Friday, September 9, 2016

Market down Friday 9/9/16 because of bear steepening

I feel bad for my incomplete lesson on the four monetary/macro conditions. 

Here is the 4 conditions again and I have added the effect on the yield curve.

            1 DOVISH FED – BULL STEEPENING (bullish for everything)
                        Short term rates fall faster than long term rates
            2 HAWKISH FED – BEAR STEEPENING (renewed animal spirits)
                        Long term rates rise faster than short term rates

            3 DOVISH FED – BULL FLATTENING (secular stagnation)
                        Long term rates fall faster than short term rates
            4 HAWKISH FED – BEAR FLATTENING (recession risk)
                        Short term rates rise faster than long term rates

What happened was that long term yields went higher overnight.  It may have been started in Germany.  Maybe Japan.  While in Germany long rates did go higher, it is the fear that Japan will engage in a big way in steepening their yield curve.  And since everything is almost completely correlated, when bonds go down so does everything else.  AND, very importantly, fear that the Fed wants to disprove the accusations that they are solely about keeping the stock market up might actually raise rates September 21.

We have been in condition 3.  A weak macro economy and a dovish Fed.  But central banks DESPERATELY want the world to be in condition 2, improving macro economics with the central banks raising rates into that strength.  While forcing up long term rates in the face of weak macros may seem delusional, it could happen.

So the fear of, more than actual policy action, is that the policy action will be to raise rates because of a belief (delusional) that the economic situation is good.

This is delusional.  The world economy is stagnant.  It has slowed down.  It is weak.  There are lots of stock funds that have strategies tied to bond prices.  Many of these are highly leveraged funds.  The potential for a really nasty sell off of stocks is high.

If the market has a nasty down draft before the Fed meets on Monday September 19, then I think they will not raise rates this time around.

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