Weldon's Money Monitor
We sense change ... a macro-change ... wafting ... as the theme of strategic portfolio allocation adjustments comes to the fore, ala the gyrations evolving in several key stock-bond linked derivatives.
Indeed, the yield on the U.S. long-bond sits at an historically LOW level, a level reached on only ONE other 'occasion', when deflation was posing a palatable risk to the global macro-economy.
It was not THAT long ago, that the press was RIFE with headlines related to plummeting rates, and thoughts of sub-zero yields.
Now, with LITTLE fan-fare at ALL ... bond yields are traversing into the netherlands below. In fact, most ALL of the fixed-income focus remains on the rising yields being posted in the short-end of the curve ...
... facilitating the conclusion that a flattening yield curve was purely a function of rising short-yields, rather than, diminishing reflation risk, as might be manifest within LOWER long-bond yields.
More INTRIGUING from the macro-perspective, we note our old standby portfolio-allocation indicator, as defined by the long-term momentum studies applied to the weekly Bond-Stock Ratio Spread created utilizing the 30-Year T-Bond, and cash S+P 500 Index.
Amid a reassessment of reflated equity valuations ... in line with the macro-message of the same weepy-tone, delivered by a flattening yield curve ... the U.S. long-bond is rallying relative to the S+P 500 ...
... and, more importantly, has violated the 52-week moving average, although, the MA remains in a downtrend, directionally, for now.
More 'telling' is the renewed directional 'rally' in the long-term Oscillator, a preliminary signal that would be confirmed with a move into positive territory by the oscillator reading itself.
Hence, at 'best' ... for wanna-be-stock-reflation-bulls ... the situation is neutral.
At worst, it's much worse.
At worst, the BEST was already priced, and probably already UN-achieved.
Here it is, the 1Q 2005, and MEGA-LOW corporate bond yield spreads along with mega-low Agency, Emerging, and Mortgage yield spreads ... in line with the reflated equity indexes, HAD priced in the BEST case eco-scenario ...
... a sustained industrial growth track.
Indeed, here it is ... the 1Q of 2005 ... with LITTLE impetus from ANYWHERE, to provide the requisite, and now sorely lacking, engine of growth.
Sure, Capacity Utilization has risen, BUT it remains FAR BELOW being ... constrained in ANY way, shape, or form.
Margin relief from lower PPI pressure may be a slight positive, BUT, overall margins are still NEGATIVE, and, there are signs of accelerating downside push, margin-wise, in some finished goods categories, ala Fed Regional Survey results.
The inventory cycle ... appears exhausted.
Fiscal policy, is nowhere to be found.
Monetary policy remains an enigma, but is HARDLY 'trending' in favor of the consumer wealth reflation theme.
Indeed, one of the biggest 'what-IF-risks' emanates from a FLAT-LINED scenario, where GDP growth equals inflation, while 'real' income growth continues to ERODE.
In other words, NO change ... will look BAD.
And, no change in the U.S. ... spells BIG trouble abroad, as cheap reflated asset-liquidity has been funneled into emerging equity markets.
This spells rally for safe-high-yielding instruments, such as European, Canadian, and U.S. government long-dated debt.
AND ... considering the INSTITUTIONAL SHORT position in U.S. Treasuries, in line with heavy exposure in credit spreads, via long everything against UST ...
... the situation in the long-end could be EXPLOSIVE.
Enough so to imply that the REST of the yield curve flattening ... will be DEFINED by long-yields that are collapsing into short-end yields, while STILL reversing, and expanding their yield discount to other debt.
Evidence some ODDITIES ... that suggest a waft-and-wisp of wind ...
... ala the upside price breakout in the stock-market derivative linked to the long-bond, via the Lehman 20-Year+ Bond Fund I-Share. ...
... which APPEARS to be breaking out to the upside WITH the I-Share for the Goldman Sachs Corporate Bond Fund, as shown below, violating a downtrend line amid heavy accumulation.
BUT ... suddenly ... the latest surge in DEMAND for debt ... is MORE HEAVILY weighted in the safety of the LONG TREASURY arena, as defined by the FACT that the Goldman Corporate Fund I-Share is breaking DOWN relative to the Lehman Long-Treasury Fund, as seen in the chart below.
VOILA ...the long-bond yield in the U.S. plunges to its lowest level since 2003.
Until now, the yield curve flattening portended a flattening in reflation risk.
Now, long-bond yield declines portend a time when the Fed will claim victory over reflation risk.
Let's look at this analogy.
The Fed is in the monetary policy elevator, in the skyscraper we might call the global macro-economy. In the elevator next to the Fed, rides inflation-deflation-risk.
The Fed elevator is equipped with a series of lights that indicate which 'floor' inflation-deflation-risk has most recently visited.
BUT, inflation-deflation in-motion, inter-floor movements are hidden.
The Fed, attempts to get their elevator, to the same floor as inflation-deflation-risk, where they can confront their adversary, and claim victory, albeit temporarily.
Such a circumstance, with MEGA-LOW inflation, and MEGA-LOW official interest rates, occurred in 2003 when the Fed declared victory over deflation, and circumvented a run by the elevators, to below 'ground-level'.
However, since then, the inflation-deflation-risk elevator has been moving, sometimes rapidly, and most often to higher floors.
Recently, as of the December CPI report, some of the year-year readings suggest that the inflation elevator has risen to a new high floor ...
... while ... the FORWARD yr-yr considerations, and, the NEAR-TERM readings, strongly suggest that the inflation-deflation-risk elevator is now, reversed, has peaked, and is already headed towards ... lower floors.
As of now, few will dispute, that the 'neutral' floor at which the Fed seeks to claim a NEW victory, over reflation-overheating-risk ... remains at a higher floor than the one at which the Fed's monetary policy elevator currently rests.
BUT, now, the risk of the Fed taking their elevator TOO HIGH ...
... and PASSING an inflation-deflation-risk elevator that is moving in the OPPOSITE direction ...
... is growing.
Thus, from a yield-curve that portended a flattening reflation ...
... we now have LOW AND FALLING long-end yields, in MANY countries, portending a DIMINSHED forward reflation risk.
This helps explain WHY the Goldman Corporate Fund can be rallying, nominally (thanks to a diminished forward over-heated reflation risk) ...
... as it BEGINS TO UNDERPERFORM ... the pure safety of Treasuries, insulated as they will be, from any hint of RISING disinflation risk.
In other words, while the inflation elevator is falling, but at a floor above the Fed monetary policy elevator, credit spreads are not yet coming under scrutiny. When the elevators PASS one another, and the inflation elevator becomes the disinflation elevator ... credit spreads could become THE focus.
INDEED, such is EXACTLY as it SHOULD BE ... as the Fed ACTUALLY BEOMES ...
... gasp ... tight.
In fact, this is what we take away from the chart on display below, in which we plot the March05/March06 Eurodollar Deposit Rate spread ...
... which does NOT reflect thoughts of a gradually, but perpetually, tighter Fed monetary policy. Rather, this chart reflects the market's belief that the Fed elevator will NOT HAVE to rise AS HIGH as was believed ...
... BEFORE the Fed started hiking rates.
We might suggest that when this spread gets to zero ... the elevators will have already PASSED one another, and the Fed will be in a position to push the DOWN button.
In Canada, the Central Bank has stopped the elevator. Nonetheless, long-bond yields north of the border ... are making new move LOWS. ...
... amid ... a TREND acceleration ... towards a more severe curve flattening.
Perhaps MOST 'telling', sight unseen, in terms of just how HIGH the Fed's monetary elevator has climbed ... is the action in the Canadian/U.S. 10-Year yield differential, as revealed in the chart below.
Simply, as BOTH bond market yields PLUNGE towards NEW MACRO-LOWS ...
... the Canadian market is LEADING the way, a bullish factor unto-itself.
... especially ... IF ... the Canadian Dollar, likely THE reason WHY the Bank of Canada did NOT have to take their elevator to as high a floor as the Fed is likely to find itself ...
... especially IF ... the Canadian Dollar begins to depreciate.
As noted in the chart on display below, a decline in the CAD below this week's low, which converges PERFECTLY with the 2004 uptrend line, and the med-term 100-day exponential moving average ... would be considered a major technical breakdown, and, would help SOLIDIFY our entire macro-thought-process.
Bottom Line: We are becoming increasingly, and OVERTLY bullish on the long-end fixed-income instruments of the U.S., Canada, and the EU ...
... while seeking the technical confirmation required to become involved with strategic allocation adjustments AWAY from reflated equity markets, and into credit-spread narrowed U.S. Treasury long bonds, as an INVESTMENT THEME ...
... and ... via speculative interest in the Treasury market, on a RELATIVE, ala the anticipation of a return to TWO-WAY risk pricing, within credit spreads.
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