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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Bitcoin Drops >1,000 (A Hindenburg Omen Moment?)

The crypto-currency Bitcoin just plunged over 1,000!

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The NYA seems to be experiencing a Hindenburg Omen moment of its own.

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But the correction/plunge in Bitcoin is clearly larger than the NYA. Bitcoin has broken through the first band in the Bollinger Band study.

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And for the Elliot Wave, Bitcoin’s decline looks like a tsunami.

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Bitcoin even broke through the Ichimoku base.

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Let’s see what Monday brings.

MONDAY UPDATE! Bitcoin has actually bounced back somewhat.

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M2 Money Velocity Rises Above All-time Low In Q3 ’17 (While Stock Market Momentum Increases To Highest Since dot.com Bubble)

M2 Money Velocity (GDP/M2 Money Stock) actually rose in Q3 2017 to 1.4282.

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At least it rose above the all-time from Q2 of 1.428.

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As M2 Money growth continues to be >2x real GDP growth YoY.

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Yet momentum in the stock market is the greatest since the dot.com bubble.

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Well, Fed Chair Janet Yellen keeps telling us everything is groovy.

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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.

 

Fed & Yellen Leave Rates Unchanged At 1.25%, Effective Rate at 1.07% (Prob of Dec Hike Is 87.5%)

The November FOMC meeting is over and they left the Fed Funds Target Rate – upper bound untouched at 1.25%.

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The EFFECTIVE Fed Funds rate is only 1.07%.

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The implied probability of a DECEMBER rate hike is now 87.5%.

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Here is the statement where they add that “the balance sheet normalization program initiated in October 2017 is proceeding.”

Yes, if you use an electron microscope you may be able to detest the “normalization” of the balance sheet.

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Let’s see if Obama-appointee, historian/lawyer/DC insider Jerome Powell will resort to inhaling oxygen in the economy … again.

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US Treasury 10Y-2Y Slope Drops To Near 10 Year Lows (Ahead Of Fed FOMC Meeting)

It is doubtful that we will learn much from today’s Open Market Committee (FOMC). Hopefully we will get additional clarity on the Fed Balance Sheet unwind schedule (it was supposed to start in October and it is now November).

Ahead of the meeting, both the 10Y-2Y and 30Y-5Y Treasury slopes fell to near 10 year lows.

And the 10 year Treasury Note volatility index, TYVIX, remains near historical lows.

And just a reminder, core PCE prices YoY (“inflation”) is at 1.33%, well below the 2% Fed target rate for inflation.

Well, apparently Janet Yellen and The FOMC aren’t following the Taylor Rule (or ANY  rule that I can detect).

I am sure that Janet Yellen would like to lock up John Taylor (in gold) and throw away the key.