Recap 2015-02-03: The Narrative as I see it


The market action the past month has been quite interesting in light of the macro backdrop. There are a few items worth highlighting in particular:

1 – US consumer confidence, a leading indicator of employment and wage prospects, rising to the highest level since the recession.

2 – The ECB announced that it will be conducting a QE program that will be more aggressive than expected

3 – The SNB dropped its floor

4 – oil prices continued to fall

In aggregate, these items suggest solid growth and benign central bank policy, and provide a good rationale for a risk on move in asset prices, along with rising yields. Instead, of course, we’ve seen the opposite. What gives? I haven’t read many good narratives explaining this, so I will attempt to do so here.

I think a key aspect of last month’s price action was ultimately driven by a squeeze in positive yielding sovereign debt. Unwillingness to take a loss is a natural drive for everyone. So as more and more high quality Euro denominated debt began to trade with a negative yield, (16% of JPM’s Global Gov’t bond index, according to their latest tally) global asset managers began a massive move into positive yielding fixed income assets, even if they had to take on currency risk. The managers who were impacted the most, of course, were European. The massive drop in the trade weighted EUR the past month, well past where fundamental models would’ve predicted, is likely one of the first round effects of that squeeze. The chart below shows the EURUSD in white vs the US 30yr yield in orange. As the chart shows, US bond tried to sell off intermittently over the past few months, but did not sustain the move as inflows from Europe continued to drive the EUR, as well as US yields, lower. This is an effect that was not limited to the US – even Japanese bond yields moved sharply lower the past month.

The result of this global shift had a number of second round effects. One of the first is that credit spreads, especially at longer maturities, widened. This occurred simply because risk free yields fell, even as corporate yields were stable. The widening in long term investment grade credit spreads (which is quite substantial, hitting levels not seen since 2012) likely resulted in a shift out of equities and into long dated corporate bonds by long duration asset managers, and in general a risk off move, given that debt is senior to equities in the capital structure.

If you’ve been following my short story so far, you’ll probably notice that in my version at least, the EUR is something of a leading indicator for this duration squeeze. And as I and many others expected, the last ECB meeting roughly marked a low in the cross. It’s still tentative, to be sure, but the EUR is not the only sign suggesting this. Sovereign yields globally, even in Japan, have reversed sharply in the past few days. (h/t CP) In addition to the EUR, other indicators are suggestive of a low in yields. The improvement in global PMI is the most important fundamentally, but so are the rebounds across non-precious commodities.

Now, I’ve been bearish duration for over a month now, and clearly have been wrong thus far. So make what you will of all this. But I remain convinced that long term yields in most developed countries globally are too low on an intermediate time frame, and I continue to expect that to play out in the coming months. This suggests that yield sensitive equity sectors like Utilities and REITS are likely to underperform.

The global fixed income squeeze has also resulted in higher volatility across asset classes. People seem to chalk it all up to the fact that the Fed’s QE is over, but I’m not quite sure about that. The capital flows I noted above, along with the oil-driven widening in High Yield credit are themselves more than sufficient to explain the rise in delivered vol, IMO. A continuation of the equity rally should result in a reversion of the volatility rise YTD.


  • RBA cut rates by 25bps to 2.25% vs no change exp. Statement:
  • Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet… Dwelling prices have continued to rise strongly in Sydney, though trends have been more varied in a number of other cities over recent months. The Bank is working with other regulators to assess and contain economic risks that may arise from the housing market… The Australian dollar has declined noticeably against a rising US dollar over recent months, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy…
  • JPM: The Danish central bank spent DKK 106.3bn to weaken the currency in January. This is almost exactly in line with point estimates based on the commercial banks’ liquidity data, albeit there was still a reasonable margin for error around that estimate. The intervention equates to 5.6% of GDP and is nearly three times the size of the Nationalbank’s previous largest monthly intervention… Denmark’s FX reserves are still ‘only’ 30% of GDP even after January’s record-breaking FX intervention. The Danish central bank has released a statement alongside the data stressing that it has an unlimited supply of kroner to sell.


  • Tue: New Zealand Unemployment, Wheeler Speaks, Japan PMI
  • Wed: EU Services PMI, US ADP Employment, Non-Mfg ISM, Australia Retail Sales
  • Thu: BoE, US Unit Labor Costs, Jobless Claims,
  • Fri: US Employment, Canada Employment
  • Mon: China Trade Balance, Japan Eco Watchers Survey, Canada Housing Starts, Australia NAB Business Confidence