Notes From Underground: Bonds Talking Trash To the Central Banks

Last week the world’s bond markets experienced an assault propagated by the MISERABLE U.S. five-year Treasury note auction on Wednesday followed by a more dismal seven-year sale on Thursday. Also, the Australian and KIWI 10-year notes suffered massive bouts of volatility even as the RBA and RBNZ intervened with more QE to stem the rise on the long end. We at Notes From Underground have warned that the markets were attacking the FORWARD GUIDANCE motivations of the world’s monetary authorities by attacking the long end of the yield curve as the area of least resistance because central bank asset purchases around the world have been targeted at debt instruments of much shorter duration.

Prior to Wednesday’s five-year auction, the note had been stuck in a range of 45 to 60 basis points, a classic case of financial repression with PCE inflation measures at 1.75%. On Friday, the five-year yield reached 85 basis points leaving dealers and investors with substantial losses on inventory and purchases. The rapid rise in yields in the belly of the curve prompted a RALLY in the DOLLAR along with a violent selloff in many commodities as large losses in the fixed income market led to profit taking in other asset classes.

The question I continue to ask: Will the FED and other central banks allow the long end of the market to experience further yield rises potentially harming the continued hoped for robust global recovery?

The answer is not simple for we have NEVER been here before, where the LONG END of the YIELD CURVE is allowed to rise as the CENTRAL BANKS continue to advocate LOWER FOR LONGER. If the FED allows the long end to reign supreme will it curtail much of the froth in bond, equity and of course commodity markets? What will the break-point be for either the global markets or policy makers?

WE DON’T KNOW.



Every time the markets have been roiled by a dramatic rise in yields — think Bernanke Taper Tantrum and Powell Pivot — the policy makers CAVED, setting up the classic Minsky scenario where complacency increases the risk of financial instability. The FED and others tried to jawbone the market at the end of the week as the ECB proclaimed that any further rise in yields would potentially harm the European recovery. The FED remained sanguine about the rise in yields, proclaiming that it reflects the success of the U.S. central bank’s efforts to stimulate the economy creating the potential for robust job gains for those who have been most affected by the Covid shutdowns. The market gave the FED a reprieve in its assault by keeping pressure on the FIVE YEAR but purchased some 10- and 30-year debt, which flattened the curves.

There certainly is far more value in the 30- than the five-year but the point of least resistance for interest rate traders is the longer end. Will there be another attack on global long rates setting up an official statement about the necessity of YIELD CURVE CONTROL? There is precedent for what was termed the ACCORD. The battle is on as the market attacks the forward guidance policy of the world’s central banks. Lower for longer will be the RED LINE for Powell and his international cronies. The test of wills has begun.

On Thursday, the Four Horsemen of Global Macro chatted with Richard Bonugli of the Financial Repression Authority. The conversation was recorded just as the debt markets were suffering the paroxysms of a war unleashed upon the world’s central banks. Enjoy the episode as Richard Bonugli does a great job extracting reems of ideas.

Click here to listen to the episode.

As an aside, an important variable to watch is the U.S. dollar for a dramatic fall in commodity prices — which is doubtful — coupled with a steep fall in emerging market currencies would conjure concerns of a global slowdown perpetrated by the massive amounts of DOLLAR-DENOMINATED DEBTS sitting on the balance sheets of emerging market corporations and other private borrowers.

The FED may pretend to be Bartleby the Scrivener by choosing NOT TO RESPOND but the strength of BOND SELLERS may provide a force that does not allow for benign neglect. Many areas to be attentive to but most importantly follow the smoke trail of the DRAGON.