Ok, so at this point (and this is a particularly apt discussion going into NFP), it’s abundantly clear that the only way this “ends well” is if the “bad news is good news” regime stays in place and the “bad” news gets less “bad” at a very, very gradual pace.
That is, risk assets habitually interpret things like lackluster CPI prints as “good” news because those prints presumably constrain policy makers in their quest to normalize.
Effectively, traders are hoping that poor incoming data will act as a kind of deterrent to hawkish policy mistakes. The fact that “bad news” news continues to be “good news” for markets suggests that traders have virtually no confidence in central banks’ ability to pull this off if left to their own devices. In that respect, the market is hoping they are in fact data dependent.
Of course that only works if the data continues to come in “just right”. Growth that’s just good enough to allow policy makers to proceed with caution, but not nearly good enough to green light a mad dash to the exits for central banks who, with each new record for global equities and every new multi-year tight on corporate spreads, feel increasingly like they’re behind the curve.
Here with a great take on this dynamic is former trader and man who has gone five consecutive days without an angry rant, Richard Breslow…
What if we’ve been seeing what’s going on and have consistently, and over-optimistically, misinterpreted the cause? That’s a really scary thought if the trades you contemplate are based on the effect without a proper understanding of the actual drivers influencing the investing environment. It may be a reality that unrepentant bond bears have to consider.
- That the global economy has been doing better is undeniable. But while it’s easy to celebrate the improved direction of things, we may have to ask ourselves whether it’s really appropriate to pop open the champagne corks? From some asset-price movements you would have to conclude yes. But there are more important ones, lamentably and intractably, warning, “not so fast, buster”
- Credit spreads continue to compress. U.S. investment grade OAS is a mere 5 basis points off multi-year tights. High yield has spent the last month coming in yet another 20 basis points.
- Peripheral spreads in Europe have lessened smartly. The 10-year Italy-to-Germany spread made a new YTD low on Tuesday. After all, everything is good there
- I’ve been associating these moves with a risk-on world that, given the aversion of central banks to upsetting anything financial condition-related, would translate into core sovereign yield curves shifting higher in a benign and measured fashion. But, in reality, these spreads just can’t be doing what they’re doing if the tapering and rate-hike stories were truly being given credibility
- So how then might the story line read? That all this nonsense that globally rising rates and widespread balance sheet reduction just can’t be a calm experience. Investors simply own too much toxic “financial products” to make that likely. And they continue to add. If spreads are still coming in, it means one of two things. People believe the hard data and just aren’t yet accepting what they are being told. Or they’re just too deep into the trade that they’d rather meet their return benchmarks now and not even think about the consequences
- But it seems just as likely that along with all of the hawkish and upbeat rate talk we are periodically subjected to in policy-maker speeches, what we are actually seeing is the re-emergence of that horrible construct, which apparently never went away: “Bad news is good news”. That the more important factor is that the Treasury 10-year at about 2.25% and the bund at all of 45 basis points are warning signs we’d so love to be able to ignore. But how’s doing so been working out for you?
- The Fed, and everyone else, had better hope that we begin to see wage inflation creep, not leap, higher. That non-employment related inflation stays away. And we have a long period of slowly rising rates with objectives higher, but not dramatically so. That’s about the only scenario that ends as well as promised