Flatter. The yield curve continues to shrink in the important middle calendar spaces where growth and inflation expectations run the place. Treasuries have been doing this since around March, a peculiar (given monolithic mainstream reporting otherwise) eight-month reign of growing pessimism rather than inflationary confidence.
Did the market foresee omicron more than half a year ago?
No. That’s not really what this has been all about. As noted yesterday, the unnervingly steady flattening (deflation potential) in the curve wasn’t so specific – and it needn’t have been. What the “bond market” has been trading is this growing suspicion that, given how the actual situation was never better than weak and artificial, the chances of something, anything going wrong were rising.
If not delta or omicron, then almost certainly another even modest shock.
And whatever the something might end up being, it would be enough to upend the set of global circumstances. Like 2018, globally synchronized growth didn’t unexpectedly transform into a globally synchronized downturn and pre-COVID recession, the transition was made plain and available to everyone in real-time.
I can't believe this needs to be pointed out, but, no, the Fed does *not* rig the bond market and it only takes about 5 seconds to prove this.— Jeffrey P. Snider (@JeffSnider_AIP) November 18, 2021
Just got out a g-damn chart.https://t.co/XfJtuue7jp pic.twitter.com/YfAVjxjaqX
Yet, to this day there are those who adamantly oppose this. Through the monumental power of the “central bank’s” balance sheet and all the Treasury (and other) assets invited onto it, the might of QE, the yield curve has been tainted to the point of trash, they say. After all, central bankers have repeatedly and plainly stated how they want interest rates to be low.
Lo and behold, low they are.
Like so many other monetary fairy tales, it sounds plausible upon first hearing the scheme. We’ve already thoroughly debunked part of this “rigging” of the bond market; I say “part” because there is another means – in theory – for where or how the Fed’s power might remain unchallenged.
What we detailed a couple weeks ago was what is called the “flow” argument. This other is the “stock” version.
The case for flow rested upon the notion of central banks constantly “being in the market” buying up Treasuries (or other), thereby causing their price to rise concurrent to the flow of central bank purchases.
Sounds nice in theory; not a single bit of evidence from practice:
What about the so-called stock effect? If QE doesn’t influence bond prices as purchases happen, and it sure doesn’t, then perhaps there is some cumulative impact from all the purchasing done from beginning to end; fewer bonds overall for the market to have had to absorb.
To try to make the case on this side of the QE argument, you’ll often see this chart employed:
On the surface, it does seem as if the more bonds central banks buy, the more “valuable” those bonds have become. But is this explanatory, or is it committing the first sin of statistics?
Correlation does not imply causation.
In fact, during a period of tight money we would expect that the prices of safe and liquid instruments would rise at nearly the same time central banks respond in their predictable way to the same tight money condition. In a world of exogenous money, like the eurodollar system, the one does not cause the other, rather both are reactions to the same thing – the exogenous money.
The fact that central banks reply in the same way as the market to tight money/deflation by buying bonds is merely the byproduct of having only one tangible tool in the kit: bank reserves.
When real, effective money (exogenous eurodollar) tightens, quite naturally there will be rising, heavy private demand for safe, liquid instruments like Treasuries and global sovereign bonds first. Central banks (eventually) then react to the deflationary symptoms of that tight money by employing their one tool, bank reserves, which requires the purchase of these same assets in order to create them.
The bond buying merely an accidental fluke, an uninteresting artifact of officials being incompetent. Thus, bond prices rise because of market action, yields drop, and then officials pile on while the media claims – absent every bit of evidence – it must be the piling on which “tainted” the bond market’s already deflationary signal.
Even Dallas Fed’s Richard Fisher (FISHER!, for god’s sake) understood at its most basic level what the Fed was doing as it wasn’t money printing or even the holding down of bond yields:
MR. FISHER. In summary, I want to mention that, as I said earlier, most of these variations that have been suggested are very un-Bagehot-like. And what I mean by that is, twisting [or QE and yield caps] entails purchasing assets that investors are fleeing toward, not assets that they are fleeing from. [emphasis added]
Correlation, not causation.
As I have often written, the Fed’s balance sheet is actually the same things, the same sort of indication as falling yields (yes, you read that right), both adding up to negative, deflationary connotations. When the central bank’s balance sheet goes up, not only is this not the cause of rising bond prices, the QE’s, again, are a reaction to the same problem which further corroborates why and how bond yields have already sunk.
If that wasn’t enough debunking (and I haven’t even touched on the deflationary effects of QE in terms of its effects on collateral availability), the final bucket of nails in the “stock” idea gets hammered home repeatedly by what my brashly astute co-host Emil Kalinowski lustily points out time and again, this being the whole rest of the “bond market” – things like eurodollar futures, swap spreads, or just the dollar’s exchange value – which is neither stock-ed nor flow-ed by central bank purchases one way or another.
In other words, it’s not just Treasury yields or sovereign bonds which very strongly display rising deflationary potential during these specific times, with the Fed’s balance sheet joining in, it is an entire array of dependable and tested financial indicators which uniformly corroborate the same notion from every important monetary, financial, and economic angle.
Like flow, stock is merely an attempt to work around what is more than an inconvenience to those wishing to (repeatedly) sell you an inflationary story without evidence. A flattening yield curve – indeed this flattening yield curve happening as it has during the highest CPIs in decades – is trying to tell you something important, the same undiluted message as has been repeatedly and properly sent time and time again.
The problem is simply QE, meaning how these messages are interpreted and perceived (distorted and twisted). I mean that in a very different way than with what this article began. Central bank bond purchases or LSAP’s (whatever anyone calls them) have been the most tested, empirically-established policy programs in perhaps economic history. It’s just that no one knows, because it is in “central banks’” best interest for you not to know, what all those tests have uniformly showed.
Flow? No. Stock. Nah. None of it does what everyone says it does. It sure doesn’t “rig” the bond market in any way.
While a flat curve may not be able to tell you what will sour the situation, it does give you a reasonable, reliable approximation for how something is highly likely to at some not-distant time.