. Why is this important? It’s a small company, with limited exposure. Except, they’re the guys who make some of the switches for fiberoptics cable around the world. They’re very active in China, and had this to say on the conference call:
“[Earnings were] impacted by the full three months of the annual price negotiations with telecom customers that typically take effect on January 1, the 10-day long shutdown at certain customers for Chinese New Year in February, the adjustment of inventory levels at some telecom customers, particularly for products which had previously been on allocation and long lead times, including WSS and ROADM line cards, and a slowdown in business in China overall.”
Slowdown in China? Well, that got everyone thinking. If China slows down, why is copper up? For weeks, we have been telling readers that China is slowing down, their numbers are fake, and that hyperinflationary fears on the back of endless Chinese buying are overblown. Maybe now investors will start realizing that in a debt deflation cycle, commodity inflation is not the big threat – lack of pricing power is.
- As if China’s slowdown won’t have enough of an economic impact, ZeroHedge reported that Bill Gross dumped 100% of his government holdings. Now, I am short treasuries and continue to believe they offer return-free risk – the worst kind, but having PIMCO front run pretty much every other bank and asset manager is a big deal. The guys at Blackrock are probably pretty worried about not having a bidder when they finally need to get out also.
- Lastly, I encourage everyone to read James Montier’s new piece on GMO’s site: https://www.gmo.com/
That is without mentioning the fact that oil is 30% higher than 6 months ago and is now flowing down to the consumer who’s seeing it in higher gas prices.
None of those pieces of information are new on a macro level. However, sometimes investors need to hear things multiple times before they understand the full implications. And I believe that we’re close to the break point, the point at which investors comprehend and then price assets accordingly. It would mean a revaluation of all industrial commodities down (China will no longer be the marginal buyer as it slows), equities down (as the E in P/E goes down and pulls down P with it), and bonds down (as government debt will no longer be the safe haven).
Relevant ETFs: TLT, TBT, GLD, SLV, SPY, SH, IWM, RWM, USO,
There is so much noise that sometimes it’s difficult to focus. Today has seen some big moves across different asset classes, but I have to point out a couple:
- Silver making new highs. Without the fanfare of gold, silver continues to shine. I’m sticking to my original recommendation of splitting your precious metals exposure to silver, gold, platinum, and palladium. If it was happening by itself, I would say that it’s just a speculators game now. But it’s not. The precious metals are sending central banks a message. The metals were just a step ahead of bonds.
- Treasuries. Treasuries have rallied recently, but they’re struggling. Like a flurry in April, which signifies the death of winter, so too the recent rally is a fool’s bounce. Treasuries cannot be the refuge they once were; government policies have ensure that for the foreseeable future.
- Oil. Energy is a necessity, integrally tied to a country’s ability to produce good, but more importantly food. Instability in the largest energy producing region in the world will continue and provide a supply-shock-bid to the complex. I prefer the second derivative beneficiaries, namely, the domestic suppliers of coal and nuclear. Government policies will start bolstering these players as energy self-sufficiency will once again come to the front of the political debate.
- Emerging markets. Risk in EM countries has been underpriced for the past 10 years. Investors who piled into regions with no democratic and capitalistic foundations will have a tougher and tougher time getting out. Hopefully, investors aren’t holding large allocation to the region. Long term, I’m looking for opportunities to invest in India, not China; Brazil, not Russia.
- US equities. I have to throw in a mention. I am short IWM. Have been for a few weeks. Will stay for a while. Yes, I have long exposure in specific sectors and companies, but the overall market is unhealthy. I’ll have more to write about the specifics of equity valuation later in the week.
Relevant ETFs: GLD, GDX, PHYS, SLV, PSLV, IWM, RWM, TBT, TLT, INP, PALL, PPLD
Tags: commodity trading, currencies, EEM, russell, short, treasuries, VWO
Commodities/Futures, Currency, Fixed Income/Bonds, Politics, Strategy/Allocation | Yaron Sadan | 
March 1, 2011 1:08 pm | 
Comments (0)
Looking at todays MacroView on a macro view, I couldn’t help notice just how many indicators are sitting at turning points – not giving a clear signal whether they’ll turn or not, but certainly giving a signal that we are sitting on shifting foundations.
MacroView is a collaboration between The Hard Trade and MacroMan – a frequent contributor to the site.
macroview_1Mar11
There are a lot of conflicting headwinds to work through. Today’s MacroView explores some, including the difference between the 2-10 spread vs. the 2-30 spread.
macroview_-_feb24
Today’s MacroView is very broad, looking at USD, gold, UST, and cattle; however the themes we explore in the charts are consistent – will inflationary pressures flow through to the US consumer? Who are the beneficiaries and the victims of the commodity moves we have been witnessing in the past few months? etc. These are running themes that we’ll continue to explore.
macroview – feb23
Even if you’re a stock trader, in this day and age if behooves you to understand the fundamental picture, even if only to understand the inputs into any valuation metrics. And the macro markets are making EXTREME moves – all time highs and lows in multiple markets. Today’s MacroView starts by looking at energy, points to discrepancies in the commodities, then looks at the impact on retail.
macroview -feb21
This presentation came out about 2 weeks ago, but got almost no press (H.T. ZeroHedge.com). The entire presentation is a must read, but I’ll just share the conclusions:
Summary and Conclusions
• We found the following promising and deserving of further consideration:
─Measures to expand retail investment in Treasury securities. These include: stepped-up marketing and advertising along with the addition of new securities that appeal directly to households as well as to institutions.
─Ultra-long bonds with maturities of 40 or 50 years. Such bonds should be strippable.
─Callable securities, especially those with relatively short maturities and lockouts, and possibly a regularly issued longer-maturity callable.
─Instruments targeting the money markets and households, including FRNs where the reference rate and reset periods are short-dated and synchronized.
─Changes in the structure of TIPS stripping program to enable investment in the “pure” inflation component of TIPS principal repayments in order to augment overall liquidity in the TIPS market.
─Buybacks and similar measures to help Treasury smooth out the large increase in rollovers coming in the coming decade.
─Interest rate derivatives to help manage liabilities and achieve cost-savings arbitrage.
•Measures we found less viable and requiring more study at this point were:
─Longer-maturity CMT-style floaters, which are complex and expose investors to a high degree of yield curve risk.
─GDP-linked bonds, where demand is uncertain and the index is subject to large revisions.
─Puttable bonds, where demand for volatility and preferred structure are uncertain.
─Foreign currency denominated bonds.
Read the full report here: http://www.treasury.gov/press-center/press-releases/Documents/TBAC%20Discussion%20Charts%20Merged%202.2011.pdf.
Is the Fed considering GDP-linked bonds? At least they’re rejecting them for now. Is the Fed really in the sales game now? Are they trying to figure out how to sell longer maturity bonds to retail investors? Is that what we’ve come to? We have been saying for a while that the Fed is the single largest hedge fund in the world. It’s also going to become the largest issuer, underwriter, owner, insurance company, etc. in the world.
What happened on Wednesday was the outlier, not the other days of the week. The entire curve has been getting weaker, except, obviously, the shortest of the short rates. Anything over a year, where the market is bigger, deeper, and more attuned to investing themes, is facing headwinds for now. Except Wednesday, right after the 10 year auction, treasuries rallied. Why? Truth is, I have no idea. On the run issues were bid and the spread to off the run issues wasn’t logical, so instead of one selling off, the other was bid. It didn’t last long, as Thursday, everything went back to where it started.
Sure you could buy these for a bounce, but as I’ve noted for a long time, the lows in rates are behind us.
The curve continues to frustrate the Fed. Taking the 10 year as a representative (although moves along the curve have not been equal as it’s gotten ever-steeper), we see yields continue higher and blow through QEII.
The market is already anticipating the political dilemma faced by the Fed: announce QEIII or not. It’s political because I definitely can’t call it economic. As the largest holder of treasury securities in the world, the Fed is facing massive losses as the yields go higher, AND on top of it, they don’t get the benefit they wanted from lower rates. It’s the worst of all worlds for them. I’ve been hearing about people trying to play the bounce in treasuries, and it will come, but the fundamentals are finally becoming reality – rates are too low and all metrics based on the risk-free rate need to be re-priced.
