I’ve been trying to reconcile the apparent mixed signals in credit markets relative to stock markets in the past 2 months.
Inflation expectations implied by the 10-Year TIPS breakeven rate broke an intermediate-term downtrend on Monday, suggesting that investors are not overly concerned with deflation at the moment. However, a broken downtrend is not the same as an up-trend.
10-Year TIPS Breakeven Rate (Implied Inflation Expectations)
Meanwhile, rates have declined substantially all along the curve, signaling that bond market investors have no fear of inflation anywhere.2-year rates are breaking down around the world.
Global 2-Year Government Bond Yields
Source: BMO CM Research
Longer-term rates broke their intermediate-term downtrend line in August, but have broken back above their short-term downtrend. A break of 3.265% on the US Ten-Year would signal a new intermediate-term downtrend. This might give equity investors pause, but in light of the relentless, mindless bullishness currently extant, lets not hold our breath.
Ten-Year Treasury Bond Yield
Stocks, copper and gold have moved to new bull market highs, with oil close behind.
streetTRACKS Gold Trust ETF
The only explanation that seems to make sense is that this is the beginning of the next liquidity surge as the banks start to make use of those reserves at the Fed. They are moving out the curve (from zero duration) and driving risk capital out the risk spectrum. Even 88bps in the 2-year is better than 25 bps or less for funds on deposit at the Fed.
As the banks move into notes they will drive 2-year yields down. Investors will then move out the curve looking for yield, which will push longer maturity bond prices higher. This is the only explanation I can come up with for the coincident rally in bonds, stocks, copper and gold.
We’ll drive stock multiples back into the stratosphere, as the economy is clearly not supportive of the assumed risk premia.
Watch the TIPS BE rate (USGGBE10:IND in Bloomberg) for a signal of trend reversal. Until then, we are firing on all cylinders.
Welcome to the liquidity surge.