Lockstep Credit Burdens The Economic Assumptions

by: Alhambra Investment Partners

By Jeffrey P. Snider

For all the supposed and assumed disparities between US monetary policy direction and that in Europe, credit markets in both locations seem to be far too much in lock-step agreement. That would suggest a few implications, the first of which is that the global financial system does not really consist of many closed systems with only minor connections as assumed in the orthodox textbook. That is especially true of the very tight links between Europe and the US, which tends toward confirmation that the global dollar short may not have, as yet, eroded all that much (if at all).

Second, and related to the first, the behavior of credit curves all over, particularly on the longer ends, is diametrically opposed to the "next year" thesis that I contend has grabbed stock markets. That counts for not just Europe that is more evident in its economic erosion, but also the US.

You see that in the timing of all these various and sundry credit indications. Throughout August, yield curves went very flat and in dramatic fashion, only to see that somewhat reverse in September. I still believe that, especially in Europe, the retracement this month was related to optimism (or even repositioning) ahead of what was thought to be a grand monetary stand in the "T" LTRO. As it ended up being very disappointing the curves have all retraced that retracement back to August again (with minor "adjustments" here and there).

In US$'s, there is no particular reason as to why the ECB's measure would have an imprint, but the timing is certainly very coincidental in both the early September steepening and then the rewind back as it is now.

For the dollar side, the theme seems to be one of an expectation of a full QE exit and even a possible rate hike. It doesn't seem, as yet, to be much of a disturbance, as the eurodollar curve above shows, particularly as the curve continues toward flattening once again. That would further suggest that credit and dollar participants are hedging in that direction more than repositioning. A check of the swap spreads adds to that, since spreads have widened ever so slightly during this process.

So where the Fed captures the short end, the link to Europe seems to be in full effect on the long end. The timing is, again, exact in its replication as the US curve saw the same dramatic flattening in August, to be somewhat undone in the first half of September before moving right back to the shape of late August once again (or nearly so in some pieces).

Far be it for me to use the forsaken term, but it does not seem as if these global-reaching credit markets are all that enamored with "global growth" as it is estimated right now. And that observation, such that it may be correct, stands in the face of monetarism moving in opposite directions on either side of the Atlantic.

As if to reinforce that view, and particularly the American economy's heavy and unfortunate involvement in it, inflation breakevens here have finally broke out of their yearlong trading pause. Contrary to all economist expectations, they did not do so to the high side (though the 5-year did for a few months, though oddly which caused my skepticism towards it).

In fact, the 5-year breakeven broke as low as anything we have seen since the end of 2011 during, coincidentally, the thick of the euro crisis. As I think there is now, there was a heavy dollar stain in that period even though most attention followed the euro side (the Fed was "forced" to reopen dollar swap lines in September 2011, followed in early December 2011 by making them unlimited in capacity). So again, the links between the US and Europe are apparent, though not quite in the fashion that would make Janet Yellen's job easier of convincing everyone that "next year" is finally the year.