COT: Accelerated Dollar Selling Into 2020

Saxo Bank publishes two weekly Commitment of Traders reports (COT) covering leveraged fund positions in bonds and stock index futures. For IMM currency futures and the VIX, we use the broader measure called non-commercial.

For the full Forex Report and Financials Report.

Five weeks of selling has driven the speculative dollar long against ten IMM currency futures and the Dollar Index down to just $5.6 billion, the lowest bets on a stronger dollar in 18 months. The first week of trading was particularly brutal with the dollar being sold against all the major currencies.

The carry supported MXN reached a nine-month high last week and is now challenging the dollar as the most popular long. The GBP long meanwhile reached 16.5k lots, the most bullish since May 2018 while EUR net shorts were trimmed to the least since November.

Leveraged fund positions in bonds, stocks and VIX
What is the Commitments of Traders report?

The Commitments of Traders (COT) report is issued by the US Commodity Futures Trading Commission (CFTC) every Friday at 15:30 EST with data from the week ending the previous Tuesday. The report breaks down the open interest across major futures markets from bonds, stock index, currencies and commodities. The ICE Futures Europe Exchange issues a similar report, also on Fridays, covering Brent crude oil and gas oil.

In commodities, the open interest is broken into the following categories: Producer/Merchant/Processor/User; Swap Dealers; Managed Money and other.

In financials the categories are Dealer/Intermediary; Asset Manager/Institutional; Managed Money and other.

Our focus is primarily on the behaviour of Managed Money traders such as commodity trading advisors (CTA), commodity pool operators (CPO), and unregistered funds.

They are likely to have tight stops and no underlying exposure that is being hedged. This makes them most reactive to changes in fundamental or technical price developments. It provides views about major trends but also helps to decipher when a reversal is looming.

Ole Hansen, Head of Commodity Strategy at Saxo Bank.

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This article is provided by Saxo Capital Markets (Australia) Pty. Ltd, part of Saxo Bank Group through RSS feeds on FX Empire

How To Trade Bonds Using Macro Indicators

Bonds; What They Are And Why You Want To Own Them

Bonds, the bond market, bond yields, and the yield-curve are important aspects of the financial markets every trader should understand. It doesn’t matter if you are a bond trader or not, understanding the nature of the bond market can provide a deeper insight into just about every other market on the planet.

First let me answer the question, what is a bond? A bond is a pledge or a promise for one individual or entity to repay a debt that can be bought and sold by the public. It is, in essence, a way to guarantee a debt, the seller is borrowing money and the buyer is lending.  Bonds can be issued by just about any type of organization but are most commonly used by governments and businesses to raise large amounts of capital.

The bond issuer agrees to pay the bondholder an amount of interest that is predetermined at the time of the exchange in return for a loan.

Governments and businesses often need to borrow more money than what they can access through traditional banking means. In order to raise this money, they use public bond markets so they can tap into a larger liquidity pool. Investors buy the bonds in return for interest payments they receive over time or upon maturity. The amount of interest the issuer pays and the owner receives depends on a number of factors including Credit Rating, Interest Rates, and Demand.

Credit ratings for bonds are similar to the credit score you get as an individual, it is a measure of the bond issuer’s ability to repay the debt. Ratings are issued by agencies like Moody’s and Standard & Poors in a range from Investment Grade through Junk. Investment Grade bonds have the least likely of default, the least amount of risk, while Junk bonds have the highest amount of risk. A higher risk of default equates to a higher interest rate for the borrower, the issuer of the bond. That is good for the owners of bonds because it means a higher rate of return.

Safety-seeking investors may accept smaller returns for guaranteed investments and focus only on investment-grade bonds.

Demand can affect a bond’s cost/return ratio the same as any trading asset. Because bonds are typically issued in batches the amount of debt available for investors to buy is limited. If there is enough demand it can drive the cost of ownership higher and lower the effective yield. This is bad news for the bond investor but good news for the issuer because it lowers their cost of borrowing.

Central Bank Policy Underpins Bond Market Conditions

Interest rates are important for bonds because they determine the cost for issuers and return for investors. What makes bond trading hard is that interest rates change over time which means there times you may want to be a seller of bonds and other times when you want to be a buyer of bonds.

The primary force behind this is the prime rate or base rate maintained by the central bank of the country in which the bond is issued. When the prime rate is high bond rates tend to be higher and when the prime rate is lower bond rates tend to be lower. The challenge for bond traders is when the central bank is the process of altering its policy and changing the prime rate.

Central banks move their target for the prime rate up and down in an attempt to maintain economic stability within their respective nations. If economic activity is too high they raise the cost of borrowing money to make it harder for businesses to borrow. If activity is too low they lower the rate in an effort to stimulate business investment and flow within the capital markets. Savvy investors can sell bonds short when rates are low and then buy them back when they are high profiting on the cost of the bonds and receive interest payments in the meantime.

Inflation – This Is Why Central Banks Change Their Policy

The number one tool that central banks use to measure the economy and determine the trajectory of their policy, whether rates are rising or falling, is inflation. Inflation is a measure of price increases over time and can be applied to many aspects of the economy. The two most commonly tracked are business and consumer inflation. To that end, two of the most tracked inflation reports are the Producer Price Index and the Consumer Price Index.

Of the two, the Consumer Price Index or CPI is by far the most important. Consumers are the backbone of modern economies. While producer prices may bleed through to the consumer level, if consumer prices get too high there is nothing for an economy to do but collapse. In the U.S., the Personal Consumption Expenditures Price Index or PCE is the favored tool for measuring consumer-level inflation. It is released once per month and as a part of the quarterly GDP announcement.

Regarding inflation, most central bankers favor a 2.0% target for consumer-level inflation. This means that when CPI or PCE prices are below 2.0% the central banks tend to be “accommodative” toward their economies and ease back on policy by lowering interest rates. When CPI or PCE is above 2.0%, central banks tighten policy by raising interest rates.

Labor Data And Its Role In The Inflation Picture

Labor data plays an important role in the inflation picture. First and foremost, no economy can function if its people are not working. The FOMC at least is mandated with two functions and one of them is to ensure maximum employment. Figures like the non-farm payrolls, unemployment, and average hourly earnings become important in that light. The difficulty the FOMC faces is that stimulating labor markets can lead to increased wage inflation.

Economic Activity, Central Banks And Bond Trading

Economic activity is the alpha and omega of bond trading. When economic conditions are good capital markets are flush, when economic conditions turn the capital markets dry up and bonds are harder to issue. The takeaway is that economic conditions are what the central banks are trying to manipulate and they do that through interest rates. When conditions are bad, interest rates will fall, when conditions improve interest rates will rise until they reach a point the economy recedes. That is the nature of the bond market and bond trading, understanding that ebb and flow is key to bond trading success.

According to Learn Bonds, when the economy is performing badly and the stock markets are highly volatile, investors tend to switch investments to fixed income securities and this boosts the activity in the bond market. But this is not always the case. High volatility can sometimes drive investors towards short-term trading via online trading platforms. This way, they can benefit from both sides of the market without having to hold stocks for long periods.

Yield Curve And Market Outlook

There is a limitless supply of bonds but not all are the same. When it comes to bonds the safest, most trusted, and closely watched are U.S. Government Treasuries. The U.S. Treasuries are issued in a variety of maturities that range from a few weeks to thirty years. The yields on each maturity are different due to demand for time-frame, either long or short-term investment and can be analyzed for insight into market sentiment.

Known as the yield curve, in good time the spread of yield increases the further out you go. This is because investors believe that interest rates will be higher in the future so they don’t want to lock-in a low yield for too long. This phenomenon results in a higher demand for shorter-maturity bonds and a “normal” yield curve. In bad times that all changes. Bond investors believe interest rates will be lower in the future so they are seeking to lock in the higher rate for a longer duration. That creates a higher demand for longer maturity bonds and a signal known as a yield-curve inversion

This graph shows a partially inverted U.S. yield curve.

The Best Recession Indicators You Have Never Looked At

I understand this won’t help your trading in the immediate term, but it could help with trigger points to identify if we are going into a sustained higher volatility environment.

1 – We can search on Bloomberg for the keyword ‘recession’ and see this has spiked to the highest level since 2011.

2 – We have seen searches of ‘recession’ on Google Trends increase to GFC levels. In this chart, Nordea Research shows prior periods where the US 2s10s Treasury curve inverted.

We can look at market pricing, to see the perception of how close are we to a US recession. Here, we can extrapolate that if we see one in the US, then we are likely to see far tougher times in other countries, such as Australia.

3 – The NY Fed recession probability model (12-months out) – this currently sits at 31%, which seems low, but consider prior probability readings going into recessions (highlighted by the red shaded areas) were not much higher.

What trigger points are worth watching?

4 – The US labour market has been at full employment for some time, but should we see cracks appear it will rubbish the Fed’s belief the US economy is in a ‘mid-cycle adjustment’. Here I look at the 4-week rolling average of the weekly jobless claims (white) and overlap against a 36-month average. Historically, when we see jobless claims rise, and subsequently break the 3-year average, it tends to precede a recession (red shaded areas)

5 – Conference Board (CB) ‘jobs plentiful / jobs ‘hard to get’ ratio. This is part of the monthly CB survey, where we see respondents offering their belief in the labour market outlook and the ease of obtaining employment. Again, if the labour market turns, its often a sign business is cutting back as we head into tougher times. This indicator has seen a dip into prior recession, showing more respondents see jobs harder to come by on a relative basis. No red flag at this juncture.

6 – CB leading index – An index of 10 leading US economic indicators, which, as we can see, will decline sharply into recessions. We are not there yet, but it is turning lower and consider that we get the July US leading index update tonight at 00:00aest. So, it is worth watching.

7 – Consumer confidence (white) vs the S&P500 – It won’t shock to see consumer confidence decline into a recession, and the sharp turning points are the red flag. As we see, the index is not giving any clear signal we are headed into tougher times.

8 – The US 10-year Treasury – German 10-year bund spread. We often see the US Treasury’s outperform its German peer, resulting in the US Treasury yield advantage over bunds coming in aggressively into recessions. It has also been a reasonable predictor of how the S&P 500 may trade too. So, the fact we see this spread narrow at this juncture is something I have an eye on.

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Chris Weston, Head of Research at Pepperstone.

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Recessionary Warnings On, and Fed’s Jackson Ahead

Global bond markets have been flashing recessionary warnings, and central banks have listened. The Fed cut rates for the first time in over a decade in July, and the ECB is poised to bring out its bazooka again in September; the PBoC has been actively intervening, while several other central banks have surprised with easings of their own in recent months

The focus this week will be keenly on the FOMC minutes to the July 30-31 meeting and the Jackson Hole Symposium. Both have yielded policy hints in the past and the markets will look for any such nuances to current outlooks, including the extent of worries over downside risks from trade uncertainties.

The big underlying questions that will remain unanswered for now, however, are not only whether the US can avert a recession, but whether it can help lift the world out of a contraction.

The markets’ fears over recession were heightened after the Treasury yield curve inverted since the idea behind the use of a yield curve is to measure investors’ perception of risk and future developments in the bond market, as well as the overall economy.

What is a yield Curve?

Theoretically, the yield curve’s tilt presents investors with perspective as to how the economy will deploy, in simple terms, bond investors’ feelings about risk. The yield curve is considered to be the most closely watched predictor of a potential recession. As such, in a healthy economy, the yield on shorter-term bonds, which expresses the return investors are getting for committing their funds, is expected to be lower than the yield on longer-term bonds.

As we stated last October,

“The idea is that short-term bonds carry lower yields because lending to someone, regardless of whether that person is the government or the average Joe, is less risky for the investor; the longer you commit funds, the more you should be rewarded for that commitment, or rewarded for the risk you take that the borrower may not pay you back. This behavior is referred to as the normal yield curve, and reflects economic expansion as investors show how confident they are about the economy by their level of demand for government bonds.”

At the point in which the short-term bonds offer higher yields than longer-term bonds, we have an “inverted” yield curve. This is widely regarded as a bad sign for the economy and a recessionary signal from the bond market. The lower the yields due to the low interest rates, the slower the economic growth.

What about last week’s yield curve inversion?

Last week, the indicator yelped even louder as on Thursday the 30-year Treasury bond made a new historic closing low at 1.974%. The 2s-10s spread was seen in negative territory only briefly for the first time since 2007. Even though it never did close below zero, markets’ fears over recession were heightened after seeing this inversion.

In general, the reason behind the inversion of the yield curve, is that in times of great uncertainty like last week but in general the whole of 2019, investors become nervous, and turn to less risky assets such as Treasurys, which are among the world’s safest investments. The higher the demand for bonds will be, the lower the yields.  As seen last week, the weak data from China, the contraction in the German economy during Q2, ongoing Brexit uncertainty, and the optimism generated by an apparent thawing in US-China relations ran head on into fresh concerns that a recession is on the way.

What to expect from now onwards?

As geopolitics remain major headwinds, Brexit is approaching the October 31 deadline fast, the protests in Hong Kong, political instability in Italy, disarray in Argentina and monetary easing from an array of countries, are seen dampening the global blow, investors’ anxiety is expected to extend further in the long term.

Hence the main theme of the upcoming months is likely to remain on the recession and trade concerns. Even though the inverted yield curve might be a signal of the start of a recession, if a recession comes, firstly it will take a while, and secondly it is expected to be a global recession, with the US economy less impacted than the rest of the world, as the US retail sales and labor market is holding up well. On the other hand, the rest of the global economies, and especially China, might suffer a severe fallout, not only due to the trade war and geopolitical tension but also due to its productivity slowdown due to its shift from export-oriented manufacturing to domestic real estate and infrastructure, the reduced working-age population etc.

Nevertheless, this week, optimism persists as investors are already pricing out some of the recession fears that hit confidence earlier in the month amid growing conviction of decisive stimulus measures, with the FOMC and ECB on very supportive footing.

Ahead of the Jackson Hole Symposium, hopes are high that the central bankers might take further steps to support economic growth if needed. The upcoming US-China trade talks and the Treasury’s announcement that it is looking into issuing 50- or 100-year bonds are also a source of cautious optimism, in the near term. A global risk-on rally lifted equities and yields, as optimism from late last week spilled over into the new week. This picture is expected to hold during the week.

Andria Pichidi, Market Analyst at HotForex

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Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.

Is This Time Different? Predictive Power of the Yield Curve and Gold

This is what the pundits claim. We invite you to read today’s article and find out whether the experts are right and what does it mean for the gold market.

Is This Time Different? Predictive Power of the Yield Curve and Gold

This time is different. This is what the experts say. The inversion of the yield curve did a great job in predicting recessions in the past, but the current inversion is not like the previous. The predictive power of the yield curve has weakened, so it does not signal the recession. This is what the pundits claim. Are they right?

First of all, many doubt whether we can really trust the signals sent by the yield curve, given that the central banks heavily intervened in the bond markets in the aftermath of the Great Recession. When the short-term interest rates reached almost zero, the Fed started to buy many securities to lower the long-term yields, which flattened the yield curve.

So it might be the case that without the U.S. central bank’s impact on the bond prices, the yield curve would be steeper or even not inverted. In other words, it might be the case the yield curve is inverted only because the long-term rates are artificially compressed. If true, the yield curve can be inverted even if short-term interest rates remain stimulative to the real economy (they are not above the ‘true’ level of long-term yields which reflect the neutral rates) and thus are not serving to depress activity.

While this reasoning is plausible, there are two problems with it. First, the Fed ended its quantitative easing program long time ago, and it has been conducted recently quantitative tightening. Second, there is a lot of uncertainty around the effects of QE on interest rates. Hence, as the San Francisco Fed economists noted,

“There is no clear evidence in the data that ‘this time is different’ or that forecasters should ignore part of the current yield curve flattening because of the presumed macro-financial effects of QE.”

Second concern about the current predictive power of the yield curve refers to easy financial conditions. The inverted yield curve should reflect tightened financial conditions and desperate entrepreneurs scrambling for funds, bidding up short-term rates. But, as the chart below show, the financial conditions remain easy (negative values indicate financial conditions that are looser than average).

Chart 1: Yield curve (green line, spread between 10-year and 3-month Treasuries, monthly averages, in %) and the Chicago Fed National Financial Conditions Index (blue line, index) from January 1971 to June 2019.

That’s true. However, the financial conditions are very often a lagging indicator, as banks turn off the credit tap only after the crisis come. Liquidity is an illusory concept. It may seem to be abundant and always just there, but when market stress occurs, liquidity often disappears.

Please take one more look at the chart above. The financial conditions become positive, i.e., tighter than on average, only in November 2007, just one month before the Great Recession officially began. And during the 2001 recession which occurred after the burst of the dot-com bubble, the financial conditions remained easy all the time!

Third, what about the reason behind the recent inversion of the yield curve? In the April edition of the Gold Market Overview, we pointed out that the March inversion of the yield curve happened not because the short-term interest rates rose abruptly, as the Fed tried to stop the overheating of the economy and prevent the rise of inflation, but because the long-term bonds yield declined, as investors became more pessimistic and started to expect interest rates to be lower in the future.

We were right. The immediate reason behind the March inversion was the drop in the long-term interest rates, as the chart below clearly shows. The same applies to May inversion. Actually, that case was even more counterintuitive, as the short-term interest rates declined, not rose! The yield curve inverted because the long-term yields plunged even more.

Chart 2: Long-term interest rates (green line, 10-year Treasuries) and short-term interest rates (red line, 3-month Treasuries) from January 2015 to July 2019.

However, everything makes sense, when adopting a long-term view. So, let’s take a look at the next chart, zooming out the bond yields. As one can see, the long-term interest rates remain in the sideways trend, while the short-term interest rates increased substantially since 2015 when the Fed started its tightening cycle.

Chart 3: Long-term interest rates (green line, 10-year Treasuries) and short-term interest rates (red line, 3-month Treasuries) from January 2015 to July 2019.


Hence, everything fits the standard theory of the yield curve inversion. But even if it does not, it does not matter, actually. According to the San Francisco Fed’s paper we’ve already cited, inversion predicts slump, regardless of the driver. In other words, only the difference between the interest rates matters for recession predictions.

The bottom line is clear. The future cannot be guaranteed, but the past shows that each time the pundits reassured us that ‘this time is different’, they were wrong. As long as the yield curve remained flat but positive, we downplayed fearmongering about the imminent recession. When the yield curve inverted shortly in March, we were disturbed, but still far from panicking. But when the key spread, calculated on a daily basis, dived deeper into negative territory and for longer in May, while the monthly average inverted in June, we had to acknowledge that the recessionary odds in the US several months ahead increased substantially. Precious metals investors should act accordingly, adjusting their portfolios to the heightened risk of recession.

Thank you.

Arkadiusz Sieron

Sunshine Profits‘ Gold News Monitor and Gold Market Overview Editor

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits’ associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski’s, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits’ employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

GBP, Yield Curve Inversion & Brexit – The Trends Remain

The Trend is King

The Pound took a knock after the UK yield curve inverted, in sympathy with the inversion seen on the US curve. The Gilt 2-/10-year yield differential went negative for the first time since the global financial crisis of 2008. This follows preliminary UK Q2 GDP data, released last Friday, unexpectedly showing a negative reading, of -0.2% q/q, and comes with markets bracing for the risk of a disorderly no-deal Brexit (which was given a median 35% probability of happening in the latest Reuters poll, up from 30% previously). The UK currency has reversed intraday gains that were seen after warmer than expected CPI data and on news that the speaker of the House of Commons, John Bercow, stated that he will fight to stop PM Boris Johnson from shutting (aka proroguing) parliament as a means to force through a no-deal Brexit.

Cable has dropped back to levels around 1.2065-70 after printing an intraday high at 1.2076. The day’s low, seen during Asian hours, is at 1.2050, and the 31-month low seen on Monday is at 1.2015.

Regarding Brexit, the scene is set for a final showdown between anti-no-deal members of parliament and the pro-no-deal Brexiteers, which include Prime Minister Boris Johnson and his cabinet (who lead a weak minority government with a working majority of just one, and with a portion of their own Tory members disposed to stopping a no-deal eventuality, but who would be galvanized by some favourable polling).

The battle will commence on September 3, when parliament reopens after the summer recess.

The BoE Problem

The UK curve also reflects the BoE dilemma. The UK 2-10 year curve inverted after higher than expected CPI readings and remains virtually flat even after the initial excitement over the higher than expected headline reading has settled down. The 2-year is trading at 0.454%, up 0.5 bp, while the 10-year is down -3.6 bp at -0.455%. The above-target inflation reading of 2.1% followed labour data on Tuesday that showed a further acceleration in wage growth, and while a Brexit-related slowdown in economic activity may reduce wage pressures, the rise in CPI is likely to at least partially reflect the decline in Sterling, which is pushing up imported inflation.

For the BoE the debate following a hard Brexit would be whether to accept the likely impact of additional inflation pressures and focus on the growth impact, which ultimately will also have a dampening effect on inflation. In the meantime, the yield curve could well invert more if a no-deal Brexit scenario becomes even more likely as the Reuters polling suggests. The trend remains very much biased to the downside for Sterling in the inevitably volatile weeks ahead of October 31.

Stuart Cowell, Head Market Analyst at HotForex

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The Bond Market Driving The Show

The idea of a flatter US and global yield curves is certainly not a new theme. In fact, it is very mature. However, the fact the US 10-year Treasury has traded with a lower yield-to-maturity than that of the shorter-term US 2-year Treasury has fully caught the attention of all market participants. As has the bid in the US 30-year Treasury, which is currently trading below 2% – a new record low, with the hunt for (quality) bonds, with any positive ‘real’ yield rolling on like a juggernaut.

Gold, as usual, is the net beneficiary of these moves in yield, and the yellow metal has resumed its bull trend. The fact we now have $16t of bonds with a negative yield is driving further flows…it is the best hedge, or offset, against negative-yielding assets we have.

Assessing the moves in US trade:

  • White – US 2-year vs 10-year Treasury CURVE
  • Yellow – S&P 500 futures
  • Green – US 30-year Treasury

As we can see, bonds seem to be leading equities, and this leads back into my view detailed earlier in the week that bad news is actually bad news for stocks, and we don’t just pile into equities because low bond yields make corporate cashflow more attractive, or results in the equity dividend yield more attractive. Lower yields are a sign that US monetary policy is too tight and the market sees a higher prospect of recession.

The S&P 500 closed down 2.9%, which for the stats heads out there was a three standard deviation move, on volumes 35% above the 30-day average, and that is a red flag. I continue to watch to see how price reacts into 2822/25. A break here and the drawdown could get ugly. A Trump tweet is never far away.

US 2s vs 10s curve

Take the picture out to a multi-decade view, and we can see how curve flattening is not a new story. The fact the market chose to react overnight when we traded below zero (inversion) is clearly psychological. Consider, that while asset markets have sensed a need for the Fed to ease quite drastically, for those who use the curve as a precursor for the US, and perhaps global recession, then it is not until rate cuts are really enacted, that we see 2yr yields falling faster than long-end bonds and subsequently we see the curve steepen.

This is where we get the recession. Luckily, we are not there yet, but the market is obviously concerned given the Fed see no urgency in cutting rates. Consider next week we get the annual Jackson Hole Symposium, where the world’s central banks will gather to discuss all things on monetary policy. What’s interesting is the title of the conference is “Challenges for Monetary Policy,”. Seems incredibly apt if you ask me!

Remember recessions don’t just happen, they are caused by a major event or a policy mistake, and in this case, the combination of tight US Fed-policy and an end of globalisation seems to be a potential trigger.

Aussie yield curve

All the focus is on the US, but we’re seeing the Aussie 2s vs 10s curve about to invert. A 41.1k net jobs seen in todays Aussie July employment change has been the catalyst here, and also why AUDUSD is up0.5% on the day.

Key stats on curve inversion

We take the inversion of the curve as a signal in a process to eventual recession. As we can see from the chart, which I borrowed from Jeroen Blokland (@jsbloklan on Twitter), the average lag from the last five occurrences from inversion (in 2s vs 10s) to an eventual recession has been 21 months. We can also see how markets reacted here.

The best yield curve to watch

While there has been so much focus overnight on the UST 2s vs 10s, my preference is to watch the US 3-month Treasury vs US 5y5y forward rate. In layman’s terms, the forward rate is the instrument the market believes is the best representation of the Fed’s long-term neutral rate. That being, the rate by which is the correct policy setting for the level of anticipated inflation and growth.

This turned negative (or inverted) on the 28 May, and backs my view that Fed policy is too tight right now. If ultra-short-term rates are above the implied long-term neutral rate, then the market is telling me they feel rates need to be lower and by around 50bp just to be at a neutral setting.

Two of the most important charts in my universe

US 5Y5Y inflation swaps

Forget the name of the instrument, effectively, these just are one of many instruments institutional traders use to express a view on future inflation expectations, and exchange their liabilities. The Fed looks at inflation expectation readings very closely, as do the ECB and other major central banks. Inflation expectations are now headed lower, and this will sit poorly with the Fed and market participants. Although it is also great for bond investors.

Bloomberg financial conditions index

The index is a weighted blend of various inputs, such as implied volatility, the S&P 500, money market rates (and others) and funding markets – A move lower here indicates tighter financial conditions. Again, the Fed sees a strong connection behind financial conditions and the real economy, so it’s important for us too. When we saw the July FOMC meeting, conditions were still accommodative enough that the Fed would not have been overly concerned. That is changing.

The markets have a major role in both the Fed’s future thinking and potentially even the US-China relations, provided the drawdown in equities is prolonged. If the markets go after a 50bp cut, and they think 50 is genuinely warranted, which seems likely given the moves in the bond market, then financial conditions will express the level of worry in markets, and the Fed will have to react.

US 2s v 5s yield curve

One of my favourite indicators on the Fed’s implied path, largely because it tends to lead other parts of the bond curve. As we can see, after inversion, it doesn’t take long before steepening plays out here (i.e. 2-year yields falling faster than 5-year bonds), and this is taking place right now. It is often the clearest precursor to aggressive rate cuts from the Fed, which I’ve highlighted in the lower pane.


Who is the big equity loser from the flatter curve? Well, take a look at the KBW banking index. It looks terrible, although traders are far more focused on the longer-term chart of the EU banking index, which is about as ugly a chart as you will see.

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Chris Weston, Head of Research at Pepperstone.

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Crazy Time in Bond Land – Buy Everything Part 2

For those who didn’t see this yesterday, it feels like this chart remains central to the markets thought process:
•    Pink – global money supply
•    Red line – G3 central banks’ balance sheet and expected future trajectory
•    White line – MSCI World index
•    Orange line – Fed fund rate and future trajectory (as priced by rates pricing)

Source: Bloomberg

It’s the equity trade that has caught everyone’s attention though, as the trend seen so clearly in so many charts are a thing of beauty, and the “buy everything” mantra rolls on in earnest. How can we be short of equities with any conviction when the weight of capital is only going one way, and whether I look at market internals or positioning, there are no signs of euphoric conditions. Take the weekly Commitment of Traders report. Here, we see CFTC data showing net long positions (non-commercials accounts) of S&P 500 futures at 86,000 contracts, and even at these levels, we can see it is certainly not stretched by any means.

We have the S&P 500 making its third consecutive record high and yet only 8.5% of companies have a 14-day RSI above 70, with a mere 14% of the index closing at a 4-week high. I can look at the percentage of companies above their 50- and 200-day MA and see these sit at 76% and 73% respectively. Not at levels where the hypothetical elastic band has been pulled too far.

The fixed income juggernaut

But we have to look at the global bond market to understand why equities and high yield credit are grinding ever higher.

There is so much chatter about the pool (USD value) of bonds that command a negative yield. To put this into context, if the corresponding government were to issue bonds at these levels, they would effectively be paid by investors to do so. It is like me going to ANZ and borrowing $1m to buy a house and ANZ paying me to borrow this principle. Mad times indeed and there are no issues with buying a negative bond, as a trade, if you feel yields will go further into negative territory (price higher) and you can make a capital return. Well, as you can see, this pool has reached record levels at $13.4t.

See how the pool of negative yielding debt is impacting the gold price (yellow line). I’d add Bitcoin here too, as they are moving together, just at a different pace. Gold is a store of value when nominal yields are going ever lower.

When it comes to negative yielding debt though, Switzerland takes the top prize. This chart has garnered some attention of late, with Swiss government bond yields negative out to 50 years. The white dotted line is the zero-yield level — mad times.

Denmark has issued debt out to 20 years maturity, and every part of the curve is now negative.

In Germany, the benchmark 10-year bund is about to trade with a yield lower than the ECB’s deposit rate. The deposit rate is the rate the ECB charge financial institutions to park excess capital on their balance sheet, effectively risk-free. The idea being, if you charge these institutions, they will be loath to hold capital on the ECB’s balance sheet and will either feed this into the financial markets (asset price inflation) in search of a return, or better yet, use the capital to lend into the real economy and actually try and make a profit.

Granted, we have seen a better feel to various EU labour market indicators, but create inflation and growth, a -40bp charge on banks excess reserves, it hasn’t.

It has been a headwind for the EUR though, and aided the perception that capital may be headed offshore and reinforced the idea that if you want carry in FX then using the EUR is a good idea.

Certainly, the bearish moves in EURCAD, EURNZD and EURAUD may extend further in the short-term, especially if implied volatility continues to be suppressed.

What changes this script?

Well, potentially Friday’s US non-farm payrolls could cause a sell-off in bonds, but we’d need to see a huge number and far in excess of the consensus of 160,000 jobs. Potentially even a sizeable revision to last months poor 75,000 read, and hourly wages into 3.4% or above. But this is a world looking to buy any pullbacks in bonds and funds have been pushed further out the curve in a bid for yield and returns.

ASX 200 daily chart

As long as yields are going down and the market holds confidence in its projections for deeper interest rate cuts, then equities will likely grind higher. So, we have all-time highs in the S&P 500, Dow, Nasdaq 100, and bullish break-outs in the ASX 200, FTSE 100, CAC 40 AND German DAX. Lower bond yields reinforce the earnings yields in the equity market, it makes the projected future cash flows more compelling, boosting net present value (NPV), and it lowers the equity risk premia.

The most significant risk to this trend has to be a market that loses faith that the price maker central banks will not act as aggressively as expected. And/or economics deteriorate to the point where we lose confidence central bank actions will even work – we are some way from this point yet, but it gives me faith gold is a long-term buy.

The blue highlighted area shows the year-to-date returns. If you’d told me that we’d be up 19% by July, I’d have questioned your logic. Mad times, but this is the liquidity-driven dynamic we live in.