On Friday the 3rd of June the Bureau of Labour Statistic reported that Non-farm payrolls rose by only 38,000 in May, well below expectations set at 160,000. We all were waiting for Ms Yellen speech, planned for Monday the 6th in Philadelphia. It has been last public speech before next FED meeting scheduled for the 14/15 of June. Ms Yellen still sent a clear message to the market: “I continue to believe that it will be appropriate to gradually reduce the degree of monetary policy accommodation, provided that labor market conditions strengthen further and inflation continues to make progress toward our 2 percent objective.” Having given a broadly positive and supportive outlook for the US economy, the FED chair, although recognised latent uncertainties as Brexit referendum, concerns about China and degree of resiliency in domestic demand, in the end she remarked the fact that one set of bad numbers doesn’t make a poor economy itself.
It is crystal clear that Ms Yellen concerns weighted on market’ reaction, or may be it is better to say that the investors did not find any hawkishness in her speech. If we try to translate it into numbers, by Monday odds for a rate rise in June had fallen to one in 50 back from a one-in-three chance from only 15 days ago. FED funds futures are showing a likelihood of 25 per cent for a rate rise at July’s meeting, well below from 55 per cent before Friday’s jobs report.
On Friday, the 10yr US Treasury yield reached a minimum of 1.627% and closed at 1.644%. The entire US yield curve flattened as well as the other government bond curves behaved the same. For instance, the 10yr Germany Bund collapsed at its historical minimum of 0.010 by closing at 0.021. Please be aware that when we reached a previous minimum level of 0.07%, late in April 2015, the deposit rate set by the ECB was -0.20%.
Do not forget that now Mr Mario has lowered the bound setting it at -0.40%, in the ambitious attempt to encourage banks to lend to firms and consumers. The main objective is to avoid that financial institution will park their money with the central bank. But the message is that potentially we can see a negative yield also for the 10yr bucket.
We still believe that prices in German bonds do not make any rational sense. In real terms, unless you believe in a strong deflation upcoming period and in zero costs charged by banks for your transactions, we are already talking about a certain loss. Investors are greedy to buy because they think they can sell them to someone else at a higher price. Indeed single banks and ECB are willing to buy more and more but clearly we are going to reach a point of no return.
I would like to conclude this “Rear View Mirror appointment by remarking what “Mr Bond” Bill Gross tweeted on 9th of June: “Global yields lowest in 500 years of recorded history. $10 trillion of neg. rate bonds. This is a supernova that will explode one day”. Of course timing is everything and shorting Bunds, even at these levels, could be very painful. But we should not forget that Mario Draghi, as Kuroda did, is only buying some time. He is giving to single countries the opportunity to implement fiscal policies. A prolonged NIRP environment will undermine the profitability of banks and insurance companies. Let’s say that not only the profitability itself but a sane management is under review. Somewhere the mechanism of QE could be badly interrupted. My advice is to set aside of this trade unless a clear trend reversal will become alive. At the moment we are talking about a no-trade. But at the same time do not forget to jump on this train whenever a strong signal will appear.