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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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If you're the "glass half-empty" type, then you're plainly out of sync ......

November 11, 2019

 

ref :- "Rising Yields Quiet Bond Market's Key Recession Alarm" , The Wall Street Journal

 

There is, or at least there used to be, a certain image of the gnarled old trader ..... one who's seen it all before and for whom sensible caution has given way to cynicism. Actually, you may have noticed that we are not averse to a dash of cynicism ourselves occasionally but the fact is that too much of it can lead to constantly missing opportunities that others have been only too pleased to take advantage of. Mind you, that doesn't mean that we're not still surprised by the enthusiasm of investors from time to time .... like last week, for example.

 

Largely on the back of friendlier noises emanating from US - China trade negotiations, the markets seemed to decide that contrary to all the prognostications for doom and gloom doing the rounds of late, everything was in fact all right with the world. Now, that gnarled old trader would probably suggest that such rediscovered optimism might be misplaced . Just for starters, growth and inflation are pretty anaemic in large parts of the globe, the knock-on effects of what may or may not turn out to be Brexit are still hugely uncertain, Hong Kong's situation seems ever more likely to develop into something really nasty , and as for the trade dispute .... well, the agreement that may be signed off (it's not certain yet) is just Phase One of an enormous task that will be fraught with difficulties, between two parties who are still a very long way apart on many issues. There's also the problem of forecasting the actions of a US President prone to switching direction at the drop of a hat and without reference to his team.

 

But that kind of thinking is plainly out of favour ..... the rapprochement is "good news" and just the kind of excuse to encourage US investors to send stock markets repeatedly to new highs. The price of Gold, the ultimate safe-haven, is an inverse indicator of confidence and in early September was trading about $1,550 per oz ..... on Friday it traded almost down to $1,450.

 

(Actually, gnarled old traders  might have been warming up their "I told you so" routines this morning after police shot a demonstrator in Hong Kong and the gold price bounced a little to $1,466 but we'll have to wait to see how that story develops).

 

Anyway, the WSJ focuses on how the upturn in confidence has affected the market in US Treasuries, and in particular the yield curve which depicts the difference in yields for different maturities. When the yield curve is "inverted" , which is to say yields on shorter-dated instruments are higher than those for longer maturities, it is taken as a fairly good indicator of oncoming recession.

 

As hopes for the economy (and inflation) grow, bond PRICES go lower and bond YIELDS rise. So for example, the yield on the closely-watched 10yr Treasuries traded as low as 1.43% little more than two months ago and was still around 1.50% a month later .... this morning it is trading at 1.94%. There have been some healthier data releases (particularly on the employment front) to support such a move, even if some might argue that to take such a rosy view is a little on the selective side  --  the manufacturing sector has shrunk for three months in a row. But more than anything the upward move in yields reflects renewed optimism for the economy now that there are signs of progress on the trade talks.

 

As for the yield curve ..... the spread between the yield on 3-month Treasury Bills and the 10yr Note had been negative (i.e. short rates higher than long rates) for almost five months, but this morning is trading at +39 basis points. The key 2yr - 10yr spread, which has briefly dipped into negative territory , is at +25bp. In fact, the whole yield curve throughout its length "un-inverted" last week for the first time since November 2018.

 

The yield curve paints a much healthier picture today than it has done of late, and its positive inclination is a result of  : 1.) the Fed cutting rates at the short end and 2.) longer yields rising as confidence grows. Of course, the fact that the yield curve has gone positive is for many a reason for confidence in itself. Some may say that you need to be careful .... in the past, recessions have often followed some time (18 months , say) after the yield curve inversion. Others might point out that the curve was not inverted for long and therefore should not be taken as a reliable portent of recession.

 

All we would say, at the risk of being labelled gnarled old traders liable to miss the boat, is that drawing too many conclusions on the back of the progress of Sino - US talks so far is taking quite a lot for granted. The WSJ points out that the return to a positive yield curve means that the shares of banks that traditionally make money out of borrowing short and lending long has been at the forefront of the latest forays of stocks into record territory --  the KBW Bank Stock Index has jumped 13% since 10yr yields climbed above 3-month returns while the S+P 500 has gained 5.3% . It thus sums up both sides of story very neatly.

 

But is there enough evidence to suggest that the story is a long-runner .... or is that being too "glass half-empty" once again ?

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