Ross-- Execellent point, I have been on this thread discussing the yield curve in relation to the market. You are right when up until July the market welcomed the idea of lower yields as good news, we were seeing bond rallying to 124 area on basis of strong economic numbers but with no inflation, if you remember the talks surrounding the market back than was that next move of Fed will be up and not down that is rate cut is not in offing rather rate hike as one of the Fed Governor in FOMC meeting was leaning on side of raise, we maintained on this thread very clearly that the rates need to be cut not becauce of 'deflationary situation' but because of high real rates in my opinion US real rates due to lower inflation are at historic highs.
Now up until July we saw market rallies based on strong economic numbers with a background of non-inflationary growth environment, at around 124 the bond movement was market based, as global situation on derivatives emerged and ASEA Russia entered in a new downturn alongwith Japan breaking the 14200 support and its 1 trillion $ banking problem refused to be defused by small maesures we saw a flight to quality or draining of liquidity and spreading of bong yields between AAA corporates and TB's, it is this withdrawl of appetite for paper that flashed the first sign of trouble, the commodity prices started falling and long end of the bond came under very strange kind of buying, I remeber clearly writing 'I have never seen these kind of strange movements' I know what recessions are like and bit of deflation also I could see no signs of slow down except in the long end curve, I at once realised that these curves are down due to some anamoly and will not stay at these levels, I was a bit early I never fully comprehended the extent of the global leveraged positions , I knew in HK something was wrong with hedge funds but I would not think that anyone would short treasury to buy Russian GKN or anyone would short Bunds to buy Italian paper, I would short the bonds at that time and I did on the merit, but truly I had no idea of the extent of the leverage of LTC to highlight one example, now once the market got a whiff of the situation and old highs were broken the commodities strangely started responding to dropping long end of the bond, the rally in thebond from 125 onwards to 129 was still related to market but betwen 129 to 135 was a short squeeze like 115 on MATIF.
The market created delfation in ther charts and started discounting the equities accordingly for close outs, here this is the point where experience pays I could see that deflation is only in the bond chart and in my opinion commodities if you neglect the longer trend the short move down is in reaction to bond rally to 135, the long bond was way out of line at 135 and hence we kept on shorting or buying puts, we knew we will see our levels and levels we saw, but the move from 117 to 124 and 124 to 128 and 128 to 135 are three different moves with parameters which are not identical.
It is just great to see that you have picked up this designed contradiction and you are perfectly in order to ask if market was so happy for lower yields why it should keep rallying if yields go higher.
I have a point here Ross, markets have never built in the 130 yield or 135, normally why were markets selling if yields were dropping? we should have seen rallies if July situation was still valid. To reverse your question that relationship between lower yield and higher equity market had broken down as the fundamentals on which bonds were rallying were not related to lack of inflation but rather flight to quality and a huge short squeeze on short positions of TB's,
the present rate cuts are primarily designed to bring the liquidty back to the market, the AAA's the secondaries, the tertiaries and the Junk bonds all need liquidity, the purpose is to converge the yields of the top and inferior papers to pre LTC level and remove this flight and fear based disengagement of investors, as I have explained earlier the 'financial bubble' will bust if we had a liquidity crisis, the banks need to rely on their traditional short end borrowing and lend at long end a traditional tool to make money or money attracts money, for all this to happpen we need lower rates, although I go little beyond and say that new economy needs new lowered rates, it has never happpened before that we had a rate cut in a economy which is has such a low level of unemployment, may be we will not see any wage pressures building even with lowered rates.
I would like to see yields heading up and like to see that 150-200 basis point spread between short end and the long end, this is shifting if the entire yield curve which I always thought a possiblity, this may be bit premature but new paradigm of the economy may have introduced beyind supply and demand certain elements like 'financial bubble' on global level which has its own demands.
I am not suggesting anything opposite rather first of all I want market to price 127-128 level in the market, I strongly believe that it was never priced that is eqwuities remaianed aloof of bonds because the market had no reason to participate in a rally which was being celeberated and serving as a death knell, we will see higher yields as economic numbers will come stronger, we will see earnings coming good so the fear or disengagement part shall be conquered, as yields move upto 5.30%-5.50% level, the long end of the market will cater for that inflationary threats as short end cater for lack of liquidity. The market at the moment or in August was priced for close outs, the strong economic numbers and earnings will erode that negative thinking, after another round of cuts as we see that normal yield curve is restored and pressures on global economy as result of higher $ and lower ASEAN currencies are addressed we may see that by March next year we will be fearing for inflation, in my opinion this round of cuts will be sharp we will see that differential developing but onve normalcy returns to market we may realise that infaltionary fears can be countered from a lower basis of short term rates, anyway market will snigg that inflation much earlier and will correspondingly bid the yields higher on long end- we will see some choppy sessions as you rightly pointed out but in the end equity markets like strong economies to flourish we will see new highs only if strong economy persists, low inflation will lead market to much much lower levels, the policies are pro market and pro highs in my opinion, please let me know if this was not completely satisfactory.. |
