Why Price Alone Does Not Render An Asset Class 'Safe'
AP Photo/J. David Ake
Why Price Alone Does Not Render An Asset Class 'Safe'
AP Photo/J. David Ake
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What makes “safe” assets perceived in that way isn’t really their price. Most often, the idea relates to the fact that there is a dependable market for its class that won’t fail except for the most extreme possible cases. If you have to, you can sell the thing the next day left to account only for short-term moves which shouldn’t be all that much.

The US Treasury market is right now experiencing selling “pressure”, most on its longest-dated instruments. Over the past several weeks, rates have risen; some say sharply, alarmingly in inflationary fashion, punctuated by a particularly big move just yesterday.

Price volatility even in safe fixed income classes such as US Treasuries is nothing new. And this “bond rout” isn’t very different when compared with other times especially in the recent past. In less than two months between October 21 and December 15, 2016, for example, the rate for the benchmark 10-year UST surged by nearly a full point; rising from 1.74% all the way to 2.60% seemingly in the blink of an eye.

The day before that apex, on December 14, the FOMC had gathered together and voted for their second rate hike of the then-forming rate hike cycle; the committee’s first in nearly a year having paused in between while yields fell indicating all the reasons they would have to pause.

The reverse of both reacted favorably to what Donald Trump’s election seemed to have signaled; that “stunning” electoral result took place within this particular two-month interest rate leap. Economic prospects rebounding, the central bank publicly acting on its confidence for the first time in twelve months, followed surely by a(nother) big dose of Uncle Sam to seal the deal.

From CNN on December 15, 2016:

"With the economy much closer to full employment now and a strong likelihood of a fiscal stimulus next year...we expect the Fed to accelerate the pace of [rate hikes] next year," says Paul Ashworth, chief U.S. economist at Capital Economics.

No disrespect to Mr. Ashworth; this was the prevailing consensus of the time, certainly from Economists, a view that the surging yields in the Treasury market had seemed finally more agreeable to for the first time since 2013.

The problem, as it has been for more than a decade, is that the economy and more so the monetary system can never get past this stage: reflation. False dawns have instead been the only consistent result, though in every case most commentary immediately leaps to the conclusion that leaves out the word “false.”

Given that, any rise in yields may not be the necessary signal of the looming inflationary escape let alone excessiveness beyond; it is, bluntly, the market adjusting to a brief period where conditions just aren’t as bad as they had been. Reflation.

Again, the reasons for this have been a litany of issues in perpetuation of the global dollar shortage. Problems, even big ones, have been a constant part of the human catalog for the entirety of human history. What defines the dollar shortage regime post-August 2007 has been the frailty rather than resilience repeatedly exhibited by a monetary system that grossly pulls back at the first sign of what might otherwise seem trivial occurrences.

The eurodollar groundhog doesn’t need to see his shadow to send him running, scurrying back into the comforts of his hole, dooming the world to six more weeks of non-accelerating economic winter. This monetary animal nowadays need fear only the hint of the possibility he might witness the smallest edge of a shadow, thus never making it far enough toward his own cavern’s beckoned opening in the first place.


It is, ironically, during these very times when that dollar shortage itself seems to take to hibernation. What had defined the pre-reflationary period of falling Treasury yields and a rising dollar gets replaced by rising Treasury yields and a falling dollar for reasons neither Economists nor central bankers seem adequately able to explain. Yet, they grow absolutely certain this time it will be more.

Lurking all the while are those monetary anomalies which, when occurring during non-reflation, are all-too-consistent with the flight to safety easily described. These same show up in erstwhile reflationary conditions only to be ignored; assuming they are recognized at all.

Yet, it is the accumulation of “anomalies” in monetary conditions that so frightens Dealer Groundhog. Eventually, one of them becomes just too much for its fragile constitution to handle such that, eurodollar first, reflation suddenly becomes anti-reflation all over again. The (next) false economic dawn not long thereafter.

So far, there have been four, maybe five (depending on how you count them) of these completed cycles; the first, 2009-11, perhaps split into two parts by a clear, sharp retrenchment during 2010 which actually had provoked Chairman Bernanke’s QE2. It was a wild, wild year when that year was supposed to have been anything else; boring, meaning recovery-like.

From the end of November 2009 to early May 2010, the 10-year yield increased from 3.21% to 4.01%; not quite the quickened rush of late 2016, still a significant “rout.” But then, a bunch of stuff about Europe. Greek bonds. A flash crash on Wall Street sending stocks plunging intraday in a way that stunned the world.

Worse, it didn’t seem to actually get better afterward; on the contrary, the robust recovery promised by global central bankers stalled out even after the ECB, where this “euro crisis” seemed to be taking place, had quickly responded in those early weeks of May 2010.

Ten-year yields had plummeted from 4.01% all the way to 2.47% by the end of that August, a few days after Mr. Bernanke’s Jackson Hole appearance appearing to pre-announce a second American QE. Lingering around that rate for a few more months, reflation resumed (or restarted) by October; the same benchmark would jump from 2.41% to 2.92% in six weeks on its way to 3.75% by early February 2011.

Extreme price volatility.

That’s really why from February 2011 until August 18 of that year, once again Treasury yields plummeted (the dollar rising), thoroughly confounding the inflationary forecasts for the second time in as many years. Not only that, worse, by July 2011 the entire global financial system had become embroiled in an even bigger crisis (if 2010 was small, then mid-2011 was approaching 2008-like) “no one” saw coming.

Central bankers, and the media which follows only them, were caught wholly off-guard because of bank reserves:

“MR. SACK. Can I add a comment? In terms of your question about reserves, as I noted in the briefing, we are seeing funding pressures emerge. We are seeing a lot more discussion about the potential need for liquidity facilities. I mentioned in my briefing that the FX swap lines could be used, but we’ve seen discussions of TAF-type facilities in market write-ups. So the liquidity pressures are pretty substantial. And I think it’s worth pointing out that this is all happening with $1.6 trillion of reserves in the system. [emphasis added]”

The global dollar shortage obvious from late 2007 to early 2009 hadn’t disappeared, never fixed by the “aggressive” highly “accommodative” monetary policy of the “hero” Ben Bernanke who never missed the opportunity to pat himself on the back for the millions of jobs his “abundant reserves” had “saved”, it had only moved into the background from the foreground of open worldwide panic.

That relative change is what accounts for these mistakes of impression.

In early May 2013, the 10-year rate again surged from 1.66%, very near its record low at the time, to 2.73% just over two months later. It would go on to reach 3.04% on the final day of the year – and then begin falling all over again (with the dollar really rising beginning the middle of 2014).

And so, the cycle has merely repeated one after another; swinging from confusion about the world going wrong to happiness that it’s finally going right leading inevitably instead to the disappointment of ending up right back in the same awful place anyway. Treasury yields lower still, the dollar somehow higher for each completed iteration.


We live in a world filled with them; history being littered with instances when problems don’t turn out to be trajectory killers.

In August 1990, for example, a confluence of unlikely events ended up a distraction in the entire Treasury market lasting several weeks during a crucial period in economic and world history. It began with a four-alarm fire, a literal fire, raging in downtown NYC, gutting a key electrical substation that served Wall Street’s primary infrastructure.

The ensuing localized blackout on Monday August 13, emptied skyscrapers, including an evacuation of the Twin Towers, before forcing the American stock exchange to early close and, according to the New York Times, “The bond market and foreign-exchange trading slowed because broker intermediaries who supply prices for buyers and sellers were cut off, their squawk-box intercoms suddenly quiet, their computers no longer humming.”

At the Federal Reserve Bank of New York, the power outage had meant the immediate deployment of backup power. Then, out of the blue, a water-cooling pipe ruptures on Thursday August 16 which unbelievably takes down two out of the three emergency electrical generators still feeding FRBNY’s vast computerized operations.

Those operations included Fedwire, the US central bank’s interbank system for settling payment claims and transactions across the entire variety of the financial/monetary landscape. Links to global settlements as well as financial market dealers, especially those trading and transacting (meaning sometimes borrowing or lending) government bonds.

The Seattle Times described the Fedwire fallout:

“The 2 1/2-hour delay also panicked dealers in government securities, whose transactions are completed through the computerized system and who also use it to arrange financing.”

On Monday August 13, when the substation fire and blackout first hit, the 10-year Treasury note yielded 8.71% (those were the days!); the 2-year note, 7.94%. Wednesday August 15, with FRBNY still safely on backup power, the 10-year at 8.64%, while the 2-year at the same 7.94%.

The next day, Thursday, with Fedwire “slowed” (meaning, practically suspended), everything was sold in government bonds; the 10-year jumped 12 bps to 8.76%, the 2-year 15 bps to 8.09%. There aren’t many records available for the event, but we do know that over the next week the payments system struggled to catch up so that as much as maybe $150 billion (a huge sum in those days) in payments messages still hadn’t been properly settled.

A week after it, by August 24, the 10-year would reach 9.05% and the 2-year 8.32%; huge safe asset selloff in a matter of just a week, leaving dealers to scramble using all available means (except, apparently, the Fed).

Yet, hardly anyone has heard of this dramatic monetary interruption. One big reason why is simply the timing: you probably remember August 1990 not for electrical problems in lower Manhattan rather because of Saddam Hussein’s invasion of Kuwait taking place not even two weeks before the fire.

Even in financial markets, Fedwire’s interruption was easily overshadowed by the S&L crisis then careening toward its own climax.

Furthermore, the US economy itself was already thrust into the opening stages of full-scale economic recession, its first since 1982.

Why hadn’t this relatively serious payments disruption, which obviously triggered more than just apprehension in monetary and fixed income markets, make the whole system come crashing down? A substantial banking crisis and a recession, and at the beginning of it a pretty serious technical money breakdown, why didn’t 1990 – as opposed to 2007 - end up being the first year of a global financial panic?

Many would reflexively argue Alan Greenspan, the monetary maestro before he was known that way; a powerful and nimble Fed keeping control over its domain. The Federal Reserve, however, did nothing – other than have engineers switch to backup facilities and then have its back office clerks begin sorting through the mountains of backing up processing data.

The growing even bursting eurodollar system, however, wasn’t afraid to confront even serious challenges back then. S&L’s? Wholesale took over. Early 90’s recession? Lots more dollars to get, and use, overseas. Fedwire shorted out for a week? Plenty of capacity to sit on it and sort it out without so much as a very, very minor footnote in monetary history.

A true anomaly, but one made so by the background conditions running behind and all around those rather interesting events.

Interestingly enough, you might have heard that Fedwire (and other electronic payment services) was shut down for a few hours just this week. FRBNY hasn’t explained the fault other than admitting to an unspecified “operational error” beginning around 12:43pm EST on Wednesday. Service was reportedly restored a few hours later, with New York officials having to extend service hours late into the evening to give interbank participants the opportunity to begin sorting out the backup in unprocessed transactions.

Sure enough, the Treasury market was hit with a wild selloff (stocks to some extent, too) the following day, yesterday.

A rare glitch, sure, but as dealers sort out liquidity positions will they look at their balance sheets and intraday support structures like they did in August 1990? Or will it get added to other liquidity issues that continue to pop up here or there (T-bills), being viewed instead through the eyes of the post-crisis groundhog?

In December 2003, then-Richmond Fed President Jeffrey Lacker examined several similar plumbing issues (Working Paper 03-16) which had come up throughout history: late 19th century bank crises; Bank of New York’s “glitch” in 1985; the (stock market) Crash of 1987; and the telecommunication interruptions due to the events of September 11, 2001.

“During the stock market crash [1987] credit concerns were the trigger and a technological malfunction occurred in the midst of the troubles as well, although there is dispute about the extent to which it had significant independent effects. In all of the episodes reviewed, however, the propagation of the shocks was similar. The redistribution of reserves among banks was impeded and payments were delayed. Moreover, bank runs either did not occur or were secondary; the main event in all was the interbank payment system.”

Problems show up all the time; that’s the messy nature of just plain existing on our chaotic plane. Which ones become something more than the others, in the case of interbank issues, has to do, as discussed in detail last week, with systemic behavior.

Even safe assets exhibit serious price volatility. By itself, that’s also just how things go. Interpreting that volatility requires at the very least some acknowledgement of the systemic condition underneath, especially during times when there might not seem any need to go looking.  

Sometimes Fedwire on fire is just a fire. Since August 9, 2007, acknowledging regular volatility, the global economy just hasn’t been that “lucky.”

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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