Month: March 2020

via Economic Cycle Research Institute (ECRI),

ECRI’s Lakshman Achuthan joined CNBC’s Closing Bell yesterday to discuss the cyclical outlook and the Fed.

Our research shows that – predating today’s rate cut – most major western economies, including the U.S., came into this epidemic in more resilient cyclical shape than many realize.

Hence, the rate cut was ill-timed.

The relevant question is whether we were headed into a recession. In answering that question – based on not just one, but more than a dozen ECRI leading indexes for the U.S. alone – our key insight is that, going into this epidemic, the economy was not in a cyclical window of vulnerability when negative shocks are actually recessionary. Despite all of the drama in the markets, the economy still isn’t in a window of vulnerability.

Within the U.S., construction was already in good cyclical shape; and while lower mortgage rates can’t hurt, they weren’t necessary to shore up the industry. And manufacturing actually went into the epidemic in a better cyclical position than most realize, and that extends beyond the U.S.

Last summer, ECRI called a Eurozone growth upturn. As of February, even with the spread of the virus, the Eurozone manufacturing PMI had risen to a one-year high. And even in the U.S. – which we knew had lagged the Eurozone in this cycle – the manufacturing PMIs are still holding above last year’s lows, despite the supply chain disruptions.

Going forward, we are keeping a close eye on all of our indexes, including several high-frequency indicators, so we will know promptly if we are moving into a recessionary window of vulnerability that would actually call for Fed action.

If we end up sidestepping a recession – not because of the Fed’s actions but because of the economy’s cyclical resilience and the efforts of medical professionals – will the Fed be able to take back those rate cuts? We are doubtful, and believe it’s now left with just two more 50-basis-point rate cuts to use when a recession really threatens.

The Fed may have intended the rate cuts to be a booster shot for the economy, but they’ve administered the wrong vaccine – because they don’t know that the economy isn’t in a recessionary window of vulnerability. So, when we really need that anti-recession vaccine, the Fed will be out of stock.

The bottom line is that the Fed’s action is far from costless. All it has done is to step on the gas on the road to Japanification.

Please note that Japan is now in its fifth recession since 2008, despite extreme monetary and fiscal policy, including Abenomics. Do we really want to go there?

* * *

Review ECRI’s recent real-time track record.  For information on ECRI professional services, please contact us.  Follow @businesscycle on Twitter and ECRI on LinkedIn.

With the release of the March Beige Book, we find that as one bogeyman departs, another arrives.

Nearly two years after Beige Book respondents first mentioned tariffs as an economic concern in April 2018, the number of instances in which tariffs were discussed was just 11 in March – the lowest since the term first emerged. However, as tariffs faded from the public’s consciousness, they were replaced with fears about the coronavirus, a term which was never before used in the beige book and in March saw no less than 48 separate mentions!

Before we look at the detailed contents of the latest Beige Book, here is a quick recap of how the Fed sees the 3 key core pillar of the US economy – overall economic activity, employment and wages, and prices – at this moment.

Overall Economic Activity:

• Economic activity expanded at a modest to moderate rate over the past several weeks, according to the majority of Federal Reserve Districts. The St. Louis and Kansas City Districts, however, reported no change during this period. And while manufacturing activity expanded in most parts of the country, here is where we got the first mention of supply chain, to wit: “there were indications that the coronavirus was negatively impacting travel and tourism in the U.S. Manufacturing activity expanded in most parts of the country; however, some supply chain delays were reported as a result of the coronavirus and several Districts said that producers feared further disruptions in the coming weeks.“
• While consumer spending generally picked up (if not for long now that millions of Americans will avoid all open areas), growth was uneven across the nation, including mixed reports of auto sales. Looking ahead, the outlook for the near-term was mostly for modest growth with the coronavirus and the upcoming presidential election cited as potential risks

Employment and Wages:

• Employment increased at a slight to moderate pace, overall, with hiring constrained by a tight labor market, and “insufficient labor lowered growth for many firms and led to delays in construction projects.” Several employers changed from temporary to permanent workers in order to attract talent, and firms made efforts to retain workers such as keeping seasonal workers on staff in the off-season.
• While employment grew across most sectors, manufacturers, retailers, and transportation companies reported lower demand for labor in some Districts. That said, wages grew at a modest to moderate rate in most Districts, similar to last period, and contacts expected wage growth to continue in this range. Companies also spent more on benefits, as the cost of benefits rose and as employers expanded benefits to attract and retain workers.

Prices:

• Most Districts reported modest growth in selling prices, as well as in nonlabor input prices. Here was one of the rare mentions of the recent trade deal: “some firms, particularly manufacturers, were optimistic that the Phase One trade deal with China would reduce goods prices, but some still struggled with tariffs and were concerned about how the coronavirus might affect prices.” 
• Meanwhile, oil and gas prices decreased across the country, which was largely attributed to weak demand from China because of the coronavirus. Retail prices were up in much of the country although some retailers had lower costs due to improved trade conditions, while agriculture price changes varied.

Focusing exclusively on the coronavirus case, here is how the global pandemic is impacting business, so much so apparently that the Fed decided to cut rates by an emergency 50bps yesterday to offset the aftereffects of the disease:

• Most manufacturers experienced revenue increases ranging from mid single-digit percentages to more than 20 percent, but two respondents cited revenue declines, both attributed in part to disruptions related to the coronavirus outbreak in China.
• Outlooks continued to be positive, with the coronavirus and the presidential election cited as risk factors.
• One retailer noted that their inventory levels were impacted by the coronavirus in China, which slowed production at some manufacturing plants.
• A textile manufacturer reported flat sales, and two firms, in advanced sensors and chemicals, pointed to disruptions related to uncertainty and supply chain challenges from the coronavirus as factors leading to their slower 2020 start.
• Although the retail sector is expected to see further weakness and downside macroeconomic risks were cited in relation to the coronavirus outbreak and the presidential election.
• One manufacturing contact noted problems with supply disruptions and shipment delays related to the coronavirus.
• A few New York contacts reported that the coronavirus has deterred visitors, though New York City hotels have continued to report good business.
• The share of firms reporting increased revenues and new orders rose, and the share reporting decreases in both measures fell significantly. The coronavirus has entered the list of concerns, which still includes tariffs and tight labor markets
• Most banking contacts were optimistic about the overall health of the U.S. economy going forward but expressed concerns over the potential impact of the coronavirus.

And one amusing twist: according to the Fed, in the Chicago district “contacts expressed frustration” that Chinese purchases of agricultural goods hadn’t happened after Phase One trade deal “and were concerned that the coronavirus outbreak would be used as an excuse for missing future trade targets.”

Of course, this is precisely what China is hoping to do.

That said, with the Fed having slashed rates in response to the coronavirus panic, it is only logical that Fed contacts across the nation would be freaking out about the pandemic.

Finally, looking at some choice anecdotes from the various the Fed regions, we find the following picture of the US economy:

• Boston: “Two firms, in advanced sensors and chemicals, pointed to disruptions related to uncertainty and supply chain challenges from the coronavirus as factors leading to their slower 2020 start. Seven of ten manufacturers did not mention disruptions from the virus to date.”
• New York: “Tourism activity was mixed. A few contacts reported that the coronavirus has deterred visitors, though New York City hotels have continued to report good business.”
• Philadelphia: “Inquiries and orders to source parts domestically were increasing because of tariff uncertainty and are continuing because of the coronavirus. Retailers noted no supply disruptions because of the coronavirus.”
• Cleveland: “Transportation firms expressed concern about the potential for supply-chain bottlenecks as a result of COVID-19. The virus aside, transportation firms expect conditions to improve slightly in the near future as rising consumer spending leads to increases of merchandise shipments.”
• Richmond: “Sales of both new and used autos were strong, although dealers expressed uncertainty from elections and the coronavirus. In the District of Columbia, some groups canceled travels because of the coronavirus.”
• Atlanta: “Due to the coronavirus, cancelled flights to China have reduced air cargo capacity significantly, which is expected to negatively affect first quarter revenues.”
• Chicago: “Some manufacturing contacts reported low inventories of inputs produced in China due to disruptions from the coronavirus outbreak; while most said the impact had been minimal so far, many expected a larger effect if the disruptions continued much longer.”
• St. Louis: “Contacts were uncertain about the impact of coronavirus on their business; no contacts reported a significant impact, but some have experienced travel and shipment delays.”
• Minneapolis: “Ice conditions have been less favorable this season in Minnesota and Wisconsin, cutting into spending from fishermen and snowmobilers in areas where trails cross lakes.”
• Kansas City: “After declining for several months, manufacturing activity appeared to be stabilizing with a slight uptick in activity in February, despite nearly half of firms noting some negative effect from the coronavirus spread.”
• Dallas: “Overall retail outlooks weakened slightly, with some contacts voicing concern over the coronavirus and its impact on supply chains and overall demand. A railroad contact voiced concern that the coronavirus could reduce shipments from China.”
• San Francisco: “The COVID-19 outbreak led to decreased aircraft demand from China and Southeast Asia, with one supplier reporting no orders received in January. Solar energy equipment manufacturers also experienced delayed order fulfillment due to supply chain disruptions related to the COVID-19 outbreak.”

As the novel coronavirus tears through South Korea’s hot zones, accelerated by the cult members who resisted getting tested after the first few cases emerged, scenes at some of the advanced capitalist economy’s hospitals are beginning to resemble the crowded hallways and demoralizing refusals that were hallmarks of the “bad old days” of mid-January through mid-February, when the novel coronavirus outbreak was at its most severe in Wuhan.

On Wednesday, Reuters reported that hospitals in SK’s hardest-hit areas have been scrambling to accommodate a surge in patients as thousands worried about having the virus crowd into hospitals and beg to be tested. In Daegu alone, 2,300 people were waiting to be admitted to hospitals and temporary facilities retrofitted to treat the massive influx of patients, Vice Health Minister Kim Gang-lip said. A 100-bed military hospital is being outfitted with 200 additional beds.

South Korean President Moon Jae-in on Thursday declared “war” on the virus, apologized for shortages of face masks and promised more support for the worst-hit areas. His office has cancelled a trip to the UAE, which has closed schools for four weeks and cancelled large events to contain the virus as the outbreak in Iran rages out of control. 27 cases have been confirmed in the tiny principality. He also cancelled plans to Egypt (which reported the first cases in Africa) and Turkey (which is in the middle of a nasty spat with Russia).

At least 92 countries have imposed some form of entry restrictions on arrivals from South Korea, including, as VP Pence said earlier, the US.

We’re not certain what the South Korean’s are planning next, but the country’s prime minister highlighted a planned $10 billion stimulus package.

“We need special measures in times of emergency,” South Korean Prime Minister Chung Sye-kyun told a cabinet meeting, referring to extra medical resources for hotspots and economic measures including a $9.8 billion stimulus.

“In order to overcome COVID-19 as quickly as possible and minimize the impact on the economy, it is necessary to proactively inject all available resources.”

To be sure, if there’s one thing South Korea is getting right, it’s the testing: the country has ramped up testing capacity to 10,000 tests a day. In the US, hundreds, if not thousands, of paranoid patients in the Seattle suburbs and other affected areas are being left on their own as their conditions don’t yet qualify for one of a limited number of tests, according to Bloomberg.

The virus, which is striking in the middle of flu season, has killed at least 9 people in the US. It’s also prompted many who have recently traveled to hot spots – and are now feeling ill (which is not uncommon among travelers) to freak out about the possibility that they may have contracted ‘the virus’. For days, Americans have been taking to Reddit, Twitter, FB etc. to share their frustrating stories about being denied a coronavirus test.

One woman who lives in the Seattle area with her husband and kids said she called the hotline after her entire family fell seriously ill all at once. But they weren’t tested because they didn’t fit the criteria which required that people had traveled to a hot spot to warrant testing. These restrictions, implemented to conserve tests as the government tries to bolster supply, delayed diagnosis of a couple of cases in Washington State.

Soon after spending the day in a Seattle suburb where coronavirus spread, Linda Backstrom began feeling sick herself.

Her twin sons fell ill, too, as did her husband, who has multiple sclerosis. They had fever, sore throats and aches. But when she called a hotline run by the Pierce County health department, Backstrom was told her family didn’t qualify for testing because no one had traveled to an affected country, had direct contact with an infected person or developed pneumonia.

“I don’t think I have the coronavirus,” said Backstrom, 58. “But, as a citizen, I’m wondering why this government doesn’t have access to testing. It doesn’t make any sense.”

Coronavirus struck at the height of regular flu season. It has killed at least nine Americans and also has fed a mounting frustration and even panic among feverish, sniffly citizens – most of whom likely don’t have the novel virus. People want to get assessed, jamming hotlines, creating competition for scarce tests and prompting jealous comparisons to other countries where testing has been ubiquitous.

Dr. Scott Gottlieb said yesterday that the administration was “catching up”, despite evidence showing it’s on track to fall well short of its promise to distribute 1 million tests by week’s end. President Trump’s political rivals have seized the opportunity to accuse him of botching the outbreak response.

“The lack of test kits is a national disgrace,” San Francisco Mayor London Breed wrote in a letter to Vice President Mike Pence on Tuesday. “We will not be able to contain, treat, or mitigate the effects of the virus if we cannot diagnose infection.”

At this point, Trump has gone on record to dismiss the outbreak threat enough times that, if the outbreak is worse than expected, or if it succeeds in crashing the economy, he will have only himself to blame if he loses the general to Joe Biden.

On Sunday, just hours before a torrid, desperation-inspired wave of buying sent the Dow Jones nearly 1,300 points higher, its biggest one day gain ever, we warned that the market is on a precipice, with both short interest…

… and overall futures liquidity…

… at all times lows.

It took one day to see just why this was a huge problem: just minutes after the Fed cuts rates by 50bps in its first emergency intermeeting rate cut since the financial crisis, one which the market priced in on Monday (yet wasn’t enough) sentiment reversed as if on a dime, and with no liquidity or short overhang to absorb the selling stocks crashed, resulting in the worst market reaction to a Fed easing, in history. This prompted many to wonder if the Fed “knows something we don’t”, and more ominously, if the Fed has lost all credibility and will now be forced to cut to zero (and and below) while launching QE5 just to keeps stocks from plunging further.

Unfortunately, for the Fed, there is now another flashing-red alert, and in addition to record low liquidity and short interest, we can also add a surge in cross-asset correlations – which in recent years seen as a far more accurate of rising market risk than the manipulated VIX – to the pre-crash indicators that are keeping traders up at night.

Commenting on the recent extreme surge in correlation within and between asset classes, Morgan Stanley writes that global “cross-asset correlations have spiked higher this week, to levels last seen in 2016” noting that within this, “regional correlations, cross-asset correlations and individual stock correlations have all risen simultaneously.”

Some more details:

This sharp increase in global correlations represents a rise in correlations at each of the three key ‘levels’ that we care about – cross-asset, cross-market and intra-market: Our correlation indices (Exhibit 2) focus on the first two of these, while the last is an important addition. For more details on the components which go into our global correlations index, see Appendix: Global correlation index components.

Cross-asset correlation (50% of our index): This refers to how closely prices in different assets are moving relative to each other (credit versus equities, equities versus rates, equities versus FX, etc.). While cross-market correlations have broadly risen across the board, credit-equity correlation, in particular, is now near a 20-year high and has only been higher in 2011.

Regional correlation (50% of our index): This refers to how closely prices in different regions of the same asset class are moving relative to each other (i.e., US versus European equities, US versus Japanese rates, EUR versus GBP). The increase here has been sharp as well, largely driven by a spike in regional equity and credit correlations. On the other hand, intra-FX correlations have remained rather subdued.

Intra-market correlation: This refers to how closely prices of different securities within an index are moving (i.e., are the stocks within the S&P 500 all moving together, or not). Notably, S&P 500 3m implied correlation has spiked higher on the back of the risk-off move. A spike in intra-market correlation is common in market stress environments, as ‘idiosyncratic’ stories (company-specific M&A, tweets) matter less than overall economic or earnings fears.

Explaining what regular readers know all too well, MS notes that correlation spikes typically happen in market stress scenarios, and observes that with growing concern about the impact of the COVID-19 outbreak, risk assets saw the sharpest decline over the past week since the global financial crisis. This is apparent in correlation moves too.

So one day after Morgan Stanley laid out the cheapest crash hedges ahead of today’s plunge (for those who put them on, congratulations), the bank looks at just where correlations look most extreme, and finds that equity-rates correlation is now extremely positive as government bond yields fall in tandem with equity markets, particularly in Europe and Japan. There are also unusually high correlations between US and European stocks, and extremely negative correlation between JGB yields and JPY, as JGB yields fall alongside a rally in JPY in the sell-off. Some more details:

• Equity-rates correlation: Across the G4 regions, equity-rates correlation are now extremely positive, specifically in Europe and Japan. A positive correlation here means falling stocks and falling yields.
• Rates-FX correlation: While FX correlations have remained subdued, we note that rates-FX correlations have declined sharply. Specifically, JGB yields and JPY correlations are very negative now, as yields have fallen while JPY has rallied in the
• sell-off.
• Equity-commodities correlation: Notably, the usual negative correlation of gold to stocks is less negative now. Gold has worked less well as a hedge in the sell-off last week, with gold falling by 4.9% on the week.
• Regional equity correlation: The correlation between US and European stocks is now unusually high.

That said, not every cross-asset correlation is surging: it’s worth noting that gold’s correlation to stocks has become less negative, which means that as stocks plunge – assuming the Fed has indeed lost control – the pet rock will soon  be the best performing asset in the world.

Authored by Michael Lebowitz and Jack Scott via RealInvestmentAdvice.com,

“A good person is as rare as a black swan”- Decimus Juvenal

In 2007, Nassim Taleb wrote a bestselling and highly impactful book titled The Black Swan: The Impact of the Highly Improbable. The book uses the analogy of a black swan to describe negative events that appear to be very rare and occur without warning.  Since the book was published, the term black swan has been overused to describe all kinds of events that were predictable to some degree. 

Last April, we wrote A Fly in the Ointment, which was one of a few articles that pointed out the risk of higher inflation to the markets and economy. Thinking about inflation in the context of the Corona Virus and the Fed’s aggressive monetary policy, might our fly be a black swan.

Coronavirus

The economic impact of the Coronavirus has been negligible thus far in the U.S., but in a growing list of other countries, the impact is high. In China, cities more populated than New York City are being quarantined. Citizens are being told to stay at home, and schools, factories, and shops are closed. Japan just closed all of its schools for at least a month. Airlines have reduced or suspended flights to these troubled regions.

From an inflation perspective, the impact of these actions will be two-fold.

1. Consumers and businesses will spend less, especially on elastic goods. Elastic goods are products that are easy to forego or replace with another good. Examples are things like movies, coffee at Starbucks, cruises, and other non-necessities. Inelastic goods are indispensable or those with no suitable replacement. Examples are essential medicines, water, and food. Many items fall somewhere between perfectly elastic and perfectly inelastic, and in many cases, the classification is dependent upon the consumer.

2. On the supply side of the inflation equation, production suspensions are leading to shortages of parts and final goods. Companies must either do without them and slow/suspend production or find new and more expensive sources.

We are purposely leaving out the role that the supply of money plays in inflation for now.

With that as a backdrop, we pose the following questions to help you assess how the virus may impact prices.  

• Will producers of elastic goods lower prices if demand falters?

• If so, will lower prices induce more consumption?

• Can producers lower the prices of goods if the cost to produce those goods rise?

• How much margin compression can companies tolerate?

• Will producers of inelastic goods try to pass on the higher costs of goods, due to supply chain problems, to consumers?

• Inflationary or deflationary?

We do not have the answers to the questions but make no mistake; inflation related to hampered supply lines could more than offset weakened demand and pose a real inflation risk.

The Fed’s Conundrum

Monetary policy has a direct impact on prices. To quote from our recent article, Jerome Powell & The Fed’s Great Betrayal:

“One of the most pernicious of these issues in our “modern and sophisticated” intellectual age is that of inflation. Most people, when asked to define inflation, would say “rising prices” with no appreciation for the fact that price movements are an effect, not a cause. They are a symptom of monetary circumstances. Inflation defined is, in fact, a disequilibrium between the amount of currency entering an economic system relative to the productive output of that same system.”

For the past decade, the Fed has consistently sought to generate more inflation. They have kept interest rates lower than normal given the tepid economic growth trends. Further, they employed four rounds of QE. QE provides reserves to banks, which increases their ability to create money. Easy money policies, the type we have grown accustomed to, is designed to increase inflation.

On March 3, 2020, the Fed cut interest rates to try to offset the negative economic impact of the Coronavirus.  How lower interest rates will cure a disease is a question for another day. Today’s big question is the Fed fueling the embers of inflation with this sudden rate cut?

Enter the Black Swan

What would the Fed need to do if inflation were to rise due to compromised supply lines and overly aggressive Fed actions? If inflation becomes a problem, they would need to do the opposite of what they have been doing, raise interest rates and reduce the assets on their balance sheet (QT).

Such policy worked well in the 1970s when Fed Chairman Paul Volker increased Fed Funds to 20% and restricted money supply to bring down double-digit inflation. Today, however, such a prudent policy response would be incredibly problematic due to the massive amount of debt the U.S. and its citizens have accumulated. The graph below shows that there is about three and a half times more debt than annual economic activity currently in the U.S.

Unlike the 1970s, when household, corporate, and public debt levels were much lower, higher interest rates and less liquidity today would inevitably result in massive defaults by both consumers and corporations. Further, it would cause a surge in the Federal budget deficit as interest expense on U.S. Treasury debt would rise.

Over the last few decades, we have seen a steady decline in interest rates. At times in this cycle, rates have risen moderately. Each time this occurred, a crisis developed as funding problems arose. What would happen today if mortgage rates rose to 7% and auto loans to 5%? What would happen to corporate profits if borrowing rates doubled from current levels? How would corporations that depend on routine, cheap refinancing of their debt obtain it?

In such an environment, taking on new debt would be much less appealing and servicing existing debt would require a larger portion of the budget. Clearly, an inflationary outbreak accompanied by higher interest rates would result in a severe recession.

Summary

What is a black swan? A black swan is an unforeseen event like the rapid spreading of the Coronavirus that results in inflation. It is not the obvious outcome but rather an obscure second or third-order effect. Our modern economic policy framework is not designed for inflation, nor are many people even thinking about it as a possibility. That is a black swan.  

Inflation is the one thing that prevents the Fed and other central banks from supporting the economy and markets in the way they have become accustomed.

As discussed in prior articles, we believe there is ample evidence of problematic inflation data for those who choose to look. At the same time, global central bankers continue to engage in imprudent policies that are inflationary in nature. Lastly, the Coronavirus threatens to hamper supply lines and change consumer spending habits.

Whether or not those factors result in inflation is unknown. Although one cannot predict the future, one can prepare for it. Inflation is not dead, but it has been hibernating for decades. Even if the odds of inflation are relatively low, that does not mean we should ignore them. As the sub-title to Taleb’s book says, “The Impact of the Highly Improbable” can be important. An event that has a 1% chance of occurring but would cause a massive loss of wealth should not be ignored.

…some might say Biden trumps Powell…

The Dow, S&P, and Small Caps have erased all of yesterday’s losses…

But bond yields continue to tumble…

So maybe the market’s demands for more rate cuts trumps Biden’s gains?

Commenting on the market’s reaction to the Fed’s “panic” rate cut, BMO’s rates strategist Ian Lyngen put it best: “the situation didn’t play out exactly as Powell might have envisioned.” While that was a clear understatement, as Lyngen explained further, there was a simple reason for the market’s shocking response: nothing Powell did would have been seen as enough by a market, which has grown habituated to generous Fed bailouts and which as of this morning is pricing 69% odds for an additional half-point move in April.

Two things follow as a result of the Fed being trapped again: i) any attempt by the Committee to walk back those expectations will need to occur in short order given the looming pre-FOMC radio-silence period, and ii) any “walk back” would lead to a market crash with traders now expecting rates to hit 0% in just a few weeks. As Lyngen puts it, Powell’s biggest risk in going the emergency route was always that investors would respond “fifty’s fine, but a hundred’s divine.”

Which begs the question: did the Fed jump the shark by slashing rates, or is the Fed’s target rate far lower?

As BMO explains, “given the backdrop of a ‘relatively’ strong domestic economic profile coming into 2020, the rapidly deteriorating outlook is remarkable insofar as it hints of underlying vulnerabilities in sentiment even before Covid-19 hit. Recall 10-year yields were unable to sustainably trade above 1.95% in light of the trade war (remember that?), geopolitical  tensions, Brexit, Europe’s flagging economy, and stubbornly low inflation. Adding a pandemic to the mix was undoubtedly going to be worth a significant rally in Treasuries.”

This leave the bank to contemplate whether 100 bps in 10s isover extended or just a reminder that are still 93 bp to go before the zero-bound comes into focus. Here as a reminder, all of Germany and Switzerland’s sovereign debt now trades in negative yield territory. The same is true for France out to the 15-year sector and Japan out to 10s.

And so, according to Lyngen, while this doesn’t suggest that US rates are poised to dip below the zero-bound (particularly not in 10s and 30s), “negative yields in the 2- and 3-year sector of the US Treasury curve have a much higher chance of coming to fruition” an admission the rates strategist says is as disturbing to write as it surely is to read, and explains:

1. We very much doubt the Fed will ever take policy rates below zero – if for no other reason than Europe’s experience with the failed experiment,
2. once the FOMC lowers rates to the 0.00-0.25% range, QE quickly comes into play, and
3. unlike the EGB market, there is more than ample Treasury supply to satisfy SOMA’s balance sheet expanding ambitions.

Why then does Lyngen think that negative front-end yields are a possibility? The answer is simple: investors’ perception that once policy rates are near zero, there’s a chance (no matter how remote) that the currently unthinkable is the only course of action. At that point it becomes a self-fulfilling prophecy, and as we have observed so often, whatever the market demands the Fed does, the Fed ends up doing. Even if it means NIRP.

That said, NIRP in the US won’t come tomorrow: first we need to retest the recent record low in the 10Y yield:

As a point of clarity, the transition from rate cuts, to framework-shift, to bond-buying isn’t one that we’re anticipating to playout immediately – or even this rates cycle. Nonetheless, given the global rates backdrop it is well within the realm of conceivable outcomes to have negative front-end yields. For the time being, we’ll content ourselves with the prospects of 10-year yields retesting the 89.1 bp lows from yesterday; a breach of which would negate the ‘it was just a panic safe-haven move’ argument.

The technicals are also set for NIRP: “Monday’s rally established a 10-year yield outside-day lower which has historically been a bullish continuation pattern. The accompanying extensions of overbought stochastics and MACD are, of course, troubling even if the repricing warrants an elevated degree of skepticism on the traditional momentum measures.”

As such, a period of consolidation at or near the yield lows “would be sufficient to work off the extremes and clear the path for another leg lower in US rates.”

Meanwhile, as Lyngen concludes, “the number of incoming inquiries on what 50 bp on Tuesday implies for the March meeting speaks to the demand for even greater accommodation as the rising probability of another cut begs the question if even that will be enough. If the ‘shock factor’ played a role in the Committee’s decision to lower rates this week, the same logic would apply to a growing chance of an additional 50 bp adjustment on the 18th. While it is still too soon to call this a base case, it is a risk which will only grow more likely in the event further downside in equities is realized.“

In short, while negative yields are virtually assured, the question of when they happen will depend on stocks: another crash, in a day or two and we may wake up in late March or early April in a whole new monetary twilight zone, one which in turn will set the stage for the monetary endgame, one heralded by the Magic Money Tree, or MMT, which will be the beginning of the end.