Perverted Yield Curve

14 Aug

We can now add the inverted yield curve to the lexicon of the average Joe along with the TED spread,  The CDO Market and The VIX. Generally, these inside baseball terms only become suitable for mass consumption when something is amiss, or perceived to be amiss. As we have pointed out repeatedly, things have been non-normal in the global rates markets for many months now, and as of late the gravity of this disconnect between  fixed income and the real economy has begun to hit home. It is our contention that the  shape of the yield curve is an indicator, a global conglomeration of the forecasts and perceptions of what market participants feel will happen at that moment in time across a wide span of time horizons. The Federal Reserve, through a variety of measures can essentially control the front end of the curve, through its manipulation of the fed funds and discount rates, the rest of the curve is dictated by the market and as such is not necessarily under the direct purview of the Central Bank. It drives us crazy to hear some talk about the need for the Fed to “catch up” with the market, and it makes us even more insane to hear some argue that the Fed needs to forcefully steepen the curve to stave off a recession. Forcing a curve steepening is akin to focusing on the hair loss for a patient undergoing chemotherapy, the hair loss is simply the result of the treatment for the underlying illness and should not be the focal point of care. If one can take away anything from the inversion in the yield curve it is that an inversion in the yield curve at negative real yields indicates only that the linkage between rates and real economic activity has been severed. A steepening of the curve at these levels will accomplish absolutely nothing, particularly if it leads us deeper into negative rate territory. 

No Love Island

7 Aug

As we try and understand the implications for ultra-low/negative rates of interest across the globe, we came across the a recent column in the FT addressing this very phenomenon. The article by John Dizard, discusses how the negative rates in Europe and low rates in the U.S. are fueling inefficiencies, bloated government budgets in the case of Europe and excess oil and gas production here in the U.S.. We would take this thesis even further to state that negative rates in Europe have led to stranded capital sitting on the balance sheets of insurance companies and pension funds( in the form of sovereign bonds) while low rates in the U.S. have led to excess capacity across almost the entire U.S. economy, the difference being only the transmission mechanism inherent in European vs. U.S. capital markets. Private equity, IPO activity and a deep credit and leveraged credit market would suggest that “excess” capital has found alternative methods of transmutation into the overall U.S. Economy. A weaker banking system, combined with a less robust private credit market, has generally driven much of the same excess capital into the Euro denominated sovereign bond markets. The end result of this dichotomy in transmission is simply where the stranded capital ends up: one as vapor in the form of negative rates and the other as actual vapor in the form of flared gas at the end of the permian producers pipeline.

Making Stagflation Great Again

23 Jul

An Op-Ed piece in the WSJ today by Peter Coors of Molson Brewing points out the input pressure that firms can encounter when tariffs are imposed, even after the tariffs are taken off. Mr. Coors, an extremely large user of aluminum sheet, primarily for beer cans, was complaining not only about the lack of global transparency in aluminum pricing but also about the apparent stickiness of pricing once certain tariffs were removed. In a world where pricing power is almost non-existent, should it surprise us that firms are taking advantage of artificial supply constraints in order to try to gain some upper hand in pricing. Mr. Coors stated that Alcoa had moved production to Saudi Arabia thus avoiding applicable tariffs, but continued to charge the tariff-based price. If someone like Molson has no market power to push back against such practices, what must it be like for the lesser players?. The problem with this type of “inflation” is that what is inflation to one company is margin compression to someone else,  particularly in a sub 2% inflation world. One can assume that we wouldn’t be reading this op-ed at all if Molson had the ability to simply pass through the additional can costs to the consumer.

Its All About The Bps, No Credit…

23 Jul

To paraphrase the philosopher Meghan Trainor:” Its all about the bps, bout the bps, bout the bps no credit”.  In a world where the extra basis point, positive or negative (believe it or not) is pushing capital flows irrespective of the credit quality or credit worthiness attached to that incremental yield, or in some cases decremental yield. Italy, Greece, and now a number of, what previously were termed high yield, junk credits  are drifting into single digit or negative territories. In a pre-Centrally planned rate environment, credit quality drove spread movement, however in this brave new world, spread movement drives credit analysis or the lack thereof. As Mark Twain was reported to have said ” History may not repeat itself but it often rhymes”  and this market is humming some pretty familiar tunes. The reach for decremental yield, without any regard for creditworthiness is a sign of something very wrong with the global capital markets and is not simply indicative of a response to slowing global growth.

Scrap Heap

2 Jul

Legend has it that during a downturn in the oil market in the late 80’s/early 90’s Jim Tisch of Loewes fame assessed the relative valuation of a drilling rig by jumping aboard and proclaiming ” I can buy all of this for $5MM”. The valuations at the time were below actual scrap value, and those purchases would  later form the basis for Diamond Offshore (ticker symbol DO). Fast forward to today where the scrap heap for this type of metal exists on the NYSE where some rig operators are trading at as much as an 80% discount to book.  The movement from deepwater to onshore/ shale combined with a  renaissance in technology just over the last 5-10 years has left a lot of floating and land based steel facing almost sure obsolescence. The question becomes: In a world where credit is endless and virtually without cost, does the question of next best use ever  enter into the equation?. We ask this because Weatherford International filed for bankruptcy protection yesterday,  and it would appear that bankruptcy attorneys will be quite busy in this sector for quite some time. What becomes of the steel we wonder, does the excess ever get scrapped for its possible best use as scrap steel? Or, does the never ending process of workout, de-leveraging, re-leveraging keep this metal “working” in some form in perpetuity.

Real Rates?

29 Jun

The records for negative rates of interest across the sovereign debt world just keep on falling. The front end of the Spanish yield curve is now in negative territory, Spain, a country whose banking issues threatened the very existence of the Euro just 5 years ago, now is charging creditors for the luxury of lending them money. Italy, the bastion of quasi-socialism and who is currently threatening to leave the EU, has rates on the front  end threatening to dip into negative territory. These types of “lending” rates defy any kind of logic and what defies logic even more is that fact that the EU is promising more of the same if economic activity doesn’t pick up. If the definition of insanity is doing the same thing over and over and expecting different results, negative interest rate mortgages (something now being offered in Denmark) might signify new levels of delusion. The question for investors is So What? In a world where the “risk-free rate” of return offers no touchstone as to where real safety or value may lie, what’s an investor to do? This question becomes particularly acute as the race to the bottom in rates is intimately tied to a competitive devaluation amongst the largest global economies. Who needs to even feign interest in a strong currency when one can borrow at negative rates of interest. The bottom line is that with both rates and currencies completely untethered from both reality and reason, it behooves investors to align themselves with an asset class which will maintain portfolio stability given the likelihood of a re-pricing of risk. We believe that the ultimate winner in this new environment will be Commodities/Hard Assets.

Good Old Days

19 Jun

Some political pundits have opined that part of the reason that populist rhetoric has become so pervasive of late is the wish to return to the “good old days”. As some have so aptly pointed out, while we have our problems today the good old days probably were not that good. By any metric: poverty levels, mortality rates, rates of democracy, etc.. things have improved measurably just over the last 20 years. We are nominating one particular area where a return to yesteryear might do us all some good: Central Banking.  In the days when QE was something that would have been positively unheard of, the goal of Central Banks was to gently lean into the business cycle utilizing the Fed funds and discount rates. In the olden days, recessions happened every so often,  capital markets declined as they are wont to do,  and somehow the global economy survived and even grew at a reasonable rate of  growth. Those days are long gone, along with the credibility of an institution that touts itself as above reproach as well as political rancor. This Fed, along with all other Central Banks around the world, has become a tired one trick pony. On this day, we listened to the Fed Chairman when asked about what a rate cut  would even accomplish given that  we have:unemployment  at multi-decade lows,  unbelievable lax financial conditions, and Government bond yields at multi-year lows and his response was that “they were pretty sure they know how these cuts filter through into economic activity”. Really!, a look at the charts below showing financial conditions as well as the yield on the 2 year Treasury would argue that lower rates are not going to accomplish much given where they already are.


Our intuition tells us that the talk of imminent rate cuts is less driven by weakening economic activity and more by a weakening in the backbone of those stewarded with guarding the  very credibility of our entire financial system. We talked about how The Donald would find a new boogey man and it appears to be Central Banks, though not confined to the Fed however as he threw some shade at Mario Draghi yesterday in response to a possible resumption of ECB QE. Interesting times, not better, just more interesting.