The Slippery Slope

The yield curve, or more accurately its shape, is the best economic forecaster I have ever met. The above chart is created by subtracting the 2 year yield from the 10 year. When the line drops below zero, not much good comes of it financially speaking. Bank lending dries up. Asset prices decline when the cost of carry exceeds the cost of long term capital. Markets correct, anticipating a recession.

The Fed's current tightening mindset is in response to the much improved labour market and the desire to "normalize" policy rates. They have yet to acknowledge that long rates may be acting as an unwelcome governor, frustrating their actions.

Whether it's the demand for treasuries from Japan/Eurozone QE refugees, or the effect of demographic and risk tolerance changes domestically, the longer term bond yield just isn't rising. Subdued commodity prices, lack of real income growth and technological change also helping to keep inflation expectations well anchored.

This not the typical playbook. For much of the post war era, when the economy was more closed, tight money was a response to rising inflation expectations. The 10 year yield would be rising, spurred on by "vigilante" bond managers. The Fed would be forced, eventually, to respond to the cries of "you're behind the curve!" After the required tightening response, engineered recession would follow.

Not this time.

The stubborn perma-bid in bonds has anchored the long end and could threaten a premature curve inversion a early as late this year.

The Trump reflation head-fake is now an embarrassing memory. Policy momentum has been stalled by inertia from a scandal-fighting Administration. The recent fading of economic data is also helping the bullish bond sentiment.

The Fed is hinting at raising rates every four months under the assumption that 10 yields will rise accordingly, keeping the curve from inverting. Maybe. But 'maybe' like 'hope', not a strategy.

Watch for clues in the next few weeks as the next, well telegraphed Fed hike is rolled out. I wouldn't be surprised if ten year bonds subsequently rally and test sub-2%. I mean, why not, Bunds are 26 cents.

That would put the Fed and their overly optimistic dot plot ahead of the curve. They would most likely have to back off their experimental "normalization". The is also a possibility of the Fed reversing the balance sheet in an effort to put upward pressure on longer term yields. The market is unprepared for either. With the current complacent bid to the NASDAQ winners grabbing all the headlines the Fed is being ignored - at the market's peril. Amazon and Alphabet's acent to $1000 may be marking the top.

Slippery slope indeed!

RISK MODEL : 2/5... Risk Off!

The Bull/Bear ratio declined to .85 and the lack of upward momentum and a falling copper gold ratio are also negatives.

Only the 200 day and VIX components are positive. A gold rally is forming around the weakening dollar and heightened geopolitical risk profile. Not good.