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The Bond Market is Talking and Eurodollars Just Inverted, Are You Listening?

The yield curve flattened again today in the face of a stock market rally. And please note Eurodollars, they inverted today.
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Eurodollar Futures Curve 2021-12-01

Eurodollars Primer 

Eurodollars are the largest trading futures contract by far, but the name is more than a bit confusing. 

Eurodollars have nothing to do with currencies. Eurodollar futures are interest-rate-based financial futures on deposits in commercial banks outside of the United States.

In short, eurodollars represent a bet on when and how much the Fed will hike rates.

Eurodollar Futures Invert

Goodbye Inflation?!

Please consider This Is A Big One (no, it’s not clickbait) by Jeffrey P. Snider.

Stop me if you’ve heard this before: dollar up for reasons no one can explain; yield curve flattening dramatically resisting the BOND ROUT!!! everyone has said is inevitable; a very hawkish Fed increasingly certain about inflation risks; then, the eurodollar curve inverts which blasts Jay Powell’s dreamland in favor of the proper interpretation, deflation, of those first two.

Unfortunately, whenever the subject of eurodollar futures comes up, whenever I write about them or Emil and I devote a show segment to their curve, quite a lot of people simply tune out. You can actually see how they start reading an article and then immediately click elsewhere once they realize this is what it’s about; or shut off our podcast episode immediately when the term “eurodollar futures” is first spoken – which is pretty frustrating and demoralizing given our show name and brand is, you know, Eurodollar University.

What do we mean by inversion? Money like yield curves are supposed to be upward sloping, which means that the price of the next eurodollar futures in line is below (higher interest rates into the future) the one before it. 

What this inversion tells us on top of all those is that another big step has been taken – in the wrong direction toward deflationary conditions. As I noted at the time back in 2018, so many times, it takes a lot for these curves to get twisted upside-down. Flat curves may not be fully normal, but they are at least in the zip code.

Key Point

Hopefully my simple explanation tells you most of what you need to know: The forward market believes rate cuts, not hikes are coming.

If you click on the Tweet chain, Snider is of course panned for his analysis that does not go with the meme of the day: Inflation is rising, here to stay, and the Fed will be forced to hike more and more.

Last Hurrah for Year-Over-Year Inflation, Rate has Peaked or Soon Will

On November 9, I wrote Last Hurrah for Year-Over-Year Inflation, Rate has Peaked or Soon Will

I was very careful to state "year-over-year rate", definitely implying that the CPI might continue to rise for a while. 

Nonetheless, inflationistas told me I was crazy. Meanwhile, the bond market continues its message: inflation concerns are overstated.

Relentless Flattening of the Yield Curve and Powell Accelerated the Move

Yesterday I noted Relentless Flattening of the Yield Curve and Powell Accelerated the Move

In testimony to Congress, Fed Chair Jerome Powell expressed concerns over inflation. He also stated it was appropriate to consider wrapping up tapering a few months sooner. Previously, the Fed's tapering target was June 2022.

Retiring the Phrase "Inflation is Transitory"

After insisting for over a year that inflation was transitory, Powell finally decided to throw in the towel.

This brought out some amusing observations from economist David Rosenberg and others.

Bonds Rip, Commodities Roll Over

Largest Intraday Market Swing in a Year

Yesterday was interesting for another reason: Largest Intraday Market Swing in a Year, What's Going On?

This flattening is signaling recession, but the timing is very unclear. If the economy was strengthening, yields at the long end would be rising. 

The only inversion is between the 20-year at 1.85% vs the 30-year at 1.78%.

I expect the 10-year will invert with the 7-year next. Currently the spread is positive by 7 basis points with the 10-year yield at 1.43% and the 7-year at 1.36%. 

What's Going On?

  1. Something is bothering Mr. Market. Omicron?
  2. Powell's recent Hawkishness?
  3. Maybe extreme valuations are finally catching up with reality.

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I strongly vote for door number three.  

Today I note the yield curve flattening continues despite stock rally.

3-Year Bond Yield Up

3-T=Year Bond 2021-12-02

30-Year Bond Yield Down

30-year Bond 2021-12-02

Relentless Flattening

  • The 3-year to 30-year spread flattened another 7 basis points today.
  • In April, the 30-year yield was 2.45%. Today, it's 1.77%. 
  • In April, the 3-year note yield was 0.30% and today it's 0.90%. 
  • Since April, the 3-year yield is up 60 basis points while the 30-year yield is down 68 basis points. 

Implications

That is 128 basis points (just over 5 quarter point hikes) of relative tightening between the 3- and 30-year bond yields.

Given the falling yields at the long end of the curve, the bond market is not at all concerned about inflation.

The move in eurodollars reinforces that opinion. 

Powell Has Blown It

The bond market message should be easy to interpret. The Powell Fed has blown it. It's too late to taper and then hike. 

If the Fed tries, it will trigger a recession. Alternatively, a steep selloff in the stock market might easily trigger a recession in and of itself. 

I remain unconvinced the Fed will get in any rate hikes at all. 

A Word About Fed Models

Inflation models are worse than useless. They make central banks complacent.

For discussion of the Fed's useless economic models please see How Bad are Inflation Models, Expectations, and Forecasts vs Reality?

For a discussion of dot plots of rates hikes expected by the Fed, please see my September 22 post Fed Anticipates Rate Hikes in 2022 and 2023 - Fade This Consensus

Thanks for Tuning In!

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