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Admit It: You’re A Yield Curve Apologist, Aren’t You?
By Kevin Muir of “The Macro Tourist” fame; reposted here with permission
I am sure many of you are sick of my yield curve talk. I have been babbling about the curve for far too long. I guess it’s a little understandable as I believe a steepener position will be “the” trade during the next crisis.
Yet there can be no denying that so far, I am wrong and the yield curve keeps going down faster than the plate of drinks at the end of David Hasselhoff’s table after a taping of Britain
Interpreting a negative yield curve is different in a rising rate environment than in a deflationary economy. Just look back further in history to the 1960s and early 1970s and you will see that long rates break higher when the yield curve goes negative, the opposite of the past 25 years. The current market is trading as if nothing has changed in the monetary world and the needs of the US Treasury since the 1990s. I agree with your trading conclusion, but it is because I believe there is a change in the underlying dynamics of the market, as a result of the Trump economic and trade policy, which the general market is in denial will actually happen without a total deflationary break down in equities that will cause a safe-haven run to Treasuries like 2008.
We will see, and probably in very short order. The BOJ and the ECB probably hold the trigger that will cause major market disruption. Will they pull the trigger and tank the market to taint the Trump economic policy before longer duration bonds like the 10Y and 30Y Treasury get pushed well above 3%? This is what I think the market believes. I expect the answer to this test question to materialize over the next 6 months as the Treasury has to issue $790B in net new issuance, and the FED continues to withdraw liquidity from the financial system, with the BOJ and ECB in the wings also getting ready to withdraw liquidity. The stock market is going to croak, even with all the buy-backs, if this program is not altered.
The higher rates trade will begin in earnest once the Fed signals that it cannot be responsible for so visibly tanking the stock market again by backing off its higher rates and balance sheet program as Trump has already noted is on a one way street to kill the market, and as a result, the economy as the C-Suite executives shut down their companies as stock prices fall. Believing that the Fed will try to avoid this outcome this time is the contrarian bond trade at the present time, and instead accommodate the US Treasury with continued low short-term rates to finance the debt. It is also the most likely and really the only practical outcome in my opinion.