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no, its not safe here in the USA, either. The Fed cannot possibly accomplish its planned “lift-off” without a bruising, public food fight among its members as the “incoming data” once again turns south. Indeed, based on the data already reported, it is likely that Q1 GDP will come in close to the flat-line, not the “escape velocity” on which the end of ZIRP has been predicated. In short, we are entering a new era of spectacular financial disorder.
That didn’t take long! Yesterday’s rip was supposed to have turned the market back up. Its close at well above the “crucial” 2060 chart point on the S&P 500 cash index meant “support” had held.
But then the euro resumed its free fall and in a few nanoseconds around 6 AM—-all bets were off. Still, this is no longer about the hourly charts on the EUR/USD or short-term movements in crude oil or end of the day robo slams on the VXX.
What’s happening is that the relentless central bank money blitz of recent years has finally pushed financial markets hard onto the shoals. Like in 2007-2008, the system is coming unhinged; there are coiled springs of price distortion everywhere and breakaway chips and shards are beginning to fly.
The absolutely preposterous yields on Eurozone 10-year government bonds (EGBs) provide today’s example of the mayhem lurking down the road. Specifically, the German bund is now trading at 0.221%, the Italian bond at 1.148% and the Spanish at 1.158%.
Yet you do not need to even think about traditional pricing metrics such as inflation and credit risk to see the lunacy of these yields. It is plainly evident that there are hundreds of basis points of risk in any of these EGB’s just on the issue of EMU break-up alone.
After all, is it really possible to believe that a currency union that has been reduced to the daily tantrums of Schaeuble and Varoufakis has a permanent future? Indeed, the best bet in all of Christendom at the moment is that the EMU—at least in its current configuration—is going to blow sky high. How well will 115 bps of Spanish yield work out in that event?
Besides that, where’s the evidence that sovereign risk and inflation have been abolished? If anything, there is a near certainty that the collapsing euro exchange rate will bring inflation——missing in action for about three months now—roaring back into the Eurozone’s HICP. Not only has it been reliably dwelling there since the euro’s inception, but Europe does import about $2 trillion of goods and services each year much of it—–including nearly all its energy—-priced in dollars.
Surely no sentient bond investor would conclude that the tiny downward hook for recent months shown in the graph below signals that inflation has disappeared forever. Indeed, since nominal yields would have produced a negative return even at the “lowflation” of the past year, traditional metrics would suggest that today’s traders have lost it.
Eurozone harmonized CPI
And so goes the same for credit risk. Italy, for instance, is manifestly ungovernable. The state share of GDP is now over 50% and Rome has no capacity to free itself from the grasp of the constituencies, special interests and crony capitalist crooks who feed on the state. So its taxes will remain oppressive and state barriers to growth immoveable.
In this context, how can its nominal GDP not remain stagnant, and its debt ratio—already at 132% of national income—not continue to climb higher? How can 115 basis points of yield possibly make sense on the sheer, undeniable facts of Italy’s fiscal dead-end?
In point of fact, however, none of this matters. That’s because the Eurozone government bond market has been driven onto the shoals by the ECB’s madcap launch into $1.2 trillion of QE. As the calculations from Barclays depicted below make clear, the ECB will be buying 2X more EGBs each month than projected net issuance. And that’s not because the Eurozone governments have suddenly eliminated their addiction to red ink. In fact, in the 2-30 year maturity category which is eligible for the Draghi program, net issuance is still running at one-quarter trillion euro per year.
So not only has price discovery in the EGB market been destroyed by the fact of QE and the prospective massive sequestration of European sovereign debt in the vaults of the ECB system banks. In addition, the structure of the operation is so contorted that it is generating flat-out irrational behavior—–the consequence of which is surely unpredictable and most certainly dangerous.
The point is, the politics of getting the Germans to go along with QE produced a financial monstrosity. To avoid credit risk and losses at the ECB level, the QE bond purchases will be made pro rata by each national central bank based on the ECB capital key. Accordingly, Germany’s central bank will be buying 11.4 billion euro of bunds per month—-or 11X the expected issuance.
The geniuses in Frankfurt have, in effect, ordered the Bundesbank to corner the market in German government debt! No wonder the 10-year German bond is trading at 22 bps—-and we are only two days into a two year program. Soon the entire German public debt will be trading at negative interest rates—and that could occur at any moment since maturities out to 7 years are already yielding in the negative column.
But that’s not the half of it. This lunacy also means that the highest quality collateral in the European financial markets—–German bunds—–will become exceedingly scare, if not non-existent. That in turn will drive the GC repo rate deep into negative territory, as well. And, as the saying goes, where the deformations and distortions go from there—-no one possibly knows.
This much is certain, however. The full ramifications of the ECB bond buying spree make Bernanke’s QE madness look tame by comparison. The Fed ended up purchasing $1.5 trillion of GSE securities, for example, out of more than $6 trillion outstanding. By contrast, the ECB program will absorb more than 4X the expected net issuance of eligible EGB and private ABS, covered mortgage bonds and other securities through September 2016.
Needless to say, long before these numbers are actually played out in the real world, the anomalies, distortions and surprises will be far-reaching, continuous and jarring. Did Mario Draghi have the slightest idea when he issued the “whatever it takes” ukase that the ECB would be driving the entire German yield curve into negative territory? Or that the ECB’s actions would gift the paralyzed Italian government with 1% interest rates and therefore enable it to plunge so deep into its debt trap that it cannot possibly recover?
Finally, add to the emerging monetary fiasco in Europe similar doses of madness in Japan, China and throughout the EM. For example, Turkish Prime Minister Erdogan’s recent ukase that the central bank must sharply lower interest rates in the context of a crashing exchange rate, and thereby complete the destruction of the Turkish Lira, makes Draghi appear to be semi-sober.
And, no, its not safe here in the USA, either. The Fed cannot possibly accomplish its planned “lift-off” without a bruising, public food fight among its members as the “incoming data” once again turns south. Indeed, based on the data already reported, it is likely that Q1 GDP will come in close to the flat-line, not the “escape velocity” on which the end of ZIRP has been predicated.
In short, we are entering a new era of spectacular financial disorder. Not only is the credit fueled global boom of the last two decades turning into unprecedented deflationary bust, but the central banks which generated it are now plunging into desperate and destructive policy spasms that will only compound the dislocations. So black swans will soon be appearing—–whole flocks of them.
Yes, by all means—duck this dip. And the next and the next.
David Stockman
That didn’t take long! Yesterday’s rip was supposed to have turned the market back up. Its close at well above the “crucial” 2060 chart point on the S&P 500 cash index meant “support” had held.
But then the euro resumed its free fall and in a few nanoseconds around 6 AM—-all bets were off. Still, this is no longer about the hourly charts on the EUR/USD or short-term movements in crude oil or end of the day robo slams on the VXX.
What’s happening is that the relentless central bank money blitz of recent years has finally pushed financial markets hard onto the shoals. Like in 2007-2008, the system is coming unhinged; there are coiled springs of price distortion everywhere and breakaway chips and shards are beginning to fly.
The absolutely preposterous yields on Eurozone 10-year government bonds (EGBs) provide today’s example of the mayhem lurking down the road. Specifically, the German bund is now trading at 0.221%, the Italian bond at 1.148% and the Spanish at 1.158%.
Yet you do not need to even think about traditional pricing metrics such as inflation and credit risk to see the lunacy of these yields. It is plainly evident that there are hundreds of basis points of risk in any of these EGB’s just on the issue of EMU break-up alone.
After all, is it really possible to believe that a currency union that has been reduced to the daily tantrums of Schaeuble and Varoufakis has a permanent future? Indeed, the best bet in all of Christendom at the moment is that the EMU—at least in its current configuration—is going to blow sky high. How well will 115 bps of Spanish yield work out in that event?
Besides that, where’s the evidence that sovereign risk and inflation have been abolished? If anything, there is a near certainty that the collapsing euro exchange rate will bring inflation——missing in action for about three months now—roaring back into the Eurozone’s HICP. Not only has it been reliably dwelling there since the euro’s inception, but Europe does import about $2 trillion of goods and services each year much of it—–including nearly all its energy—-priced in dollars.
Surely no sentient bond investor would conclude that the tiny downward hook for recent months shown in the graph below signals that inflation has disappeared forever. Indeed, since nominal yields would have produced a negative return even at the “lowflation” of the past year, traditional metrics would suggest that today’s traders have lost it.
Eurozone harmonized CPI
And so goes the same for credit risk. Italy, for instance, is manifestly ungovernable. The state share of GDP is now over 50% and Rome has no capacity to free itself from the grasp of the constituencies, special interests and crony capitalist crooks who feed on the state. So its taxes will remain oppressive and state barriers to growth immoveable.
In this context, how can its nominal GDP not remain stagnant, and its debt ratio—already at 132% of national income—not continue to climb higher? How can 115 basis points of yield possibly make sense on the sheer, undeniable facts of Italy’s fiscal dead-end?
In point of fact, however, none of this matters. That’s because the Eurozone government bond market has been driven onto the shoals by the ECB’s madcap launch into $1.2 trillion of QE. As the calculations from Barclays depicted below make clear, the ECB will be buying 2X more EGBs each month than projected net issuance. And that’s not because the Eurozone governments have suddenly eliminated their addiction to red ink. In fact, in the 2-30 year maturity category which is eligible for the Draghi program, net issuance is still running at one-quarter trillion euro per year.
So not only has price discovery in the EGB market been destroyed by the fact of QE and the prospective massive sequestration of European sovereign debt in the vaults of the ECB system banks. In addition, the structure of the operation is so contorted that it is generating flat-out irrational behavior—–the consequence of which is surely unpredictable and most certainly dangerous.
The point is, the politics of getting the Germans to go along with QE produced a financial monstrosity. To avoid credit risk and losses at the ECB level, the QE bond purchases will be made pro rata by each national central bank based on the ECB capital key. Accordingly, Germany’s central bank will be buying 11.4 billion euro of bunds per month—-or 11X the expected issuance.
The geniuses in Frankfurt have, in effect, ordered the Bundesbank to corner the market in German government debt! No wonder the 10-year German bond is trading at 22 bps—-and we are only two days into a two year program. Soon the entire German public debt will be trading at negative interest rates—and that could occur at any moment since maturities out to 7 years are already yielding in the negative column.
But that’s not the half of it. This lunacy also means that the highest quality collateral in the European financial markets—–German bunds—–will become exceedingly scare, if not non-existent. That in turn will drive the GC repo rate deep into negative territory, as well. And, as the saying goes, where the deformations and distortions go from there—-no one possibly knows.
This much is certain, however. The full ramifications of the ECB bond buying spree make Bernanke’s QE madness look tame by comparison. The Fed ended up purchasing $1.5 trillion of GSE securities, for example, out of more than $6 trillion outstanding. By contrast, the ECB program will absorb more than 4X the expected net issuance of eligible EGB and private ABS, covered mortgage bonds and other securities through September 2016.
Needless to say, long before these numbers are actually played out in the real world, the anomalies, distortions and surprises will be far-reaching, continuous and jarring. Did Mario Draghi have the slightest idea when he issued the “whatever it takes” ukase that the ECB would be driving the entire German yield curve into negative territory? Or that the ECB’s actions would gift the paralyzed Italian government with 1% interest rates and therefore enable it to plunge so deep into its debt trap that it cannot possibly recover?
Finally, add to the emerging monetary fiasco in Europe similar doses of madness in Japan, China and throughout the EM. For example, Turkish Prime Minister Erdogan’s recent ukase that the central bank must sharply lower interest rates in the context of a crashing exchange rate, and thereby complete the destruction of the Turkish Lira, makes Draghi appear to be semi-sober.
And, no, its not safe here in the USA, either. The Fed cannot possibly accomplish its planned “lift-off” without a bruising, public food fight among its members as the “incoming data” once again turns south. Indeed, based on the data already reported, it is likely that Q1 GDP will come in close to the flat-line, not the “escape velocity” on which the end of ZIRP has been predicated.
In short, we are entering a new era of spectacular financial disorder. Not only is the credit fueled global boom of the last two decades turning into unprecedented deflationary bust, but the central banks which generated it are now plunging into desperate and destructive policy spasms that will only compound the dislocations. So black swans will soon be appearing—–whole flocks of them.
Yes, by all means—duck this dip. And the next and the next.
David Stockman
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