View: View any further UST curve steepening opportunistically, like flatteners vs. 5yr
Resurgent equity markets continue to take centre stage with a raft of analysts’ papers regurgitating the likely benefits of more quantitative easing, cobbling this move together with evidence of economic green shoots (which higher equity markets supposedly tell us are there). That other favourite topic, what all this means for bond yields, is also back in the spotlight, centring on the fact that this uptrend in stocks will invariably trigger rotation out of safe haven bond markets into riskier assets, as evident during both previous instances of QE. But with the Fed committed to holding rates low until mid-2015 at the earliest now, with an additional bias for directing policy to flatten the curve via the twist, it’s difficult to see this juncture as a significant inflection point for core yields. Indeed, higher yields are one thing that would kill a recovery in a still debt heavy economy where dynamics are still ultimately deflationary. Rather it should exert shorter-term corrective pressures within the broader trading range, particularly at the longer-end of the curve, before yields edge lower once again.
Full report below…
View: OMT helpful, but not unexpected. Should temper Fed doves demands for easing
While the crux of what the ECB was working on was well flagged in advance of Thursday’s policy meeting thanks to the usual ‘official’ leaks there seems to have been enough doubters to trigger a very positive market response to the official unveiling of its new bond purchasing plan. It is perhaps partly down to timing; we didn’t actually expect such explicit detail until the German Constitutional Court had dealt with the ESM issue and the fact that there was not any immediate pressure to finalise a strategy thanks to effective verbal support over the summer was another reason to pursue things in the usual Eurozone timeframe, i.e slowly. Furthermore the hostility of the Bundesbank to debt monetisation, as they see it, was (and still is) problematic. It appears Draghi just accepted that this wasn’t something that could be resolved with Weidmann clearly the sole dissenter when the board came round to voting. Another factor might be worth mentioning is the proximity to the FOMC meeting from which the market also expects support, admittedly aimed at addressing growth rather than solvency/survival of the Euro. We’d normally have expected some buck passing to the more proactive Fed, although in this instance the opposite might be true, more on that later.
Full report below…
View: Fed expectations buoy stocks, better risk reward looks to be Gold
Reading through the Fed minutes is the boring part of those Wednesday evenings, far more entertaining is just how the market interprets what is often just subtle tweaks in the committee’s rhetoric, the August minutes being an excellent example of this. Headlines would lead us to believe that there has been a substantial shift in tone, inferring that the Fed has now primed the market for QE3 in September, snatching the comment that the Fed “will provide additional accommodation”. However, this overlooks the balance of the sentence which read “as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.” Together this is far from a definitive statement even if it sounds a little more accommodating than the minutes from the June meeting which itself is unsurprising given the data flow which completed the picture for (the softer) Q2.
Full report below…
View: Investors will reward measures for growth, see any Fed easing as DXY positive
Often the market makes demands on policy makers and often they are unwarranted, triggered by swings in short-term sentiment rather than changes in trend. However the monetary policy decisions we’ve seen over the past week or so seem to be somewhat different, highlighting a number of key issues that run deeper and are likely to have prolonged implications for markets and possibly mark the trigger point for the breakdown of some of the relationships that have driven markets since the onset of the financial crisis. More specifically we think we could be at that point where growth steps into the driving seat as investors focus more directly on debt sustainability. Central bank stimulus, or lack of it, should also be seen in this light. The impact of resultant interventions are also likely to differ to the inflationary effect we saw previously, be it equity prices or commodity moves.
Full report below…
View: Payrolls print is not an inflection point, open short 10-yr UST @ 2.05%
While most were absent Friday enjoying the Easter break those less fortunate were subject to a rather disappointing payrolls print with the headline missing the 200k consensus forecast by some 80k jobs and revisions were broadly flat (January -9k, February +15k). Hours worked also dropped back to 41.7 from 41.9 and earnings flat-lined, a further drag. The unemployment rate did drop to 8.2% from 8.3% but the participation rate was also a little weaker and therefore this improvement was not enough to offset the negative reaction the headline release brought.
Full report attached…
- ANALYSIS:US Mar Payrolls +120k, 8.2% Unemplymt-Only Fair News (forexlive.com)
View: Euro$ strip to continue to steepen, U2/U3 spread could double
While the shift in tone of the March FOMC statement may have been subtle the markets reaction has been fairly pronounced with yields shifting up across the curve. The adjustment is not too surprising, in fact it’s what we have been saying for many weeks, namely that the US economy is improving, led by the labour market, which the Fed is slowly starting to acknowledge. There was also some understated acceptance that there were fewer risks emanating from the external environment although these still posed ‘significant downside risks’, a tone that is overkill in our view. Of course the 2014 language remains and the programme to reinvest maturing paper into the longer-end of the curve continues, with just one dissenter in the form of Lacker.
Full report attached……
View: Fed’s stance a short-term headache for USD, impact on risk assets more prolonged
I started to write this note on Sunday which is a lesson as to why one should finish things at the time and not let them slide down the pile. At least with the FOMC now out of the way we can add some additional colour on how the DXY is trading and the implications this should have for markets overall both in the near-term and in the coming months. We identified the technical reversal signal seen in the dollar index in our weekly strategy, last weeks close leaving a nice bearish engulfing pattern on the chart which not only spanned the previous week’s trading but the one prior to that, adding some more force to this set up. Following the Fed last night we can add some further insight to this view and frame it more effectively in a macro context.
Full report attached below…..
- Weak $, many say risk on, I say self defense (ritholtz.com)
- Previewing Today’s Economic Events And FOMC Announcement (zerohedge.com)
View: DXY reaction to FOMC reinforces dollar bull credentials, S&P aiming for new lows
One of the downsides of trying to prep the market up for future policy decisions is that it limits the scope for a positive surprise. This has been happening throughout this cycle (although was also a regular feature during Greenspan’s incumbency), most noticeably ahead of QE2 and now it’s happening with the ‘twist’. Extending the duration of the Fed’s Treasury holdings by rolling down the strip was widely expected by the market, the only surprise in the outcome was that it appears the Fed wants to anchor rates right across the curve, extending buying right out to the 30-year rather than focus just on the 7-10-year sector (where most corporate bond issuance occurs) as most expected. So this was clearly the ‘surprise’ as reflected by the shift on the govvie strip (10/30’s spread fell 13bps vs. a 8bps move in the 5/10’s). There were also steps designed to ease pressure on the housing market, with early repayments from the Fed’s MBS portfolio set to be recycled into Freddie/Fannie paper, aiming to increase availability of mortgage refinancing. We suspect the effect will be rather muted, after all one of the principle obstacles that households have had when looking to refinance has been lack of equity or in many instances negative equity which is unlikely to change. The policy is instead likely to benefit those with sturdier balance sheets which are also probably the same people who would use such a windfall sensibly even if Bernanke really wants them to gear up and spend to kick the recession down the road a bit.
Looking at the potential implications our view is really unchanged from what we wrote on Monday, namely we think the curve had already priced in the bulk of the twist (at least 5-10’s) and that being short stocks and long the dollar has much more upside. Indeed, the immediate reaction in stocks was even more forceful than we expected and should extend from here. This really reflects the feeling that there is a widening void between Bernanke’s idea of what monetary policy can achieve and reality (The Chairman’s God complex is maybe one unkind way of describing it). Of course there are policy tools still available, underlined by Obama’s poorly received jobs package, but most have already been used and abused meaning the effectiveness of new measures (including the twist) will be muted. Weak data will reinforce the recession view which is still underestimated by the mainstream despite what has been going on.
Our expectation is we’ll see new lows in equities; a move through 1,100 would reaffirm our mid-term goal of 900 target for the S&P500, only a move back above 1,230/50 would suggest we’re wrong.
Equally the fortunes of the dollar index continue to improve, with the chart remaining extremely bullish. The break we identified on the 9th September (http://wp.me/p1G1Fr-cj) has performed as expected, retracing in the first instance back to the 200-DMA around 76.00 before accelerating again to make new multi-week highs at 78.30+ and confirming those 80+ targets in the process. The immediate objective remains a move through 80.682 and back towards the Dec/Jan top at 81.30/50. Ahead of there are some interim resistance levels, 78.70/90 area first and then the psychological 80.00 mark, but as we’ve previously noted they should be straightforward to clear if (as) risk aversion intensifies. Based on our 900 S&P view aiming for the dollar index to break up towards 82.59/83.55 would be fitting and even those 2008/2010 highs above 88.70 are not that fanciful. We’d tie that in with what we wrote here on brent too: http://wp.me/p1G1Fr-cr.
- Why Goldman Is Surprised By The Market’s Reaction To The Twist, And What’s Next For The Fed? (zerohedge.com)
- A few more analyst reactions to the FOMC statement (ftalphaville.ft.com)
View: Curve priced for ‘Twist’, EUR should weaken, Stocks have downside
Markets have a lot to digest this week, not only should we see some fruits/fallout of EU/IMF negotiations with Greece over its next bailout payment but Bernanke et al. are also convening for the extended September FOMC. Both could be pivotal, the first potentially delaying what we have long felt is an inevitable Greek default while on the other side of the pond there should be an answer to what type of stimulus the Fed is planning. Lots to get excited about then, though probably not enough to really end current uncertainty in any decisive way. Perhaps one way to describe this period is the eye of the storm; everyone gets a bit of a breather before it all kicks off again.
On the European side despite tough rhetoric from politicians none of the key issues really look to have been resolved. For example the German’s are still prescribing austerity to the debt stricken club Med and dismissing the viability of euro bonds, which would effectively place core Europe’s balance sheet on the hook for peripheral liabilities. At the same time Merkel continues to be vocal in stating Greece won’t be allowed to default. We accept that the euro has always been a political and not an economic project at its heart but find it difficult to believe that the EC, regional governments and central banks really buy into the idea that the current timeline of reform is adequate to prevent the crisis snowballing out of control. We’d side with the view that it already has, and that current press conference unity is merely part of this slow motion car crash in action.
This leaves plenty of opportunities in the market. Although the ECB’s expanded bond buying programme ended the game of playing the more exciting bond spread wideners volatility has migrated elsewhere with France still vulnerable not to mention the banks and regions equity markets. Finally the euro itself looks prepped to absorb more pressure. We maintain our view that selling the EUR is still a low beta way of participating in the crisis, the market quickly tagged our initially 1.35 target after the ECB meeting but still lower levels look reachable in the coming weeks (sub 1.30). The debt crisis is only one part of this equation. The dollar (DXY) also looks to have turned up, which is a natural EUR negative while rate differentials which had underpinned earlier strength are also now more of a headwind as traders look to price in an unwinding if earlier ECB tightening.
Moving on to the Fed meeting its difficult to see where the surprise is going to come from and following the market reaction to President Obama’s jobs plan even something aggressive may not please investors. The core scenario seems to be for the Central Bank to shy away from outright QE3 (many already of the view that QE2 was an abject failure) and instead delivering a derivative of the early 1960’s ‘operation twist’ whereby the bank would aim to extend the duration of its vast haul of UST’s, flattening the curve and according to Bernanke’s text book cheapen the cost of long-term credit. Unfortunately the market has priced this in already with the yield curve flattening by some margin over the summer (5yr-10yr spread tightened by approx. 35bps). This was of course helped by the Fed’s pledge to keep rates on hold through to mid-2013 but the real driver has been the dire economic data which seems to have encouraged most to just give up thinking about a first rate hike.
With the curve already looking like the Fed probably wants it too it’s difficult to think what would actually be achieved by stepping in to lower long-end rates. This also overlooks the fact that the transmission mechanism is broken anyway, underlined by the inability of house owners to re-mortgage due to falling equity levels and a general lack of demand for credit, highlighted both by companies cash piles and the vast amount of dollars lodged by banks (unwilling or unable to lend) at the Fed. And more importantly no one really believes operation twist worked in the first place, the economy was already turning up at the time and unlike now that recession was of the more traditional type (i.e not a credit bubble). With this in mind it looks prudent to book profits on any curve flatteners, or at least cut back on the short legs.
We’d also be inclined to be short equities based on the view that the Fed’s policy options are far narrower than Bernanke seems to think they are and thus so is the scope for a positive market reaction, or if not immediately disappointing enough for a sustained positive reaction. Technically there is still room for a push into the 1,230/50 area in the e-mini contract but the market should struggle to break out of the top of that band. We’d only reassess this view if we see a close above 1,259.
- John Mauldin On Operation Twist, And The Fed’s Latest Huge Bailout Of European Banks (articles.businessinsider.com)
- Twist and Shout? (ritholtz.com)
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