I haven’t been very active the past few weeks – mostly because I have been trying to make sense of how the markets could possibly be flattening when all things have been pointing to a massive steepening: (1) The Fed and ECB Pillars of long rates cracking as they get closer to tapers later this year, combined with (2) higher longer term rates causing equities to correct on a valuation basis.  One would think this double tightening of financial conditions would extend out the Fed’s “gradual” hiking approach.  We did get a reasonable steepening last week, but we are far from the yield highs made earlier this year.  The main thing holding me back from adding to our longer end bearish/steepening positions has been the noticeably weaker inflation and retail data.  As you know, when I try to sort out conflicting thoughts, I just like jotting them down and evaluating.

  • I’m going to channel my inner John Murphy (technical analyst) and just point out that ten year cash yields are near this year’s downtrend line and 10 year and 30 year futures are at recent support levels (possibly forming a double bottom or head and shoulders). We could be setting up for a large move.
  • The price action could be interesting on a lightly-manned 4th of July Monday. Because if someone wanted to mess with the technical traders and algos, Monday would be it.
  • Gundlach (a bear) was in hiding during the rally, and now he seems to be possessed by Trump and tweeting multiple times a day. I’m not sure if this is a sign of a reversal or a continuation.
  • Remember the Bernanke Taper Tantrum? This could be a Draghi Taper Tantrum.  I just want to remind people that during Bernanke’s taper tantrum, ED greens-golds pack spread got to 210bps (currently 40.5bps and a 6mo low of 30.5bps) and ED greens-blues-golds year fly got to 30bps (currently 1.4bps and 6mo low of 0.6bps).  I’m not suggesting we get anywhere near those levels, because: (1) the Fed has hiked 4 times already, removing 100bps of steepening potential from the longer end of the curve, (2) the Fed may hike a little more in the next year or two, taking more longer end steepening potential away, and (3) the BOJ is likely to keep QE for some time.  That having been said, the flattening levels reached last week were absurd when: (1) the Fed seems anxious to start the tapering of reinvestments (probably September), and (2) the ECB is less dovish (and may discuss tapering within the next year), and (3) central banks seem concerned about market complacency and valuations.
  • We’re probably not going to get further bearish comments from Draghi in the very near term. He may be freaking out right now that the Euro is so strong.  But sometimes when you start a small fire, it may start burning out of control.
  • EDs sold off despite the weaker (inflation) data, thanks to assists from the other central bankers (Draghi, Carney, and Poloz). The green pack in EDs were down 15.6bps on the week.  But ER (EU) greens were down 15.7bps, L (UK) green were down 18.5bps and BA (Canada) greens were down a whopping 24.7bps.  With the bond markets becoming more globalized, the US long end is going to get a tailwind from the other bond markets.
  • The latest inflation data in the US was not particularly inspiring for bears. I suppose you could have expected weaker PCE inflation from the disappointing CPI data.  However, it’s unclear the Fed has to do much with inflation so low.
  • The flattener folks haven’t given up. EDU9 1yr fly was actually DOWN 0.5bps on the week from already-low levels, on a steepening and reflating curve.  I suspected the people liking flattneners (because they like the low terminal rate story) may have been hedging their position for tapering with shorts in the 30 year bond last week.  But the last two days have seen better curvature action around the greens, so perhaps we are starting to see some capitulation.  We’ll have a better idea next week.
  • I believe in reflation and longer term hikes (all other things being equal). However, I’m not a big believer of 2017 hikes.  Yes – Yellen, Fischer and Dudley all have dots showing another hike this year.  And they have sounded somewhat confident that inflation would rise.  But it has fallen… more.  4% core PCE (and headline PCE) does not scream the need for another hike this year.  Neither does unchanged retail sales the past 4 months (0% growth).  Let’s see how the data plays out next week.

Speaking of data next week, I think we could get some interesting price action next week, so let’s plan ahead…