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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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So many great stories but in the end we're back to that yield curve thing ......

July 25, 2018

 

ref :-  "Fed Presidents Seek Powell Put to Prevent Inverted Yield Curve" , Bloomberg Markets

 

We could have jumped in a number of directions this morning, or maybe a round-up of the hot topics would have been the way forward. There's no shortage of them :

 

Turkey : Does the central bank's unexpected decision NOT to raise rates in spite of inflation running more than three times over target confirm that President Erdogan has indeed taken control of monetary policy ? The spike in bond yields and fall in the Lira suggests that investors think so, and that the President's truly bizarre theory that it's higher rates that encourage inflation will be put into practice. Not for the first time we are reminded of the popular misconception about King Canute, who went down in folklore as being so convinced of his divine regal status that he sat in front of the incoming tide and ordered it to retreat. The outcome was a pretty damp one for the old king, but the reality was that he was demonstrating to his fawning acolytes that he was a mere mortal with no such superpowers. We somehow doubt that President Erdogan is going down his chosen route just to demonstrate his own limitations.

 

Japan : It was speculation that the Bank of Japan was discussing some tweaking of their massive and ongoing stimulus package that sent yields in Japan and around the globe sharply higher on Monday. Things have since calmed down, and arguably people were reading quite a lot into not very much. Some people are convinced that until inflation gets somewhere near its 2% target, any such speculation must be premature. It's certainly a fair point. But it's also quite reasonable to assume that so keen are the BoJ to help out the struggling banking sector that they might well consider fiddling with the yield curve .... for example keeping the level of stimulus the same but weighting it further to the short end. And there's a reason why investors should be quite so twitchy about a possible change in BoJ policy ..... of the world's major central banks (US Fed , ECB and BoJ) , it is the last anchor to a world of massive central bank stimulus. The Fed is raising rates and reducing its balance sheet and the ECB will finish its QE bond-purchasing by year-end (if all goes smoothly). If the BoJ is even discussing the idea of shifting longer yields higher, that would be highly significant.

 

US / EU : President Trump meets EU officials led by Jean-Claude Juncker in Washington today to discuss tariffs and trade. Already the President has been stirring things up on Twitter by suggesting that they could scrap all tariffs and barriers and have a truly free market, but the EU would never go for that (they're a "foe", remember). It would be interesting to be a fly-on-the-wall at the meeting. We all know about Mr Trump, but Mr Juncker has no shortage of self-regard himself and has been described by Mr Trump in the past as "a brutal killer" ..... yes, really. We have no idea how the discussions will go, but can hazard a guess .....

 

And so we're back to the US yield curve, and the report from Bloomberg that some of the regional Fed presidents are nervous enough about the possibility of the curve inverting (short-term rates higher than long-term) to advise Chairman of the US Fed Jay Powell against his stated policy of further hikes in short-term rates, albeit at a gradual pace. The root of their anxiety is pretty straightforward : every recession over the last 50 years has occurred with a year or two of the curve inverting  --  an undeniable truth but one that omits the fact that not every inversion has been followed by recession.

 

Still, they're asking for what's becoming known as the "Powell Put"  ,  a not entirely appropriate reference (in our opinion) to the much discredited "Greenspan Put" of yesteryear. "Greenspan" is Alan Greenspan, the long-serving and ultimately controversial Chairman of the Fed from 1987 - 2006. "Put" as in Put Option, a most obvious method of ensuring against downside market moves. Although he always denied that there was such a policy in place, stock market investors came to believe that Mr Greenspan could be relied upon to rescue them from significant price falls by cutting rates.

 

In truth, the so-called Powell Put would be rather different, not least because it applies to the bond market rather than equities. The suggestion is that since the flattening of the yield curve and its potential to become inverted is a result of the consistent rate hikes, then the Fed should be prepared to cut short-term rates if inversion was to become a reality. The other way that it's different is that the current chairman doesn't seem to buy into the theory at all. His view is that given the pace of growth, very low unemployment and inflation levels already back on target, gradual rate hikes are the correct path .... and looked at in that light it's hard to disagree.

 

Mr Powell told members of Congress last week that the issue of the flattening yield curve is not so much about fully justifiable rate rises at the short end of things, but is a function of ultra-low low yields at the long end  --  which have so far stubbornly refused to budge (to any great degree) when in other eras they certainly would have done. Exactly why that is the case probably lies largely at the door of the massive global stimulus programmes that have hoovered up so much of the world's government debt, and regular flights-to-quality in a much-troubled world. Mr Powell seems to saying that since the old dynamics have changed, it would be wrong to apply the old preconceptions about the yield curve. That does make sense, but won't do him any favours if he's proved wrong.

 

Quite why yield curve inversions should presage recessions of the past is not totally clear. The best explanation that we've heard is that inversions seriously damage the fortunes of the banking sector, for whom borrowing short-term and lending long is traditionally a large part of the income stream. The banks in turn are then less likely to lend to businesses and households. That worry would certainly still apply, but Mr Powell does not seem like a man likely to adjust monetary policy just to avoid a curve inversion that may or may not have any significance in the modern environment.

 

It's not only regional Fed figures in the ear of Mr Powell , of course ...... President Trump is having a right old go too. In fact, it was his lambasting of Fed rate hikes (and the spike in Japanese yields) that caused the curve to steepen recently  -- the 10yr yield minus 2yr yield went from 24bp to 33bp. But historically speaking this is still almost flat, and you never know ..... Mr Powell might turn out to be so keen to maintain the independent credentials of the Fed that Mr Trump's interference might have precisely the opposite effect to the one intended.

 

 

Now wouldn't that bring on a Trump Grump .......

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