The Fed Panicking: Yield Curve Tumbles To Fresh 11-Year Lows

Despite the stock market's Amazon-bounce gains, US Treasury yields are lower and the yield curve flatter once again - tumbling to its flattest since Oct 2007.

Deja vu all over again...

10Y Yields are holding below 2.80%...

And the yield curve has crashed to fresh flats not seen since Oct 2007...

The entire curve is rolling over...

As a reminder, Bloomberg notes that according to the minutes of the Federal Open Market Committee's Jan. 30-31 meeting, the most recent for which minutes are available, showed that some policy makers thought it important "to monitor the effects of policy firming on the slope of the yield curve," noting the strong association between curve inversions and recessions.

Which confirms what The San Francisco Fed warned...  about the flattening of the yield curve...

"[it] is a strikingly accurate predictor of future economic activity.

Every U.S. recession in the past 60 years was preceded by a negative term spread, that is, an inverted yield curve.

Furthermore, a negative term spread was always followed by an economic slowdown and, except for one time, by a recession."

Furthermore, as the two Fed authors explain below, the recent decline in the Treasury curve is sending recession probabilities notably higher.

Uneven Economy & The Hidden Depression

Are we in a depression?

The question seems absurd.

There has been GDP growth since 2009 and some mild inflation to go with it. In fact, this is the second longest economic expansion on record.

As Robert Shiller said over the weekend (though in the context of warning against complacency), "[i]f the economy manages to expand for 16 more months, the United States will have set a record."Unemployment is the lowest in history, nothing like the 17% we had by a U.S. Bureau of Labor Statistics estimate a decade after the stock market crash in 1929 and the average of 18% in the 1930s. House prices have come screaming back across the nation. The stock market has increased by more than 15% annually beginning in 2009. And even middle-class wages have shown signs of picking up lately.

Depression-Era Demographics In Some Exurbs

And yet, even overlooking the opioid epidemic and the 42 million Americans on food stamps (happily down from nearly 48 million in 2013), there are disturbing signs around the country that all is not well.

For example, a recent article in the New York Times by Robert Gebeloff focusing on Hunterdon County in New Jersey shows that many suburban and exurban Northeast and Midwest counties have stopped booming. More people are dying than being born or moving in through immigration or migration. Hunterdon County, 60 miles from New York City, is the sixth richest county nationally with a median household income is over $100,000. But young people are having fewer children, and the recession-stalled migration patterns are only resuming in certain parts of the country. According to Geberloff,"Some of the once-fastest-growing counties in the United States are growing no more, and nationwide, the birthrate has dropped to levels not seen since the Great Depression." Since a recent peak in 2007, lifetime births per woman in the U.S. is down 16%.

Because deaths are outnumbering births in so many outer-ring counties,flummoxing demographers waiting for a trend reversal, migration is crucial. But lower immigration puts stress on Northeastern suburban counties losing population to the South and West. And while more people living in cities may lower long-distance commuting and urban decay, "population stagnation in places that had been growing will most likely bring its own sets of problems, including pressures on real estate values and eventual shrinking of political representation."

While births have declined, migration within the U.S. has resumed to pre-recession levels. However, the trend is toward Florida, Texas, and Arizona, which have all seen population inflows. Rural parts of the country have been struggling with these demographic problems for a while now, but Gebeloff's article shows that they are hitting what have been much more well-off areas now. In Hunterdon County, a 460-acre Merck campus sits abandoned, and enrollment in some school districts is down 20%.

Patio Man Still Thrives

But if outer ring Northeastern suburbs are in jeopardy, that's not the situation everywhere. In 2002, when it looked like exurbia or life in what he called "Sprinkler Cities" was the future, David Brooks wrote a column for the Weekly Standard called "Patio Man and the Sprawl People" partly about how urban types were annexing old line, inner ring suburbs, while more traditional suburbanites were claiming the outer rings where they could enjoy peaceful patios, happy kids, slender friends and "the massive barbecue grill towering over it all."

Now, it seems, the outer rings are struggling mightily, but perhaps only in the Northeast and Midwest. In other words, Brooks's 2002 analysis somehow holds up today.  This is how he described the trend in defending suburbia, or the movement from old suburbia to new suburbia — "The truth, of course, is that suburbia is not a retreat from gritty American life, it is American life. Already, suburbanites make up about half of the country's population (while city people make up 28 percent and rural folk make up the rest), and American gets more suburban every year." And they make up 53% of America now, according to Jed Kolko in a post for the statistically oriented news site, FiveThirtyEight. Moreover, in a 2017 post, Kolko wrote, "The suburbanization of America marches on," as he noted the fast growth of Southern and Western metro areas, including Cap Coral-Fort Myers, FL, Provo-Orem, UT, and Austin-Round Rock, TX. Kolko also highlighted educated rural areas and the Pacific Northwest as growing regions. Those include Olympia and Spokane in Washington and Eugene and Salem in Oregon. Boise also made his list for growth of metro areas with 250,000 or more people.

The big population losers, unsurprisingly, have been rural areas. And while the "urban revival" is real, according to Kolko, it has mostly been for rich, educated people, in particular hyperurban neighborhoods rather than broad-based return to city living. Patio Man continues to thrive – just not in Hunterdon County, New Jersey.

Overall, the country is hardly in a depression, but things are grimmer than many think in some surprising places.

Goldman Slashes iPhone Sales Estimates Due To "Demand Deterioration"

Two months after the Nikkei reported that Apple will halve its production target for the iPhone X in the three-month period from January from over 40 million units to around 20 million, in light of slower-than-expected sales in the year-end holiday shopping season in key markets such as Europe, the U.S. and China, and after JPM similarly warned that production of Apple's flagship phone would plunge of 50%, "even larger than the decline of the iPhone 8/8+" and noted that the "weakness will continue in 1H18 as high-end smartphones are clearly hitting a plateau this year"...

... this morning Goldman joined the Apple skeptics when the bank's analyst Rod Hall wrote that demand expectations for March and June quarters are already weak but early Q1 demand indicates "even lower actual numbers than consensus is modeling" and as a result, he is trimming his replacement rate expectations in response to what has been weak replacement consumer behavior this cycle.

Below is the gist of the note:

We reduce our replacement rate assumption for FY'18 by ~2pp to 33% from 35% earlier due to weaker than expected demand for the iPhone X. We have cut our Chinese replacement rate by 3pp to 19% for FY18 and also reduced our ex. China replacement rate by 1pp to 38%. Further, we cut FY'19 and FY'20 replacement rates by 1pp each to 32% and 29% respectively. We note that our assumptions for FY19 could prove conservative if larger format devices drive a better cycle in China this coming December quarter though we believe that data so far suggests that a more cautious approach is prudent.

We now forecast the overall replacement rate to drop by 7pp over the three years from FY'17-FY'20 similar to what we calculate occurred from FY'14-FY'17. This may appear overly conservative on its face but we point out that replacement cycles in emerging markets where iPhone base growth is highest tend to be materially lower than in developed markets where most Apple analysts reside.

In light of this, Hall cut his iPhone sales estimates for the March and June quarters by 1.7 million and 3.2 million units to 53 million and 40.3 million units respectively.

He also cut his 2019, 2020 iPhone revenue and net income forecasts: Goldman now sees revenues decrease by 2.4% and 2.7% to $256.6bn and $272.5bn for FY'18 and FY'19 respectively; the company's revised revenue estimates for FY'18 and FY'19 are 2.2% and 0.4% below consensus, while its net income estimate for FY'18 is 2.2% below consensus and for FY'19 is 1.2% ahead.

On a shipment and ASP basis, Goldman cut its FY'18, FY'19 and FY'20 iPhone shipments forecasts by 3.5%, 4.0%

and 1.8% to 217.3m, 223.8m and 223.4m units respectively - below consensus estimates of 221.3m, 226.8m and 238.3m units. However, the bank's ASP estimates for FY'19 and FY'20 are 1.6% and 4.0% ahead of consensus "due to proprietary bottom up modeling" that suggests consensus continues to underestimate the impact of a mix shift toward higher priced phones "even as we now assume that Apple reduces prices somewhat in the high end."

Hall warned that AAPL will have "material channel inventory" to clear in June in order to prepare for rollout of new products this fall, and has modeled just 1MM units of inventory build into the June quarter.

Unleashed, the Goldman analyst also reduced his ASP estimate for the June quarter by 2.3% due to above-average forecast inventory burn of 6.0 million units.

There was some good news: the Goldman analyst said that while replacement rates continue to decline in our model, the growing installed base provides support for the Y/Y growth in replacement shipments. We estimate that the primary installed base, made up of only first-hand iPhone owners, stands at 631m units in FQ1'18 and is growing strongly at 12% Y/Y.

Goldman's conclusion:

iPhone demand expectations for March and June are already weak but we believe that early CQ1 demand indications suggest even lower actual numbers than consensus is modeling. We are slightly reducing our March unit expectation and make a larger reduction in our June quarter unit and ASP forecast. We now model 1m units of inventory build into June which is atypical. This leaves Apple with material channel inventory to clear in June to prepare for the launch of new products this Fall. We also are trimming our replacement rate expectations looking forward in response to what has been weak replacement consumer behavior this cycle. We reduce our March and June QTR units by 1.7m and 3.2m to 53.0m and 40.3m units respectively. Due to an above average forecast inventory burn of 6.0m units in the June QTR we are also reducing our ASP forecast for that QTR by 2.3%. Looking forward we are also reducing replacement rate expectations which brings our FY19 and FY20 unit forecasts down by 4.0% and 1.8% respectively to 224m and 223m units.

Finally, Hall also cut his Neutral-rated Apple price target by $2 to $159, the second lowest on the Street, which has a median PT $195. Apple stock was modestly lower on the news.

Fwd: Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).Trader: "The Probability Of 10Y Yields Collapsing Is Much Higher Than Most Realize"

One day after he correctly warned that equities have not yet bottomed - just hours before the Dow Jones tumbled from up over 200 to down over 400 points at one point as the tech sector imploded - this morning former Lehman trader and current Bloomberg macro commentator Mark Cudmore issues another warning, this time about Treasuries, which he thinks may be poised for a sharp spike higher as yields tumble. He explains why in his latest Macro View column below:

Treasuries Jump May Be the Start of Something Bigger: Macro View

The probability of Treasury 10-year yields collapsing is much higher than most investors seem to realize. The readjustment in pricing may be just getting started.

It's not going to take too much for serious discussion to begin over the possibility the Fed's hiking cycle may be at an end, or near an end, already.

This doesn't even need to become the base case for yields to slump, it just needs to become a plausible- enough outcome for the market to squeeze out the large speculative short position in Treasuries.

The building blocks for this narrative are already in place. Thursday's PCE inflation data may provide the required catalyst.

Financial conditions have tightened considerably in the last two months. Libor spreads have widened significantly -- because of structural issues -- but that still acts as effective policy tightening.

Trade, politics and commodities are all going to start weighing on the growth outlook. The slump in equities may soon be significant enough to be a concern for the Fed because of the impact on consumer sentiment, which has remained a bright spot in U.S. data, and the wealth effect.

As the manufacturing center for so much that the U.S. consumes, China's PPI has had an excellent correlation with U.S. CPI in recent years. The former is still trending down after both measures peaked in February 2017. The March data for both is due April 11. Given how industrial metals and agricultural prices have slumped this month, there are strong reasons to expect China PPI to slide again.

The technical break lower in yields was made Tuesday. Fundamentals are supportive of the move. Positioning is offside and therefore any related corrective adjustment will quickly add downside momentum to yields.

Tomorrow brings February's PCE data, supposedly one of the Fed's preferred inflation measures. The consensus forecast is for the core number to climb to 1.6% year-on-year. That paltry rate of inflation would still be the highest since since March last year.

A miss of just 0.1 of a percentage point and investors will start considering the possibility that inflation may already have peaked, and hence perhaps so has the Fed's rate-hiking cycle. That would put the cat amongst the short Treasury pigeons (positions).

BofA: "What If A New Bear Market Has Begun?"

In a new report from BofA's equity derivatives team, the bank analyzes how vol regimes have existed through time spanning subsequent bull and bear markets, where bull market vol tends to be a good predictor of the following bear market vol (chart below, left-hand side). The bank has found that vol tends to be somewhat predictable within market cycles, and that bull markets in particular exhibit a "volatility smile" in which realized vol is more elevated during the first and fourth quartiles of each period relative to the second and third quartiles (chart below, right-hand side).

Simplified, and rather intuitive, this shows that volatility rises heading into the end of a bull market. Which is ironic because as Nitin Saksena notes, as recently as the end of January and before the Feb vol shock, realized vol was near the most depressed levels in history, suggesting perhaps even more upside pressure as we head into the late stages of this bull market. For perspective, 12m realized vol as of 26-Jan-2018 (the peak of the current cycle) was 7.0%, a level below even the least volatile bull market in history from June-1962 to Feb-1966 when realized vol was only 8.4%.

How quickly things have changed in the past 2 months, when both implied and realized vol has exploded higher.

So what happens next in theory?

To answer that question, BofA first looks at a stylized example, and finds that based on historical data, vol has risen 3/4ths of the time in the last 12 months of a bull market relative to the period prior to the last 12 months. The BofA chart below on the left-hand side plots looks at some of the more popular recent bull markets and plots the SPX realized vol 24 months to 12 months prior to the end of period vs. SPX realized vol during the last 12 months. The chart shows that 9 of the 12 periods (those above the dashed line) saw vol pick up, the biggest being the bull market ended by the start of WW2 (Apr-42 to May-46). In other words, "history suggests that if we are indeed in the final innings of the current bull market, it is more likely than not that we will see upward pressure on realized vol."

To be sure, rising vol in itself is not a necessary and sufficient condition for a recession, although even if the bear market is 24 months away, vol still tends to rise according to BofA. What's more, even if the there is some gas left in today's bull market - a case made by virtually every Wall Street analyst - increasingly more are expecting an uptick in realized vol.

Specifically, we found that vol also tends to increase heading into the final two years of a bull market relative to the year before. The most prominent examples occurred during the Oct-90 to Jul-98 bull market, which saw a large pickup in vol in the last two years amid the start of the Tech Bubble, and the Aug-82 to Aug-87 bull market, which saw vol take off ahead of the Black Monday crash in Oct-87.

Stepping back from the abstract, BofA's next question is troubling, if only for the bulls, because the bank asks, point blank, "what if Jan-2018 was the peak and we are now at the beginning of a new bear market?"

To answer this, BofA extends the above analysis further to examine how vol reacts during the first 12 months of a subsequent bear market relative to the final 12 months of a bull market. The bank's results indicate that in 13 of 15 bull-to-bear market rollovers, vol increased. Of course, this result is not exactly surprising as everyone - perhaps with the exception of a 23-year-old "hedge fund manager" - expects bear market vol to surpass bull market vol (after all, full period median bear market vol is 21.0% versus a bull's 12.9%).

There is one caveat, or rather two: there are two instances in which vol declined at the start of the bear market relative to the end of the prior bull market: Jun-49 to Aug-56 and Oct-74 to Nov-80.

So going back to the original question: was Jan 2018 the peak for the market... something which Morgan Stanley determined last week, and has a new bear market unofficially begun, the first in a decade? Should we get a few more days like today's Nasdaq collapse, we won't need complex vol analyses for the answer.

Bernanke Beliefs Busted: New Research Foretells QE Domination

The title refers to a consensus-shattering paper that was unveiled at the University of Chicago last month before a Who's Who of economists and central bankers.

Paul Krugman gave the keynote, but the meeting's focus was on the paper's authors - two Wall Street big shots, Morgan Stanley's David Greenlaw and Bank of America Merrill Lynch's Ethan Harris, and two academics, James Hamilton and Kenneth West. To keep it simple, I'll call them GHHW.

The paper more or less shredded former Fed chief Ben Bernanke's favorite defense of his quantitative easing (QE) programs - that QE lowered Treasury yields.

In fact, if you believe in the accuracy of the type of analysis GHHW conducted, QE may have actually increased Treasury yields. By parsing data and financial news more thoroughly than in prior studies, the authors found that yields rose, on average, when bond traders were presented with news about QE. (I recommend Hamilton's blog write-up for a quick summary, although if you're also looking for key charts, see Exhibits 4.11 and 4.12 on page 82 of the paper.)

But despite having the data to fully reverse the findings of other researchers, GHHW didn't take it quite that far. (They were too polite for that.) Up against a strongly pro-QE crowd, they settled on the less ambitious conclusion that "the Fed's balance sheet is a less reliable and effective tool than as perceived by many." Between the lines, though, they painted a picture of QE being about as powerful as the host city's passing game. (To save you the trouble of looking it up, Daaa Bears ranked last in the NFL.)

As far as pre-GHHW "perceptions," the authors described a consensus that QE lowered 10-year Treasury yields by about 100 basis points, an amount they then refuted. That 100 basis point consensus is consistent with a few different literature reviews, as pointed out by GHHW, and also with claims by FOMC members. It went undisputed by the attendees in Chicago who published their comments. (Three Fed regional bank presidents, an ECB Executive Board member and a few others delivered formal responses.)

The new research is important, in my opinion, not so much for academic reasons but because I think it foretells the future.Before I explain why, though, I need to insert a disclaimer about the likely accuracy of any study that attributes yield changes to QE news of one type or another.

That is, methods for establishing how much QE moved the bond market are essentially guesswork, even after GHHW's improvements. Bond prices respond to traders and investors not only establishing new positions but also unwinding or rebuilding prior positions in combinations unknowable and for reasons derived from all past fundamental and technical information and ultimately also unknowable. Trades may occur because prices have gone up in the past, because they've gone down in the past, because the market is overbought or oversold, because a different market has become more or less attractive, because traders seek opportunities to lock in profits or cut losses, and for countless other reasons. As such, it's easy to jump to the wrong conclusion by attaching a single fundamental cause to every price change—there's no such thing as a sequence of single-cause price changes, and even if there were, we could only guess at the causes.

Why GHHW Upsets the Playing Field

All that said, let's acknowledge that some researchers' guesswork is better than others. I suspect GHHW are closest to the truth, partly because they were more careful than others, but also because a different type of result predicts their conclusions. I described that result in "QE's Untold Story," where I showed that commercial banks and broker-dealers extended credit between QEs by just as much as the Fed extended credit during QEs, and that the two sources of credit growth alternated depending on whether QE was "on" or "off." Here's the key chart from that analysis:

As I described last year, the Fed grabbed the credit-growth baton for QE laps and returned it to commercial banks and broker-dealers for QE pauses, and whoever didn't have the baton stood still, creating the "argyle effect" shown in the chart.

Unlike GHHW, "QE's Untold Story" didn't separate short and long rates (the data didn't allow for that), but it challenges the orthodox narrative from a different direction. Namely, it says if you draw a circle around banks, broker-dealers and the Fed, the amount of credit supplied to everyone outside the circle appeared to be unaffected by QE. Whereas the orthodox narrative holds that those outside the circle were forced to chase a restricted credit supply, the data tell a different story.

Or, another way to say the same thing is that banks accepted reserves as an adequate replacement for assets transferred to the Fed—they didn't seek to replace those assets on a like-for-like basis—and that decision would have diluted QE's effects on yields. Some banks may have even welcomed the chance to replace long-term assets that were mismatched to their liabilities with different assets that carried no such mismatch risks.

Also, the federal government's decision to lengthen its debt profile would have diluted potential QE effects as well, as noted by GHHW and others.

So plenty of other evidence shows why QE didn't work as planned (it paints the bigger picture behind GHHW's findings), it's just that economists haven't paid much attention to it. Macroeconomists, in particular, are known for reaching hasty and unrealistic conclusions, so it's not surprising that they might paper over the holes in their QE studies or rely on theories that ignore the true mechanics of bank credit, which makes it difficult to grasp the relevance of the data in "QE's Untold Story." Getting banks right is especially important (see my articles "Learning from the 1980s" and "An Inflation Indicator to Watch" or for a fuller discussion, my book Economics for Independent Thinkers.)

As Hamilton wrote on his blog, "Our study raises a caution about the event study methodology. There is a potential tendency to select dates after the fact that confirm the researcher's prior beliefs about what the effect was supposed to have been."

In other words, economists tend to fit the "facts" to their theories rather than the other way around.

Who Might GHHW Have Been Thinking Of?

Hamilton didn't name names, but consider that Ben Bernanke spent much of QEs 1, 2 and 3 selling the very conclusions GHHW debunked. Have a look at these excerpts from Bernanke's speeches during his last few years at the Fed:

• "Securities purchases by the central bank affect the economy primarily by lowering interest rates on securities of longer maturities." (11/19/2010-1)
• "The evidence suggests that such purchases significantly lowered longer-term interest rates in both the United States and the United Kingdom." (11/19/2010-2)
• "Purchases of longer-term securities have not affected very short-term interest rates, which remain close to zero, but instead put downward pressure directly on longer-term interest rates." (2/3/2011)
• "Generally, . . . research finds that the Federal Reserve's large-scale purchases have significantly lowered long-term Treasury yields. . . . Three studies considering the cumulative influence of all the Federal Reserve's asset purchases, including those made under the MEP, found total effects between 80 and 120 basis points on the 10-year Treasury yield. These effects are economically meaningful." (8/31/2012)
• "A growing body of research supports the view that LSAPs are effective at bringing down term premiums and thus reducing longer-term rates." (3/1/2013)
• "The preponderance of studies show that asset purchases push down longer-term interest rates and boost asset prices." (1/3/2014)

To his credit, Bernanke was crystal clear in explaining what he was trying to achieve and why he believes it worked. That made him an easy mark when GHHW, whether they intended to or not, took direct aim at his published positions. Bernanke needed their meticulous analysis like the North Side Gang needed Al Capone.

And with that background in mind, let's look to the future.

What to Expect in the Next Deleveraging

In the next severe economic downturn (whenever it occurs), central bankers are likely to embrace QE as readily as Bernanke did. They'll first lower the fed funds rate as much as they can, but then they'll feel the pressure to do more. (Sidenote: GHHW also disparaged negative interest rates.) They won't say,"Look, the economy has too much debt and the best thing we can do is be patient and, well, do nothing more than we've already done." That would violate the principles of today's hyperactive interventionism - the chattering classes accept few excuses for policy inaction, and not knowing if a policy does more harm than good isn't among them.

So the question is this: When tomorrow's quantitative easers succumb to the pressure to act, how will they explain their actions? Actions require narratives, and with GHHW having toppled Bernanke's narrative with Chicago-strength winds, policy makers will need a new one. So what will it be?

I would say one narrative is more likely than any other - that is, QE fell short of the objectives only because it wasn't large enough, and to work properly it needs to be absolutely massive. Future Fed chiefs will argue that you can always bring yields under control if you just buy enough bonds, and to some degree they're likely to be right. Their new motto will be "the bigger the better."

Speculative?

Maybe so, but it's also exactly what New York Fed President Bill Dudley told us to expect in his response to GHHW. He said, "If LSAPs are not as powerful as some of the event studies imply, the answer is not to simply discard the tool, but instead to look for ways to enhance its efficacy and use it more aggressively (emphasis mine)." Dudley then touted open-ended asset purchases, commonly known as QE infinity.

And that's not all. Consider the charts and speech by ECB Executive Board Member Benoît Cœuré, also delivered in response to GHHW. Cœuré showed that the Fed's QE left about half of total Treasury issuance in private hands after accounting for foreign central bank holdings, whereas the ECB has soaked up so many bonds that private investors are left with possibly less than 10% of all German Bunds. He then shared data suggesting that the ECB bossed Bund yields by more than the Fed bossed Treasury yields, as you might have expected. He argued that the key to QE success is to use the oldest trick in market manipulation - buy such overwhelming amounts that everyone else has to forage for a puny remaining supply. (Alright, he may not have called it market manipulation, but the rest is an accurate summary.) In other words, Cœuré's GHHW response was to pen an ode to QE domination, which seems the natural endgame.

Conclusions

To be sure, the central banking gods may have written a bigger QE into our future long before their emissaries convened in Chicago, but now their plans are even more clear. Expect the Fed to follow the ECB and Bank of Japan in making sure the next time it expands its balance sheet, it'll achieve total domination. You might imagine the Fed's balance sheet blanketing the bond market in a thick, full-length coat (thick enough to withstand those Chicago winds), one that'll make the current balance sheet look ragged and threadbare by comparison.

And you might also expect the irony to be lost on central bankers such as Dudley and Cœuré. Can the cautionary advice in a paper titled "A Skeptical View of the Impact of the Fed's Balance Sheet" really lead to a more aggressive use of that balance sheet? In fact, I think it will.