With global stock indices, and the S&P, both just shy of all time highs, even as bond yields stubbornly refuse to validate the "equity upside" story, Bloomberg's macro commentator Richard Breslow, looking at recent yields and spreads writes that "in reality, these spreads just can’t be doing what they’re doing if the tapering and rate-hike stories were truly being given credibility" and has a troubling thought: "what is bond yields have been right all along"? If that's the case, "what we are actually seeing is the re-emergence of that horrible construct, which apparently never went away: “Bad news is good news.” That would mean that "the Fed, and everyone else, had better hope that we begin to see wage inflation creep, not leap, higher. That non-employment related inflation stays away. And we have a long period of slowly rising rates with objectives higher, but not dramatically so." Why? Because "that’s about the only scenario that ends as well as promised." He explains his concern in his latest overnight Trader's Notes:
# Worry That Bond Yields Have Been Right All Along.
What if we’ve been seeing what’s going on and have consistently, and over-optimistically, misinterpreted the cause? That’s a really scary thought if the trades you contemplate are based on the effect without a proper understanding of the actual drivers influencing the investing environment. It may be a reality that unrepentant bond bears have to consider.
That the global economy has been doing better is undeniable. But while it’s easy to celebrate the improved direction of things, we may have to ask ourselves whether it’s really appropriate to pop open the champagne corks? From some asset-price movements you would have to conclude yes. But there are more important ones, lamentably and intractably, warning, “not so fast, buster”
Credit spreads continue to compress. U.S. investment grade OAS is a mere 5 basis points off multi-year tights. High yield has spent the last month coming in yet another 20 basis points. Peripheral spreads in Europe have lessened smartly. The 10-year Italy-to-Germany spread made a new YTD low on Tuesday. After all, everything is good there...
I’ve been associating these moves with a risk-on world that, given the aversion of central banks to upsetting anything financial condition-related, would translate into core sovereign yield curves shifting higher in a benign and measured fashion. But, in reality, these spreads just can’t be doing what they’re doing if the tapering and rate-hike stories were truly being given credibility.
So how then might the story line read? That all this nonsense that globally rising rates and widespread balance sheet reduction just can’t be a calm experience. Investors simply own too much toxic “financial products” to make that likely. And they continue to add. If spreads are still coming in, it means one of two things. People believe the hard data and just aren’t yet accepting what they are being told. Or they’re just too deep into the trade that they’d rather meet their return benchmarks now and not even think about the consequences.
But it seems just as likely that along with all of the hawkish and upbeat rate talk we are periodically subjected to in policy-maker speeches, what we are actually seeing is the re-emergence of that horrible construct, which apparently never went away: “Bad news is good news”. That the more important factor is that the Treasury 10-year at about 2.25% and the bund at all of 45 basis points are warning signs we’d so love to be able to ignore. But how’s doing so been working out for you?
The Fed, and everyone else, had better hope that we begin to see wage inflation creep, not leap, higher. That non-employment related inflation stays away. And we have a long period of slowly rising rates with objectives higher, but not dramatically so. That’s about the only scenario that ends as well as promised ....