I’ve been thinking about the Churchill quote referring to Russia. Rather than referencing Russia my thoughts turn to the flattening yield curves that began on Monday. As commodity, global equities markets, the Chinese yuan and the precious metals all staged strong rallies, the long-end of the yield curve also rallied, especially the 10-YEAR. As a result, the 2/10 curve flattened to a 10-year low of 15 basis points. On Tuesday, the curves flattened even more as the 2/10 closed at 10.7 basis points. As Vizzini from the Princess Bride would say, “INCONCEIVABLE!” To support the rally in the long-end of the curve there was a retracement of the recent rally in global equity markets (the NIKKEI, DAX and S&Ps were all down substantially). This suggests that the positive news from the G-20 meeting has now been cast asunder because investors are struggling to comprehend what actually took place in Buenos Aires between the U.S. and Chinese delegations.
The more Kudlow, Mnuchin and Trump talk, the more confused business leaders and investors become. The Trump team cannot broadcast a consistent message so the markets are left to wonder what was agreed to at the end of the G-20 conclave. The official communique was a cacophony of platitudes reading like the Democrats or Republicans campaign platforms: 31 points of concern about world problems and promises to confront them all upon arrival home. There were promises to reform the WTO rules in a bow to Trump. Infrastructure was noted as a key driver of economic prosperity, therefore more money through public/private partnerships will be sought (a nod to Macron and the Italians). Point 27 was a nod to everybody but Trump as international trade and investment were acknowledged to be an “important engine of growth, productivity, innovation, job creation and development.” This was followed by promises to reform the WTO in an effort to improve a rules based multilateral trading system.
There was something for everyone. The Chinese even seemed to be willing to take a page from MAO. The effort to be non-provocative would allow time to reconcile the criticisms raised by the Americans and others. The Chinese view the world with a much greater respect for time. It takes more than a QUARTER for many things to unfold. (This of course was summed up in the exchange between Chou En-Lai and Henry Kissinger about the French Revolution in 1971 when they first met to discuss Nixon’s trip to China). Again, as the markets digest the multitude of White House leaks and tweets, the stock markets took three steps back, which supported Monday’s curve flattening.
Except I am not buying into the nonsense of this flattening for if the U.S. economy is beginning to slow and inflation is receding I offer this: The current deficit is going to explode, making the supply-siders in the Trump administration and their projections appear very wrong. I SAY IT AGAIN: ANYBODY BUYING U.S. long duration Treasuries need THEIR HEADS EXAMINED. Because the trillion-dollar deficit this year with a 3.7% unemployment rate is beyond reprehensible, especially since we have a president who has prided himself on being a “BIG SPENDER.” Why is the curve so dramatically flattening? There are numerous conjectures but I surmise that the combination of fed rate hikes and a balance sheet unwind is taking its toll, regardless of what New York Fed Vice President Simon Potter maintains.
Regardless, I am not looking to get long 10- or 30-year debt. I would be more comfortable buying steepeners, BUT I HAVE NOT MADE A LIVING DEFYING MARKET ACTION. I will be patient and wait. The 5/30 curve, which has been a far different story, flattened the last two days as the power of the 2/10 forced capitulation on the 5/30 and is back to testing its 200-day support. Pay attention. The only markets that held their Monday rallies were: yuan, oil, gold and silver, and BONDS. As I warned in the previous blog post, pay close attention to the YUAN.
One thing is certain: Robert Lighthizer is the lead negotiator with the Chinese and as a veteran of the James Baker team of the Plaza Accord BOB LIGHTHIZER KNOWS CURRENCIES. The appreciation of the YUAN will buy goodwill with the negotiator-in-chief. These are difficult times, indeed. Remember that some of the uncertainty in the bond markets is a residual of massive central bank intervention and is breaking the signalling mechanism of the bond vigilantes.
***Europe’s leaders did not suffer the wrath of Trump as there was no direct attack upon the European auto sector, while Chancellor Merkel and President Macron were saddled with their own problems. Also, Trump was very diplomatic in deference to the passing of President Bush 41. An attack upon the EU would have been an insult to George H.W. Bush as the media was gushing over the wisdom that it took to unify Germany and solidify a United Europe after the collapse of the Soviet Union. But on Tuesday, the three largest German automakers met with Lighthizer and Secretary Ross in an effort to dissuade the Trump administration from invoking tariffs of German auto exports to the U.S. under the guise of national security.
As previously discussed, Europe has many problems as the ECB QE program is set to end. There’s Italian debt, Brexit, a slowing German economy, and the rise of populism in so many EU nations. On Monday, there was a story in the Financial Times titled, “Scholz Says France Should Give UN Security Council Seat to EU.” The German Foreign Minister publicly chided the French for hoarding its veto on the UN Security Council when it should be a seat held by all of Europe. Another fissure in the EU edifice. Oh, and German bunds closed at 26 basis points. The most despised financial instrument in the developed economic world refuses to depreciate. A riddle, wrapped.