As sell-side strategists parse the entrails of positioning data, and update their greed & fear models, to guess whether markets are due a rebound, investors should not forget the big picture. The conditions for further weakness remain in place. On the macro-level, the sharp slowdown global liquidity has been warning for a while that global—more specifically U.S.—equities had been rallying on borrowed time. Closer to the ground, the sell-off suggests that the multiple-crushing rise in bond yields and oil prices finally got the better of risk assets. The perma-bears will tell you that this is the drawdown to end all drawdowns, dragging global equities down to the netherworld of 2008 and 2009 price-levels. They have absolutely no justification for making such a call, but it won’t stop them peddling this narrative. Prudence suggests that we keep a close eye on liquidity in the credit market and, more specifically, signs of illiquidity in corporate bond funds and ETFs. The short-run is anybody’s guess, but if the recent past is a guide, it’ll go something like this: The market will rebound, eventually, retracing about half of the initial plunge. It will then roll over again, making a new low—the classic double-bottom—which can be bought aggressively.
Read MoreThe easiest way for U.S. bond markets to entice investors to abandon their obsession with a flattening yield curve—and whether it’ll soon invert—always was to steepen it. The spreads between 5y/10y and two-year yields have widened to 17bp and 30bp, respectively, about 10bp wider than at the end of August. More importantly, this move has occurred as a result of higher mid-to-long term yields. A few basis points don’t make a trend, but the combination of U.S. 5y and 10y bond yields pushing above 3% introduces a number of erstwhile dormant narratives into the mix. Perhaps the mythical neutral, or terminal, rate is higher than the Fed and markets think? Fed Chair Jerome Powell admitted recently that the FOMC probably doesn’t know where this rate is. This argument makes little sense in the context of the dots, which seem to imply that a policy rate of a bit over 3% in 12-to-18 months time is deemed restrictive. But it makes sense if this signal is no longer relevant for markets. The always optimistic David Zervos, the Chief Strategist for Jeffries, detects a shift at the Fed. “The most important takeaway here is that the probability of an aggressive late-cycle curve inversion has plummeted. (...) Maybe Jay goes there if we start ripping toward 3500 in spoos, but it won’t be because of the inflation or growth data.”
Read MoreWe will probably spend a big part of Q4 deciphering the economic data through the murky looking-glass of U.S. hurricanes and Asian typhoons, so just to be clear. I am still not happy with the trajectory of global leading indicators. Narrow money growth has collapsed, and recent data suggest that the slowdown will worsen in Q3. M1 in China rose 3.9% year-over-year in August, the slowest pace since the middle of 2015, and the trend in the U.S. and Europe also is poor. In the U.S., M1 is growing just under four percent on the year, the weakest since 2008, and the EZ headline also has slowed, though it is robust overall. The crunch in narrow money chimes with central bank balance sheet data. My home-cooked broad index, which includes the SNB and Chinese FX reserves, is now falling on a six-month basis. These data don’t mean the same in all economies—M1 is not a good LEI in the U.S. for example—and the Chinese numbers will turn up soon to reflect recent efforts to ease financial conditions. That said, a slowdown in US dollar liquidity matters for non-US markets, and the Chinese M1 numbers lead by six-to-nine months. The overall story is clear: Global liquidity growth has slowed to a trickle, warning about risks of growth and asset prices.
Read MoreThis will be a short update. I am working on a more extended macroeconomic essay—and I am trying to finish a short story—both of which are stealing time. In any case, I have little to say about the main themes beyond what I said last week. In the bond market, I concur with the points made early last week by Bloomberg’s Cameron Crise. Everyone knows the Fed is determined to keep raising rates, but market-pricing suggests that we are close to the end of the road for this hiking cycle. Between those contradicting points of view, the debate about the importance, or lack thereof, of the flattening yield curve has turned into a black hole threatening to consume all other stories in the bond market. I am sympathetic to that, but I don’t think the story is complicated. The 2s5 and 2s10 will invert in the next six-to-nine months, setting up an end of the U.S. business cycle towards the end of 2019 or at the beginning of 2020. At least, I think this is a reasonable base case until either of the following things happens. First, the Fed could suddenly decide that it doesn’t want to invert the curve. I doubt it, but the appointment of Richard Clarida as Vice Chair—apparently, he cares about the curve—certainly is an interesting development. Second, it is possible that the curve can steepen, or hold its current spread, even as the Fed fund rate motors higher.
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