Most economists surveyed by The Wall Street Journal expected Federal Reserve officials to begin winding down their $4.5 trillion portfolio of bonds and other assets this year.
Nearly 70% of business and academic economists polled in recent days expected the Fed will begin allowing the portfolio, also called the balance sheet, to shrink by allowing securities to mature without reinvesting the proceeds at some point in 2017. Of the economists who expected a shift in the Fed’s balance sheet strategy this year, the majority predicted the process would begin in December.
In last month’s survey, just 22.2% of economists expected the Fed to begin shrinking its portfolio this year. Fewer than a quarter of economists in the latest poll expected the Fed to wait until the first quarter of next year to start to whittle down its portfolio, compared to a third last month.
In recent weeks, Fed officials have said they are discussing plans to start gradually reducing the large bondholdings the central
Stan Druckenmiller recently elucidated: “Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity… most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets.”
Even with the bond market’s muted response to the Federal Reserve’s plan to begin winding down its almost $4.3 trillion portfolio of mortgage and Treasury securities, there are plenty of reasons why the calm probably won’t last.
Out of style for almost a decade, volatility may be on its way back if you take a closer look at the mechanics of the Treasury and mortgage markets. Despite the Fed’s mantra of seeking to carry out its policy shift in a “gradual and predictable manner,” analysts say the effects of ending the reinvestment of the proceeds from maturing securities will still be felt.
This is the “most highly anticipated event in central-bank history,” said Walter Schmidt, senior vice p
Since the election the financial markets have been trying to price in “Trumpflation.” This is the idea that the combination of infrastructure spending, tax cuts, rising deficits, immigration curbs and protectionist policies could reverse the disinflationary trends we have witnessed over the past few decades and more dramatically since the financial crisis. The selloff in the bond market amid surging interest rates might be the single most important piece of evidence in this regard.
Over the summer I noted we were likely witnessing the final blow-off stage of the bond bull market (see this and this). Since then the long bond has fallen nearly 15% leading many pundits to conclude it has already begun pricing in the prospect of Trumpflation. However, if you look at the data, it appears it’s just not pricing in as much deflation anymore. In fact, by some measures the yield 10-year treasury bond would still need to double in order to finish the job.
This week’s EVA brings the second edition of our new Random Thoughts format. The goal with this approach is to cover several key, but often unrelated, topics in a quick overview fashion.
In this issue, we are looking at, once again, the powerful financial force known as credit spreads. Fortunately, they are not indicating financial stress at this time. We are also examining the supposed truism that this is one of the most detested bull markets of all time. Then, we wrap up with a look at the Fed’s and Wall Street’s forecasting track record (hint: both make a dart-board look good!).
As always, your feedback is welcomed and appreciated.
When the spread isn’t the thing. One of the themes this newsletter has emphasized most heavily this year has been the importance of the spread—or difference—between government and corporate bond yields. As we have repeatedly cited, when that gap is widening in a pronounced way bad things tend to happen both to the economy and financial
Tranquility that has enveloped global markets for more than two months was upended as central banks start to question the benefits of further monetary easing, sending government debt, stocks and emerging-market assets to the biggest declines since June. The dollar jumped.
The S&P 500 Index, global equities and emerging-market assets tumbled at least 2 percent in the biggest rout since Britain voted to secede from the European Union. The yield on the 10-year Treasury note jumped to the highest since June and the greenback almost erased a weekly slide as a Federal Reserve official warned waiting too long to raise rates threatened to overheat the economy. German 10-year yields rose above zero for the first time since July after the European Central Bank downplayed the need for more stimulus.
Fed Bank of Boston President Eric Rosengren’s comments moved him firmly into the hawkish camp, sending the odds for a rate hike this year above 60 percent. He spoke a day after ECB President Mario D
We’ve been bulls on 30-year Treasury bonds since 1981 when we stated, “We’re entering the bond rally of a lifetime.” It’s still under way, in our opinion. Their yields back then were 15.2%, but our forecast called for huge declines in inflation and, with it, a gigantic fall in bond yields to our then-target of 3%.
The Cause of Inflation
We’ve argued that the root of inflation is excess demand, and historically it’s caused by huge government spending on top of a fully-employed economy. That happens during wars, and so inflation and wars always go together, going back to the French and Indian War, the Revolutionary War, the War of 1812, the Mexican War of 1846, the Civil War, the Spanish American War of 1898, World Wars I and II and the Korean War. In the late 1960s and 1970s, huge government spending, and the associated double-digit inflation (Chart 1), resulted from the Vietnam War on top's LBJ’s War on Poverty.
By the late 1970s, however, the frustrations over military stalemat
As German bond yields breach unthinkable levels, BK was struck by a chart from Deutsche Bank – it is a chart of German yields since 1807.
Take a moment to reflect on this chart – in over 200 years, German bond yields have never been lower. This period of time includes such notable and notorious events as:
- US Civil War
- The British Railway Mania Bubble
- The Panic of 1873 and The Long Global Depression
- Industrial Revolution
- Thomas Edison’s Invention of Electric Light
- Invention of the Automobile
- Stock Market Panic of 1907
- World War I
- 1929 Stock Market Crash
- The Depression of the 1930’s
- World War II
- Japan’s Real Estate Bubble and Crash
- The Dot-Com Bubble
- 1987 US Stock Market Crash
- 1997 Asian Currency Crisis
- 1998 Russian Default and Long Term Capital Management Bailout
- The US Housing Bubble and 2008 Great Financial Crisis
During each of these spectacular and horrific events, German bond yields managed to stay in a range of roughly 4-10% with the occasional spike up or down. However du
The chart above tracks the broad stock market against the spread of lowest-rated investment-grade corporate bond yields. They normally track each other very closely as they both reflect broad investor risk appetites.
When investors are hungry for risk stock prices move higher and corporate spreads get narrower. When risk aversion takes over, however, stock prices fall and spreads widen.
Another reason they closely track each other is corporations’ ability to access credit is very closely tied to the overall demand for equities. When it’s very cheap for companies to borrow, it’s very easy for them to fund stock buybacks and acquisitions of other companies.
Certainly, these two factors have been very important to the bull market of the past six years or so. Ray Dalio recently said he estimates that buybacks and M&A have roughly amounted to 70% of the total demand for equities.
As spreads widen, it becomes more expensive for companies to borrow and thus more difficult to fund stock bu
When first-generation ETFs launched in the 1990s—such as the SPDR S&P 500 Trust (SPY) and the PowerShares QQQ Trust Series 1 (QQQ)—lead this year's outflows, that is a sign that institutional investors are scared. These first-to-market ETFs have the ample liquidity that big institutions tend to love, with many trading more than $500 million in volume a day. While newer ETFs that may do the same thing or more for cheaper have been launched in the intervening years, early ETFs still tend to curry favor with large investors that value liquidity. These investors tend to be more tactical, and thus outflows from these ETF stalwarts are a bearish sign.
U.S. Treasuries of all maturities are raking in cash
According to Bloomberg, when U.S. Treasury ETFs are the brightest bright spot, that's not good. They have taken in more than $3 billion in net new cash (while junk bond ETFs have seen $2 billion in outflows). What is especially bearish is that the inflows int
Omega Advisors Founder, CEO and Chairman Leon Cooperman discusses his outlook for the markets. Of course he was short on time so we have no idea if he's short bonds but that would be my guess. Hat tip Sadiq for this interview.
Over the years, it's become essential (to me) to understand monetary policy and money flows across the globe. With all of the recent 'pining' over whether the Fed will begin to raise rates this year, I felt this piece from Financial Times gave a great representation of who is worried over what, and why. I truly recommend you give if it a read. There's also more discussed on this article. Enjoy.
Why is the Fed considering raising interest rates now?
America has seen its longest private sector hiring spurt on record, and unemployment has halved since its peak. The Fed thinks the hot jobs market could spur a pickup in inflation and wages. Given it is tasked with keeping inflation low, it is considering raising the cost of borrowing to keep the economy on an even keel.
Why have rates in the US been held so low for so long?
The US was hit by the crash in its housing market and banking sector between 2007-09. The Fed felt it needed to pull out all of the stops t
I've long wondered about MLP's as interest rates begin to creep higher and crude oil, obviously, remains low. After all, they're supposedly not tied to the price of crude oil, right? Certainly 2015 has not been their "year" as the 10 year fluctuated, leaving me even more cautious but did this translate into a buying opportunity? Consider this interesting piece here by TheReformedBroker
I’m sitting at the Strip House with a wholesaler from a large mutual fund / UIT sponsor two years ago. He’s a good guy but he’s there to sell. I’m there to eat thick-cut slab bacon and shrimp cocktail. I told him in advance that I’m not a buyer, but I have an open mind.
He’s showing me an SMA (separately managed account) strategy whereby his firm’s team of experts picks the best MLPs. The pitch is that MLPs are a way to participate in the growth of energy infrastructure but without having exposure to the volatility of oil prices. MLPs, he explains, are uncorrelated to the price of oil because they a
With the new Intermediate-Term Trend Model (ITTM) BUY signal on TLT and the break out for second time above the March low, I decided it was definitely time to abort the bearish Adam and Eve double-top pattern that I have been watching in earnest. Instead, I'm now seeing a rounded bottom; also known as a saucer bottom, it is a reversal chart pattern representing a long period of consolidation that turns from a bearish bias to a bullish bias (ChartSchool article on Rounded Bottoms located here). The Price Momentum Oscillator (PMO) has also been making a case to move bullish on TLT, it has continued to rise and is now in positive territory. The SCTR value is rising again and the On Balance Volume (OBV) shows that volume is behind this move (thumbnail shows that best). The recent Long-Term Trend Model (LTTM) SELL signal suggested the double-top would execute, but now it appears that signal is in jeopardy as the 50-EMA reaches out to crossover the 200-EMA.
You can see the major double-top
The Great Bond Bull Market started in the fourth quarter of 1981, after the 10-yr Treasury yield hit an all-time of almost 16%, and about a year after the year-over-year change in the CPI hit a post-Depression high of almost 15%. It most likely ended 31 years later, in July 2012, when the 10-yr yield fell to 1.4% at the height of the PIIGS crisis, and three years after the CPI hit a post-Depression low of -2.1%.
As the chart above shows, inflation is arguably the principal driver of yields.
By the way, the first bond bear market of the current century started in 1950 and also lasted 31 years. The bear market that is now beginning to unfold will undoubtedly also be many years in the making, and we can only guess at how much yields will eventually rise. I certainly hope they never get as high as they did in the early 1980s, and I don't expec
It seems not all money managers out there have the warm-n-fuzzies for equities in 2015. Especially considering the almost two year sell-off in commodities, finally joined by crude oil in dramatic, face ripping action. In fact, one feels that the rise in interest rates in 2015 will do what is not expected; flatten the yield curve.
If the curve flattens gradually, most traders said it probably means investors believe the Fed will keep future inflation in check with gradual rate hikes. Bond traders hate inflation because it erodes the value of their fixed-income investment.
But if the curve-flattening trend speeds up?
"It's time to trade out of investments whose success depends on a strong economy... for both stocks and corporate bonds," said Anthony Crescenzi, chief bond market strategist at Miller, Tabak & Co., an institutional brokerage.
This means reducing exposure to sectors like retail, transportation and automobiles and moving into defensive picks like health care and consume
IT HAS been a consistent theme of this blog in recent months that global growth has been slowing, a fact some investors may have missed in the good news about American GDP. The latest confirmation came from the World Trade Organisation, which cut its forecast for trade growth this year from 4.6% to 3.1% and for 2015 from 5.3% to 4%. The WTO doesn't forecast economic growth directly; it takes its lead from other international organisations (Rabo Bank reckons the IMF is set to reduce its growth forecast in the next few weeks).
What is interesting from the WTO announcement is that even the revised forecast relies on a bit of optimism. Actual trade growth in the first half of the year was just 1.8%; the organisation is relying on a rebound in the second half. The first half regional numbers were revealing; Asia increased its exports by 4.2% but its imports by just 2.1%. In effect, it has been gaining market share. North America was more balanced, increasing exports by 3.3% and imports by
I'd be trading this bad boy to the long side. In this seven year weekly chart, not only has it broken my three trend line rule, there was positive MACD convergence (as shorts began to massively cover) and the 200week SMA which was prior resistance, has now become support.
It certainly appears that the "low" in low rates was in in 2013.
I should also note that the monthly chart is deeply oversold. At some point, you simply run out of sellers.
I've long said that when in mortgage banking, we watched the 10yr. each week for direction of rates and we completely ignored the Fed raising or lowering rates. They were a laggard; the 10yr was already there.
Yep. If this were a stock, I'd be trading it long, buying at support or out of the short side completely. Maybe not expecting anything spectacular in terms of upside but ROC would indicate no heavy selling; short covering more than anything else.
I believe we've entered the phase in our bull market where "good news" is now bad new
Your hear the reassuring echos all of the time. "Don't worry! The market will always come back." But do they? What about dividend reinvesting and adjusted for inflation? Given the data, one can easily
Consider these two overlays — one with the nominal price, excluding dividends, and the other with the price adjusted for inflation based on the Consumer Price Index for Urban Consumers (which I usually just refer to as the CPI). The charts below have been updated through today's close.
The charts require little explanation. So far the 21st Century has not been especially kind to equity investors. Yes, markets usually do bounce back, but often in time frames that defy optimistic expectations.
The charts above are based on price only. But what about dividends? Would the inclusion of div
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