Recap 1-13-12

Main Items:

  • US Consumer Sentiment improved to 74 in Jan, vs 71.5 exp and 69.9 prev
  • US Import Price Index declined to 8.5% YoY in Dec vs 8.4% exp and 9.9% prev
  • US Trade deficit worsened to 47.8bn in Nov, worse than expected. This will likely decrease 4Q GDP estimates by up to 50bps.
  • JPM earnings were inline at 90c, but Revenues missed: 21.47bn vs 22.56bn exp. JPM is now finished repurchasing stock.
  • Greece: IIF talks paused, no ‘constructive’ response. IIF said it hopes Greece will be in a position to re-engage talks. This is supposedly a negotiating tactic. –Dealbook
  • S&P Cuts:
  1. Italy by 2 levels to BBB+
  2. France will lose AAA
  3. Austria will lose AAA

Overseas:

  • UK PPI Output Core declined to 3.0% YoY in Dec vs 3.2% exp and prev

Commentary:

One of the interesting disconnects today is the wide divergence between the strength of US data and US treasury yields. The chart below of the 10y (white) and US economic surprise index illustrates this nicely.

Naturally, the questions are: (1) why is this happening and (2) when will the relationship come back?
The sheer size of the US treasury market suggests that any answer to (1) requires the involvement of major real money entities. Possible answers to (1) include buying by entities that no longer want EU sovereign debt, buying by the Fed, and lower GDP long term expectations. At the risk of assuming correlation = causality, given that the disconnect appears to have occurred in conjunction with the sharp widening in EU sovereign spreads, a strong candidate appears to be that various real money entities have stopped buying sovereign EU debt in favor of Treasuries. Here is a chart of all 3 data series, with the spread of 10y French debt over bunds in yellow:

If this hypothesis is correct, Treasury yields and US data surprises are likely to re-couple only if both (a) EU sovereign spreads tighten on a sustained basis and (b) US data continues to surprise on the upside.

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4 thoughts on “Recap 1-13-12

  1. In my view, the relationship between the surprise index has broken down because there is too much capital out there (this is an explanation for a lot of things that I see out there). When big banks were leveraged to the hilt, US consumers were borrowing like crazy and Western governments were running sizeable (but manageable) deficits, capital was much more discerning, as there were any number of “safe” investments. Now with huge deleveraging going on across the private sector in the Western world, there is just too much cash out there (when people de-lever, savers are left with cash to deploy). With a paucity of credit demand from “safe” debtors, major government bonds markets are seeing enormous inflows – hence the depressed yields. If this analysis is correct, this will be a factor for years to come – there is going to be a TON of capital destroyed by inflation in the major government bond markets.

  2. Yes that certainly is the question. I think the answer is that deleveraging is ongoing (ie more cash to be put to work) and that this relationship will suffer until that process is complete. That being said, it is hard to imagine a more complete breakdown in correlations.

    A more specific inquiry into how the Citi economic surprise index is calculated may allow truly inquiring minds to come up with a better answer to why the correlation has broken down (could it be explained by grouping of estimates at low levels, or possibly a higher dispersion in estimates etc?). I am not very familiar with how this index works is there a document available detailing how it is generated?

    I do think you are on to something with your comments about real money avoiding euro-denominated assets like the plague..

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