Digital Gold? Bitcoin Rebounds From Correction While US Dollar Weakens

Yes, the US Dollar is FIAT currency (not backed by a precious commodity like gold, silver or even iron pyrite).

Bitcoin, the largest crypto-currency, has more than recoverd from the “correction” last week. It has resumed its all-time high price This is happening as the US Dollar weakens.

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Here is Bitcoin relative to Gold. Check out their relative performance since September.

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Is it digital gold? Well, Bitcoin is an alternative to FIAT currency like the US greenback, the Euro and the Yen. The massive expansion of Central Bank balance sheets has certainly concerned investors.

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An example of an 1899 $5 silver certificate.

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US Industrial Production Rises To 2.88% YoY, Capacity Utilization Rises To 77% (M2 Velocity Still Dead)

Call it rebound from the horrible hurricanes in Texas, Florida and even Georgia. The October Industrial Production numbers are out and IP YoY climbed to 2.88%.

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Capacity utilization rose to 77%, although it is still below the Fed target (not spoken of recently) of 80%. The last time was 80% Capacity Utilization was during the housing bubble.

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The problem is that M2 Money Velocity (GDP/Money Stock) remains at an all-time low.  Although we are seeing a stabilization in labor force participation.

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The US Federal Reserve is printing currency (M2) at a rate almost twice as fast as Industrial Production growth.

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Here is a photo of a young Janet Yellen contemplating print more and more money.`

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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 U.S. Yield Curve Is Flattening and Here’s Why It Matters (Will The Fed Cause Yield Curve Inversion?)

Bloomberg has an interesting article this morning of the US Treasury yield curve.

(Bloomberg) — If you haven’t been paying attention to the persistent flattening of the U.S. yield curve, you’re way behind it.

 Peter Cecchini, chief market strategist at Cantor Fitzgerald, calls it “the most important thing to have a clear idea about now.” Billionaire fund manager Bill Gross says we’re rapidly approaching a point at which the trend will induce an economic slowdown. Others claim it’s only natural, with the Federal Reserve raising short-term interest rates in the face of stubbornly low inflation. 
To put it simply, the Treasury yield curve measures the spread between short- and long-term debt issued by the U.S. government. It’s the extra compensation that investors demand to lock away their money for an extended period.
 
No matter which theory of flattening you subscribe to, the world’s biggest bond market is sending a signal that traders can’t ignore. The longer the trend continues, the more likely its effects could spread to bank earnings and the real economy, while at the same time it would limit the Fed’s ability to respond when these risks emerge.
To get a sense of just how dramatic this trend has been, here’s a look at a handful of curve measures now versus the start of 2017. In trading Monday, they were all close to the flattest levels in a decade.
  • From two years to 10 years: 72 basis points, down from 125
  • From two years to 30 years: 119 basis points, down from 187
  • From five years to 10 years: 33 basis points, down from 52
  • From five years to 30 years: 80 basis points, down from 114

Everyone has their favorite theory for why this is happening and what it means for the economy and the markets, and all of them likely play a part so here’s a breakdown of each one:

It’s the Fed’s Fault

The simplest reason for the flattening comes from looking separately at what’s going on with short rates, the most sensitive to Fed policy expectations, and longer-term yields, which take their cues from the outlook for inflation and economic growth.

After years of balking at tightening monetary policy for fear of disrupting markets, Fed officials finally stuck to their plan in 2017, earning bond traders’ trust in the process. The two-year Treasury yield is at the highest level since 2008 as investors prepare for a rate hike in December, and begin to build up expectations for further increases next year.

With short-end yields climbing, the curve historically tends to flatten as longer-term rates rise more slowly. But since the start of 2017, 10-year and 30-year yields have actually declined. And the culprit behind that appears to be stubbornly muted inflation.

Even with U.S. jobs growth humming along and unemployment at the lowest level since 2000, the Fed’s preferred gauge of price growth was running at just 1.6 percent in September. It fleetingly rose above the central bank’s 2 percent target at the start of the year, but has since struggled.

This all raises the specter of what some call a potential “policy mistake” from the Fed.

That narrative “has ruffled a few feathers,” BMO Capital Markets strategists Ian Lyngen and Aaron Kohli wrote in a note last week. “Growth is moving at a solid clip and the labor market is ostensibly at full employment — so why aren’t we in an environment with a steeper curve and higher yields?”

Their conclusion is the Fed has built up a reputation as an inflation fighter. That means going forward, traders should expect a lower yield range for 10- and 30-year Treasuries than they might have otherwise.

Supply and Demand

Another factor pinning down longer-term yields: forced buyers, both in the U.S. and elsewhere.

Asset-liability managers like insurance companies and pension funds are always seeking duration, and 30-year Treasuries are among the best ways to get it. Combine that appetite with increased demand from passive mutual fund giants like Vanguard and BlackRock, and you’ve got a recipe for a sustained bid on the long end of the Treasury curve.

If that wasn’t enough, Treasury recently announced that it wants to focus increased issuance in bills and shorter-dated coupon maturities, like two- and five-year notes. That creates relative scarcity at the long end of the curve and a premium at the short end to absorb the extra supply.

Some see it as no coincidence that on the day of the Treasury’s refunding announcement, the yield curve from five to 30 years flattened by the most in two weeks.

“For all the discussions about the yield curve these days, one factor that is really driving positioning in the Treasury market is the expectation of future Treasury issuance,” Ben Emons, head of credit portfolio management at Intellectus Partners, wrote in a note.

Draghi’s Driving

To Cantor Fitzgerald’s Cecchini, those looking only within the U.S. to understand the yield curve are missing the bigger picture.

The global bond market is still awash in central bank purchases, he said, most notably from the Bank of Japan and the European Central Bank. And over the course of the past few years, the yield spread between 10-year Treasuries and German bunds has grown wider, creating an opportunity for overseas investors to add U.S. debt.

The ECB, led by Mario Draghi, announced last month that it plans to keep buying bonds through September 2018, albeit at half the current pace from January. It’ll also continue to reinvest proceeds from maturing debt for an extended period. The bank’s main refinancing rate has been pinned at zero since early 2016, sending yields negative on trillions of dollars of debt from Germany to Italy and the Netherlands.

“As long as the ECB continues to buy the long end of the curve, they’re in control of developed market long-ends, including Treasuries,” Cecchini said in a telephone interview. “It’s very hard to draw from history in this environment. The lessons from history only make sense if facts and circumstances are close to what they were.”

History’s Guide

If one does take history at face value though, the $14.3 trillion Treasuries market is sending a warning about the economic outlook. Yield curves are the flattest in a decade, and it’s no coincidence that about 10 years ago marked the start of an 18-month recession. The yield curve has proven a reliable indicator of impending economic slumps when it inverts, and short rates exceed longer-term yields.

Lacy Hunt, chief economist at Hoisington Investment Management, sees a good chance of an inverted curve as soon as a year from now if the Fed continues to shrink its balance sheet. He says the tightening policy will likely choke off credit growth and curb excess reserves, slowing the economy and suppressing inflation.

Banks typically prefer a steeper yield curve because they generate income from the spread between long-dated loans and deposits that are priced on shorter-term rates. Without the gap, their performance suffers.

It’s already starting to show this year: U.S. financial stocks have trailed the S&P 500 as the yield curve has flattened. While banks’ lending margins have increased slightly from their 2015 lows, they remain below the average of the past 30 years, according to the Fed.

A potential increase in the cost of credit is at the heart of what worries Janus Henderson Group’s Gross.

“In a highly levered economy with a lot of debt, and that typifies the U.S., we don’t have to go flat, perhaps another 20 to 30 basis points of tightening would be enough in order to induce certainly a slowdown in the economy,” he said on Nov. 3.

The flattening trend may be a warning sign, or — to borrow one of the phrases Gross helped to popularize — it might just be “the new normal.” Either way, it’s a trend that’s poised to dominate bond traders’ decisions in the months to come.

I agree with Lacy Underall Hunt. Further rate increases and a Fed balance sheet unwind could lead to an inversion of the US Treasury yield curve. Inversion is when the 10 year T-note yield is below the 2 year T-Note yield. Inverted Treasury curves occur several months before entering into a recession.

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Here is the US Treasury Actives curve today compared with December 1, 2006 when the yield curve was last inverted, mostly in the short-end of the curve.

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The Thrill Is Gone! Treasury Curve (10Y-2Y) Remains Under 70 BPS As 10Y Term Premium Remains Negative

BB King sang it best with “The Thrill Is Gone.”  

Now that hopes for tax reform are gone (probably for a year), the US Treasury 10Y-2Y curve slope remains below 80 basis points. Far below where it was when Trump was elected President when optimism of something new (like tax reform) in Washington DC breathed life into the bond market.

The 10 year Term Premium also remains negative.

Yup, the thrill is gone.

Short-Volatility Funds Are Being Flooded With Cash (VIX Evaporating)

The SPX volatility index VIX is near an all-time low as The Federal Reserve attempts to raise their target rate and unwind their $4.46 trillion balance sheet. The question remains as to how further rate increases and balance sheet unwinding will impact equity volatility.

(Bloomberg) Exchange-trade products betting that volatility will sink lower have never been more popular.

Even as the CBOE Volatility Index plunges to its lowest on record and U.S. stocks march to fresh highs, investors have continued to give the short-volatility trade their vote of confidence this year. With $2.4 billion in assets, short volatility exchange-traded funds are backed by the most cash on record, according to data compiled by Bloomberg.

The funds’ meteoric rise is to some degree a bet that the U.S. stock market will keep rising, since the VIX and S&P 500 move in opposite directions about 80 percent of the time. With the S&P 500 up 16 percent and at its highest on record, the $1.1 billion VelocityShare Daily Inverse VIX ETN has surged 141 percent, heading toward its best yearly performance in five years.

For now, the volatility bears have the momentum. Inverse VIX funds have nearly tripled in size this year alone. The amount of assets tracking short-volatility products rose above that of their long-volatility counterparts for the first time in two years in the third quarter.


In fact, regardless of direction, volatility itself is an in-demand asset class. The popularity of volatility products far outweighs that of other prominent corners in the U.S.-listed ETF market. With $4.6 billion in assets, they are larger than funds tracking any single European country, other than Germany. They also have more assets than those tracking all frontier markets and all ESG (environmental, social and governance) strategies combined.

However, despite the growth and the stellar returns, it’s unlikely most short-volatility investors have stuck around to see all of their triple-digit profit. Because of the funds’ structure, holding periods tend to be as short as a few days or even just a few hours.

With Central Banks practicing volatility suppression (monetary easing), the equity volatility index is near all-time lows (under 10)

Here is the VIX volatility surface.

For the TYVIX (10 year Treasury note volatility), it remains near the all-time low.