Bond Traders Should Prepare for Yield Curve to Zero Out in 2018 (Really?)

(Bloomberg) — Just how much further can the relentless flattening of the U.S. yield curve go? All the way to zero, according to T. Rowe Price Group.

The asset manager, which oversees about $948 billion, is the latest to weigh in on the trend that’s pushed Treasury curves to the flattest levels in a decade. The Federal Reserve has raised interest rates twice this year and is set for a third hike in December, leaving two-year notes at the highest yields since 2008. Meanwhile, demand from overseas investors, insurers and pension funds has kept 10-year yields near their 2017 average.

“The peak yield on the 10-year Treasury should roughly approximate where the final level of fed funds settles out, so that to us implies a flat yield curve if we assume the Fed will do two or three hikes in 2018,” Mark Vaselkiv, chief investment officer of fixed income at T. Rowe Price, said at a press briefing. In his eyes, the Fed will likely stay the course, and the difference between short- and long-term debt could reach zero as soon as the second half of next year. 

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Expectations are beginning to build for the Fed to step up its pace of rate hikes as inflation shows signs of stabilizing and with the lowest unemployment rate since 2000. Economists at Goldman Sachs Group Inc. and JPMorgan Chase & Co.are among those forecasting that the Federal Open Market Committee next year will likely tighten four times, rather than the three implied in policy makers’ projections.

If the committee does what Goldman and JPMorgan project, on top of a December move, the midpoint of the fed funds target rate would be 2.375 percent. That’s higher than the current 10-year Treasury yield of 2.35 percent. In other words, if the Fed can’t move the long end, officials will bring about a zeroing out of the yield curve.

“Once you get fed funds above 2 percent, you’re starting to get closer to the zone where you can talk about a flat yield curve,” said Steve Bartolini, a fixed-income portfolio manager at T. Rowe.

Fed’s Resolve

Some bank strategists aren’t so sure the Fed would willingly allow that to happen. Bank of America Corp. strategists say the flattening trend will prevent the Fed from raising rates as fast as officials may want. 

The central bank wouldn’t risk “consciously putting short-term rates above five-year term rates,” Bank of America strategists led by Shyam Rajan said this week in a note. They’ve never allowed that to happen aside from a brief period in its previous tightening cycle, they wrote.

Lacy Hunt, chief economist at Hoisington Investment Management, said last month he sees the yield curve inverting by the end of next year as long as the Fed keeps shrinking its balance sheet. John Herrmann at MUFG Securities Americas wrote in a note this week that he’s targeting 2020 for the spread to hit zero.

The timing matters because an inverted yield curve has proven a reliable indicator of an impending recession. When the spread between short- and long-term debt shrinks, it tends to hurt bank earnings and the real economy.

The yield curve from two- to 10-year Treasuries is about 64 basis points, near the flattest since November 2007. The last time the spread was at that level and still getting narrower was April 2005, about two-and-a-half years before the recession began. It remained close to zero for about 18 months.

‘‘Within a 12-month horizon, it makes total sense that the curve typically flattens when the Fed hikes,’’ said Alan Levenson, T. Rowe’s chief U.S. economist.

Let’s see how many rate hikes there will be. According to WIRP, the only above 50% implied probability in the 1.5-1.75% range is for the March and May FOMC meetings of 2018.

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Unless the 10 year Treasury yield falls by 80 basis points as the short-term rates rise, the yield curve will not likely invert.

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Unless, of course, we rapidly approach a recession.

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ECB’s Loose Monetary Policy Has Created Asset Bubbles, But Little Inflation (Hasn’t Helped Deutsche Bank Much Either)

(Bloomberg) — The European Central Bank’s unprecedented monetary stimulus has done little so far for inflation. For asset prices, it’s a different story. A gauge measuring weighted price developments of property and financial assets of German households rose 8.7 percent in the third quarter compared to the previous year, the most since at least 2005.

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For a closer look at German existing home prices and the DAX (German Stock Market) compared to ECB stimulus, look no further. Yes, both German home prices and the DAX have skyrocketed with the ECB’s massive monetary stimulus.

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Deutsche Bank’s stock price has declined from over 90 Euros per share in May 2007 to 16 Euros today (after Cerberus (aka, “The Hound of Hades”) was revealed as DB’s top shareholder). All that monetary stimulus and DB is still under 20 Euros???

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And then there is the EU’s paltry core inflation rate at 1.1% YoY after all that monetary stimulus.

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Queue up Don Ho and his hit song “Tiny Bubbles.” 

Cheers!

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The Yellenburg Omen! Are Fed Rate Hikes Nailing The Stock Market?

Recently, the Hindenburg Omen has been flashing red, signifying a coming stock market correction. But the Omen has flashed several times since 2008 and nothing has happened.

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A closer look at the McClellan Oscillator.

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The VIX stock market volatility index is on the rise.

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But will another rate hike in December by Yellen and crew cause further declines in the stock market? It lends itself to a new term: Oryellian.

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Goin’ Down: UST 10Y-2Y Curve Flattens To 65 BPS As Real Weekly Wage Growth Declines To 0.4% Growth YoY

As Bruce Springsteen sang,  “We’re goin’ down!” At least the US Treasury curve contines to flatten and real weekly earnings growth YoY continues to decline.

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With declining real wage growth, many Americans will have to switch from Heineken to Pabst Blue Ribbon!

But enough of this dire economic news. How about we listen to one of The Boss’ more upbeat tunes, “Sherry Darling”?

Your Mamma’s yappin’ in the back seat
Tell her to push over and move them big feet
Every Monday morning I gotta drive her down to the unemployment agency
Well this morning I ain’t fighting tell her I give up
Tell her she wins if she’ll just shut up
But it’s the last time that she’s gonna be ridin’ with me.

Oh wait. That song is depressing too!!

 

Treasury’s Surprise Debt-Maturity Move Eases Sting of Fed Unwind (Treasury Will No Longer Seek Extending Debt Maturity)

Since Congress shows little interest in fiscal responsibility, one way Treasury can deal with the staggering fiscal deficits is to extend the maturity of US debt (aka, strectching out those debt payments).

(Bloomberg) — As the rest of Washington fixated on tax reform and a new Federal Reserve chair last week, the Treasury Department unveiled a borrowing strategy lacking fanfare but having potentially big implications for the bond market and the U.S. economy.

In a step that could limit upward pressure on long-term interest rates from bigger budget deficits and a reduced Fed balance sheet, the Treasury will break from a policy in place since 2009 and stop attempting to lengthen the maturity of the government’s debt.

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“The Treasury is trying to avoid making the mistake of throwing out long-maturity debt where there isn’t sufficient demand, which could really steepen the yield curve,” said Gene Tannuzzo, a money manager at Columbia Threadneedle Investments, which oversees $484 billion. It “seems to be making an effort to avoid a yield shock.”

That’s important for the health of the economy. Yields on longer-term Treasury debt serve as benchmarks for everyone from home buyers to corporate treasurers. A “steepening is where we could get into problems with the housing market,” Tannuzzo said.

It’s probably also welcome at the Fed, which has begun to slowly reduce its balance sheet by not rolling over some of the maturing Treasury and mortgage-backed securities in its portfolio. Fed policy makers have gone out of their way to make the unwind as painless as possible for the bond market — and the Treasury’s new approach will help in that regard.

The shift comes as a surprise. It wasn’t that long ago that Treasury Secretary Steven Mnuchin was talking about issuing an ultra-long bond with a maturity of more than 30 years. While Mnuchin signaled he was backing away from that idea in a Bloomberg interview late last month, Treasury officials went further in the department’s quarterly refunding announcement last week.

“We’re looking at kind of a stabilization from here” in the weighted average maturity (WAM) of Treasury debt, acting Assistant Secretary for Financial Markets Monique Rollins said at a press briefing in Washington on Nov. 1.

Rising Maturities
The average maturity of the $14 trillion-plus in marketable Treasury debt outstanding was at a near multi-decade high of more than 70 months on Sept. 30. That’s up from 49 months in December 2008 and is above the 60-month historical average dating back to 1980. It’s still, though, about a year less than the average of the Group of Seven industrial nations, according to data compiled by the International Monetary Fund.

The Treasury maintained its longer-term debt sales at $62 billion this quarter for the seventh straight time, opting to meet any increased financing needs from run-offs by the Fed through the sale of bills. The yield curve flattened in response as the attraction of holding longer-term Treasuries grew.

The department’s decision means that “at least initially, the Treasury is completely offsetting the impact of the Fed unwind” on long-term interest rates, said Seth Carpenter, chief U.S. economist at UBS Securities LLC in New York and a former Fed and Treasury wonk. 

The central bank began reducing its holdings of Treasury and mortgage-backed securities in October, initially limiting the monthly draw-down to $6 billion of the former and $4 billion of the latter. The caps will be gradually increased to an eventual $30 billion for Treasuries and $20 billion for housing debt. [In fact, the unwind is so slow that you can barely see it compared to the $4.456 trillion left to unwind].

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The alteration in the Treasury’s approach doesn’t mean the bond market will be spared from having to digest extra supply as the Fed unwind continues and budget deficits increase on the back of potential tax cuts.

Indeed, Treasury officials last week flagged the likelihood of stepped-up sales in future refundings. The department will “look at raising auction sizes,” Rollins said.

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With The Federal government on a path of uncontrolled acceleration in spending,

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Particularly with M2 growth outpacing real GDP growth YoY.

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But at least the US Treasury 10Y-2Y keeps declining putting less pressure of debt refunding (and helping the housing market with lower 10 year Treasury yields).

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But with skyrocketing Federal spending and widening budget deficits, “We’re gonna need a bigger boat.”

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Deutsche Bank Ramps Up Leveraged Loan Business In “Hail Mary Pass” For Revenues (More Risky Lending)

Deutsche Bank is still suffering from the global financial crisis where their stock price peaked at $125 and is now only $16.93, despite the staggering intervention from the European Central Bank (ECB).

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Deutche’s revenues have been faltering due to a decline in trading revenue. DB’s trading revenue was down 30% year-on-year to €1.512 billion versus €2.162 billion in Q2 2017.  Trading revenues in Q2 2017 fell 18% year-on-year to 1.666 billion euros versus 2.027 billion euros.

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Hence, Deutsche Bank is now throwing a “Hail Mary pass” and  hoping that leverage loan growth saves the day.  A leveraged loan is a commercial loan that is extended to companies or individuals that already have considerable amounts of debt. Lenders consider leveraged loans to carry a higher risk of default, and as a result, a leveraged loan is more costly to the borrower.

That’s the ticket. Bet on risky corporate loans as your HMP (Hail Mary Pass). Well, leverage loans had their best year in 2017.

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But DB’s rank in terms of leveraged loans is shrinking.

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DBs earning per share is the stuff of … the German Battleship Bismarck.

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Yes, global central bank policies have definitely encourage more risk taking.

Deutsche Bank? F*** that $hit. JP Morgan Chase!!!

Here is Boston College’s Doug Flutie making his memorable “Hail Mary” pass against Miami. The blueprint for DB’s leverage loan pass for increased earnings.

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T2: Italy’s New Record Target2 Imbalance (Capital Flight)

TARGET2 (or T2) is the real-time gross settlement (RTGS) system with payment transactions being settled one by one on a continuous basis in central bank money with immediate resolution.

Sounds simple? The problems is that massive imbalance have appeared between the suppliers of credit (like Germany) and the demanders of credit (like Greece and Italy). It is the direct result of an unsustainable balance of payment system. The imbalances represent both capital flight and debts that can never be paid back (like Italy).

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Italian banks are not popular with many Italians, particularly the populist Five-star Movement.

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Particularly with Italy having the lowest TARGET balance with the ECB (although Spain is no slouch either).

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Any wonder why the ECB is dead set on low rates and an expanding balance sheet in an effort to keep rates low?

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Here is a photo of the REAL T2 (Terminator): Mario Draghi.

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