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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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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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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Venezuelan State Electric Company’s Trustee Declares Default (CDS Skyrockets To Over 16,000!)

The news the Venezuela is actually defaulting on its electric company bonds is hardly a surprise. Yet 1 year credit default swaps on Venezuela and their energy company PDVSA skyrocketed!

(Bloomberg) — Venezuela’s state electricity company was declared in default by Wilmington Trust, the trustee for the company’s bonds.

Electricidad de Caracas owed investors $27.6 million in interest payments on the notes due in April of next year. Its 30-day grace period expired on Thursday.

The $650 million of bonds had fallen to an all-time low of 23 cents on the dollar, showing that investors perceived them as the riskiest notes maturing during the next year in the world’s riskiest nation. While a default by the state oil company Petroleos de Venezuela, and possibly even the sovereign, could lead creditors to try to lay claim to the crude producer’s assets, Elecar, which PDVSA bought a decade ago, has nothing for overseas investors to seize.

“The Issuer’s failure to pay the overdue interest on the Notes on or before
November 9, 2017 constitutes an Event of Default under Section 5.1(ii) of the Indenture,” Wilmington Trust wrote in the letter to bondholders.

Some traders had long suspected that the bond could be a candidate for selective default because it contains no cross default clauses with PDVSA or sovereign notes. While bondholders may try to establish an “alter-ego” argument, that would most certainly be a lengthy legal battle.

The reaction in the CDS market?

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Hey, at least Venezuelan oil prices are rising!

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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.

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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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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