The Bond Market Stopped Being Polite Last December

The Bond Market Stopped Being Polite Last December
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It almost rises to the level of a paradox. Whenever things go wrong, you can be sure officials will be quick to blame speculators. At the end of last October, for example, the People’s Bank of China began a series of stepped up bill auctions. The country’s currency, CNY, had been plummeting against the dollar for most of the year. In an attempt to stop the bleeding, a falling currency is no stimulus, the central bank aimed to drain liquidity out of Hong Kong.

These were cash management bills being issued quite purposefully in China’s offshore RMB market (CNH). By soaking up excess liquidity, offering a decent return on short-term risk-free, this would make it harder for speculators to borrow RMB with which to short CNH. That’s the theory, anyway.

So far, CNY has regained its footing. Whether it stays that way is an open question. China has much bigger problems than Hong Kong currency opportunists. Falling CNH or CNY has almost nothing to do with them, and everything to do with worldwide monetary malfunction.

It’s easy to forget that the more basic the market, the less likely there are speculators involved in it at any capacity; at least of the sort that gains so much official disdain. Everyone who participates in a market speculates, so it’s impossible to create any legitimate distinction.

In the textbook, market makers run matched books so they wouldn’t qualify. In theory. What central bankers aim to do, or what they often think they are doing, is to clear the field of non-economic bettors attempting to make money for no discernable economic purpose. Get these out of the markets, or make it harder for them to wreak their selfish havoc, and the market’s natural buoyancy will take over again.

As we know it rarely works in practice how it is written in Economics. Money dealers of this type are never neutral and therefore they are among the heaviest of any speculative players.

A big part of the reason for that is how these most fundamental financial institutions operate. They occupy a very special place in the systemic hierarchy, placed there by very clear necessity. As such, they observe a lot that we never can. If something is wrong in Brazil, hypothetically, and therefore the Brazilians aren’t in that much demand for global financing the banks will know it before it ever shows up in some economic or financial statistic.

If dealers were running a neutral book, bad luck for Brazil. Since they don’t, dealers can take that “inside” information and use that knowledge to adjust their own positions. Maybe Brazil’s problems are idiosyncratic, and global banks simply reset their base and move their capacities to another location that isn’t so risky.

Or, this global network might sense that what’s wrong in Brazil is itself a symptom of something else. In this alternate case, they may even decide to reduce more of their speculative positions including those that might not seem to have any direct connection to Brazil at all.

And the more they do just that, the unhealthier market signals can become. In response, the near paradox, the worse it gets for markets due to this inside knowledge the more the official sector tends to incorrectly blame speculators who aren’t even there. The fault lies with officials, not dealers nor speculators.

The reason is obvious. No central banker will allow any market to disagree. If they say the economy is booming and dealers get a very real-time sense it’s not, the dealers are going to act contrary to what the central banker says and does. In the central banker’s mind this simply cannot be because he believes (based often on surveys of only Economists working at these firms) they all unequivocally agree with him.

Thus, the only real choice is for monetary officials to either blame evil speculators or themselves. Economists never say they are sorry.

Markets were rocked way off their axis in December, the culmination of several months of growing risk-aversion. From October through the end of last year, curves more than anything suggested something bad was happening right then. Inversion in eurodollar futures or US Treasuries, a picked up bid for German bunds already yielding practically nothing, even JGB’s getting back to negative yields, there was a palpable sense that something went very wrong.

And that sense was being delivered from the inside out; it is the dealers who distort curves, not speculators. If eurodollar futures are being bid more and more down the curve meaning forward in time, inverting the thing, that’s not some day trader or the 40-year old office worker adjusting her 401(k). There is no Mrs. Watanabe pushing down on the bond markets, offshore repo collateral, and derivatives in FX.

As more and more data has come in, it has almost uniformly confirmed the negative impression. All around the world, it appears as if the global economy struck a landmine during that October-December window.

EM data has been negative. China imports collapsed, the level of exports leaving the country down for the first time in years. Italy fell into technical recession and the latest data from Eurostat suggests the entire European economy if not already joining the Italians it will be soon enough. Industrial Production fell by 3.6% - in December – just about equaling the worst month during Europe’s last outright recession.

German GDP was ever so slightly positive in Q4 after having been negative in Q3. While that may avoid a rush of media headlines putting Germany’s economy in the same position as Italy’s, rather than suggesting a contraction has been avoided it actually confirms that very danger. Six months of slightly negative “growth” in this sort of environment is almost surely a first step in the wrong direction. If Germany is in trouble, the rest of the world must already be.

But what about America? The US has seemed above it all. While minor and intermittent negative indications had been gathered up around the rest of the world during 2018, our economy was written up glowingly. The term “decoupling” was even resurrected to suggest that whatever else may be going on out there, it wasn’t going to happen here.

The primary datapoint agreeing with that view was the unemployment rate. It was so good, so unbelievably awesome, that it was suggesting businesses both needed desperately to hire new workers as well as finding it more and more difficult to do so. Compared to the lethargy of the last decade, these were terrific problems to have. This contrasted so sharply with global experience.

It didn’t matter that these very same markets kept disagreeing with the assessment. In the mainstream, if Jay Powell has the unemployment rate then those evil speculators be damned.

The employment condition was, supposedly, the US system’s chief point of strength. Yet, once the oil market turned starting last October, that view has been exposed. If the labor market was as it has been claimed, then inflation would be accelerating. It would have to be.

Firms that compete for workers are forced to pay more to secure them. No company is going to idly submit to higher costs, therefore they will adjust the prices of their products to reflect these circumstances. If it doesn’t show up in the CPI, then either they can’t pass along higher costs to consumers or they aren’t competing for workers in the first place.

Neither of those options suggest an immunized American economy. Instead, they propose a still unhealthy one.

As it has turned out, nothing has shown up in the CPI. The latest reading for January 2019 from the Bureau of Labor Statistics puts consumer price inflation at the lowest level in more than two years; going all the way back to September 2016. The growth rate rises and now falls solely on oil. Powell’s unemployment rate has been missing its mark.

The BLS, though, is one of the few government agencies that has been able to remain current with its statistics. The federal government shutdown from December into last month meant that quite a few agencies responsible for surveying economic participants and then crunching panel information turning it all into economic data went unfunded. Without funding, no data.

At one of the most crucial moments in recent history, all surrounding this one particularly momentous month, December 2018, US data almost totally disappeared.

The Census Bureau, for one, went completely dark. They are just now catching up to accounts that while always in arrears are now several months behind. One of its first to be brought back on line was US trade in November. Not nearly as bad as China, still the figures weren’t good. An ominous sign suggesting deterioration from October.

Yesterday, they put out the big one. Though many will try, there is no way to spin retail sales numbers this bad. For December.

Already, mainstream commentary clinging by the smallest thread to the unemployment rate has excused some of it as if the government shutdown itself is (partly) responsible, that it was cold, how gasoline prices had fallen, etc.

Year-over-year, retail sales were up just 1.44% (unadjusted). During a typical recession, retail sales since they don’t factor inflation will still grow by an average of 3%. Seasonally-adjusted, December retail sales collapsed by 1.24% from November 2018. The last time there was a monthly decline of this magnitude was in 2009 as the global economy was stumbling out of the Great “Recession.”

And this wasn’t for the month of September or February, either. December is the big one, the month every single retailer around has pinned for its calendar all year. Christmas is everything in the industry. Retail sales jut up during this special month (in the unadjusted data) because Americans spend far more for the holidays than they do at any other time.

Or, they usually do.

At Christmas 2015, during the worst of the last global downturn, retail sales managed to grow by 0.36% month-over-month (before crashing in January 2016). Minus one point two is equal to what happened in December 2007 – the first month of the Great “Recession”, holiday spending crushed by the weight of a housing bubble by then totally unraveling.

You know who didn’t need the Census Bureau to confirm that the US labor market wasn’t holding up, and that American spending and therefore the entire economy was actually at high risk of being pulled into the enlarging downturn vortex? Speculators. Those essential, internal money dealing agents who are privy to a lot of what is going on in the hidden economic spaces at any given moment.

They knew about, and then traded on, a whole global economic mess. It wasn’t just their financial contacts in Brazil suggesting something was up down there in South America, it was contact with agents in Brazil as well as China, Japan, Italy, even Germany, and, yes, the United States.

It takes a whole lot of determined effort to make a yield curve invert even a little. They have a natural and inherent shape. As any curve might begin to distort, there are always heavy speculators, an overwhelming number of them, looking to push it back toward normal; to arbitrage the non-hysterical side of the trade. If that curve inverts anyway, and then twists even more upside down, this hysterical side is no longer the side being viewed that way.

Chinese imports, German industry, and now American consumers. Or, two months ago all of these.

I wrote in February 2018, almost exactly a year ago:

"The Fed says inflation is coming, though even they have been forced to admit fairly regularly (including their latest policy statement released this week) they don’t really know why. It is, at this point, more an article of faith in the mainstream than rational and reasoned analysis. The bond market is once more politely (for now) suggesting they take the time to figure out what they don’t know. Money isn’t hiding, it’s constantly evolving."

The bond market stopped being polite about economic risks last December. They’ll say it was unexpected, but unsurprisingly it seems pretty clear that all the biggest parts of the global economy have now confirmed them. Speculators, every last one. 


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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