Do negative yields call for bold new economic policy?

An emerging topic that's gaining traction of late is the tremendous shift seen in developed nations bond rates with some nations sovereign debt trading at negative yields, a world first. The ever expanding debt load that's fallen below zero yield has begun consolidating after initially bulging outwards at an alarming pace but could be fuelled further if investors search for positive return is exacerbated by the enormous demand for both US Treasuries and UK Gilts.

As of today the US 10 Year Treasury yield recorded an all time low as buyers stormed through sellers demands as fears from Brexit flood the market with worry and the outlook for the interest rate environment drifted away from expectancy of normalisation after a lengthy period near zero, a once thought lower bound of rationality.  

Stocks are overstretched and have been for a while considering the previous quantitative easing measures that had were in place for some time which prompted companies to take advantage of the low cost of borrowing to repurchase stock in the open market. Although the effects of this helped extend the bull market by an extra year or two the party soon came to an end when the taps turned off and earnings were suppose to continue their growth.

This hasn't happened, in fact earnings are fading fast along with the global economy that can't find the right footing to leverage the mounds of debt created to act as stimulus.

The US Federal Reserve divergent plan to act in a different manner to its developed nation counterparts is a far greater mission than had been expected which is why investors foresee it departing from this policy stance and reverting back to its old habits of printing money till the cows come home.

Why is this all bad?

Simply because the world cannot function on the perpetual money creating scheme that has so many politicians fixated with in an effort to cover up their own flaws. We've entered a new era of economics and the need to find policies that branch off from convention yet address the evolutionary problems that constantly grow as year go by cannot be without fail.

We trust the message of the bond market over stocks.#stocks vs #bonds$TLT vs $SPY#GrowthSlowing@KeithMcCullough pic.twitter.com/EvlfjctE6o

— Hedgeye (@Hedgeye) July 1, 2016

Will the Fed's hesitancy lead the market to see more risk?

Wait and see; that's the approach expected to be taken by the US Federal Reserve at today's announcement around its decision on interest rates that are yet to see further hikes after initiating the first such increase in rates in almost a decade following the Fed's December meeting. Since then the market has been largely affected with issues like China's economic growth stagnancy, a European refugee crisis and now a possible exit from the EU by the United Kingdom.

All these events have prevented the Fed from acting on their aspirations of seeing the Fed Funds Rate sit at a targeted level of 1.4%...pretty rich coming from a central bank that's been artificially fuelling asset bubbles since the introduction of Quantitative Easing.

Many at the time shot down the FOMC's projections by reiterating the weak global economic outlook that seemingly took hold of proceedings in the latter half of 2015 that was expected to last throughout the entire 2016. We've seen those conditions escalated in the first half of this year with advanced economies taking the front seat in terms of uncertainty, all showing signs of dragging down global growth.

5 things everyone will be talking about this Fed day https://t.co/BpeQaWs9ht pic.twitter.com/EGLOIU2ex1

— Bloomberg (@business) June 15, 2016

Brexit might be the excuse used this time but the Fed knows very well that if it continues to stall hiking interest rates the higher the likelihood will be for it to renegade on its normalisation policy.

The real risk presenting itself in the global financial system resides in the fact that central bankers are losing their influential hold on directing their economies by allowing world government's to fall back on monetary policy to reboot the global economy.

This no longer stands as a strong deterrent of deflation that poses a risk to an ever increasing debt mound that injected myopic confidence into a system with the results proving unsuccessful. It also shows a worrisome sign for the economic outlook that partly fed the miniscule economic growth numbers we've seen up until now.

Questions are being asked whether US Treasury's will follow in the footsteps of fellow nations such as Japan, Switzerland and now German in dipping below negative yields?

I don't think the answer to the question should be to speculate whether they could but rather what are the implications if they do and these nations should decide to start the normalisation process considering their bond instruments are amused "safe" and investors continue to flock into them to weather the financial storm.  

Update on Global Bond Yields as Global Growth continues to slow pic.twitter.com/h6jL2hcWlF

— Keith McCullough (@KeithMcCullough) June 15, 2016

Are negative yields taking over the bond market?

As chaos begins to descend into financial markets again after a hiatus that saw oil prices bounce strongly, the Chinese growth dilemma take the backseat and central bankers announcing additional rounds of quantitative easing measures to be put in place, the outlook remains hazy with investors increasingly placing their bets in the least perceived riskiest asset namely government bonds in the hopes that it could yield them some sort of meager return that's been absent in portfolio's in the last year.

Subsequently the demand for high quality government bonds issued by nations such as Japan, Switzerland and now Germany has been driven so far that yields have turned negative, a first time phenomenon that's left many puzzled.

Critics of the current monetary view of Negative Interest Rate Program (abbreviated NIRP) by advanced economies such as those mentioned above have spoken out at arm's length about the distressing outcome these nations could be headed into if they don't allow sanity to prevail in realising the limits of monetary policy having reached an irrevocable end at the extreme side of the spectrum.

A staggering $10 trillion bonds at face value currently trades underneath a yield of 0% which has been steadily rising as the situation spins out of control compelling investors to seek out riskier alternatives that hardly leaves much comfort in its placement. Parlously slated assets that are starting to feature in portfolio's include long dated and junk grade status bonds.

In the case of the former, investors feel it justified to give up the opportunity of lending capital out in the short term just for the opportunity to earn a positive yield!!! Furthermore the implication of such belief leads one to ponder the ramifications that will be felt when desperation no longer holds appropriate and the shift in policy direction takes hold, amounting to immense losses suffered as a result.

For all its worth if one outcome were to come of the present and the future it would be the underlying fact that no single controlling economic policy mechanism is able to steer forth the weight of economic activity without the assistance of the other. It would also stress the need that government's inaptness to respond in a constructive manner doesn't exist under the premise of socialist ideology instead working on a fallacious conception that infinite quantities of money are available at hand to allay the harshest economic circumstance which couldn't be farther from the truth.

The global economy is slowly metamorphosing into the ugly looking monster that reared its head in the Financial Crisis however this time the consequences will be worse.      

Paradigm shift!
Government bonds: 'return-free risky assets'! pic.twitter.com/CPRHqj0a6f

— jeroen blokland (@jsblokland) June 10, 2016

Is the Danish central bank creating currency risk?

At the start of the week I decided to focus my attention on major currencies and the volatile climate they were exhibiting as well as the troubling situation most developed nation's central bankers are finding themselves in trying to reverse the years of expansive monetary policy measures that has produced ill-effects that are seemingly weighing down economic activity.

The monetary noose that hangs around these nations necks seems to be getting tighter with every consecutive week that passes as the trickling news flow slowly starts to build up momentum to turn this cash flush fanfare into a nightmare on Elm street.

Being aware that there are a number of countries mostly in Europe that implemented such extreme measures of sinking interest rates below zero before the ECB and BOJ joined the foray, it would make sense to find the nation that's had these measures in place the longest and assess whether there's been a level of success.

As luck would have it I found a handful of stories about the Danmark Nationalbank who currently holds the longest reign of interest rates in negative territory with the ongoing recording setting feat sitting at four years!!!

The funniest part is only last week Governor Lars Rohde cautioned those who wished to speculate against the central bank saying officials would unpack whatever measures were necessary to stop the Danish Krone from appreciating against the Euro. The reason for such a strong message is revealed in the fact that the DNB has placed a peg on the level it wants to protect the Krone from surpassing against the Euro.  

Don't bet against #Denmark’s central bank https://t.co/cDZcwbmWm2 via @PeterLevring pic.twitter.com/s2rm7Fkk1u

— Zoe Schneeweiss (@ZSchneeweiss) May 13, 2016

Tough talking didn't prevent a scare from happening early last year when the Swiss National Bank, who itself had a floor in place against the Euro, abruptly removed the peg in an unexpected move that created a toxic currency whirlwind of volatility that reverberated throughout the entire financial market.  At the time, the DNB defended its own peg bravely after speculation became rife that it could follow suit with the SNB and remove the floor.

However once things settled down the Krone began depreciating, helping it avoid the inevitable ascent the DNB hoped to ward off but this time it decided to use foreign currency reserves it had built up over years since negative interest rates hadn't assisted its objectives up until that point. 

It's imperative to understand that the reason the SNB removed the floor against the Euro is because the ECB was speculated to and has now begun a protracted quantitative easing program that would would sponge up all the foreign reserves the SNB had available which had fast depleted once speculation grew. The issue came in the nature of the communication between the SNB president Thomas Jordan and the public with the perceived level of trust towards the central bank amongst the highest out of all its peers.

Jordan's timing of the removal of the peg was left too late in the game and miscommunicated improperly that direct fault can be pointed at him and his colleagues for creating mass panic that left financial markets reeling.

Currency intervention an imminent risk in Denmark, Nordea says https://t.co/DT8mJYPwQ0 via @CHRWIENBERG pic.twitter.com/mo4WDNLMKJ

— Bloomberg Markets (@markets) May 20, 2016

If common sense prevails, the market would've realised that the mammoth monetary stimulus currently being effected by the ECB dwarfs all the monetary programs being meted out by Nordic countries including that of Denmark. These nations are simply too small to compete against monetary stimulus of this size and scale which means their local currencies get brushed aside by the waves of crisis-fearing money making its way to their shores in an effort to shelter wealth.  

This probably explains the markets skittish sentiment after Lars Rohde made comments refusing to concede his effort to the market and allow a free hand to decide appropriate equilibrium. It translates into the possibility of seeing another SNB type shock descending into market sphere's, adding risk at a time when major currency volatility is at its height.

The worrying foreign currency reserve drain that's occurred over the last year surely puts the writing on the wall for DNB officials or is this yet another case of attempting to cover up the flaws of a failed process that isn't working and probably won't be the saving grace of the world burdened with troubled economic times.

#Denmark Foreign Reserves have been shrinking for some months sending worries over whether the peg will be remove pic.twitter.com/atKWg44xsH

— Quinton Mendes (@CadeTradeR) May 20, 2016

Travelling Technicals with Global Indices: Swiss Market Index

With a modest population of just over eight million people, Switzerland's position in the world order remains amongst the top mostly because of the political neutrality the country holds as well as the loosely regulated financial sector that encourages plentiful capital inflows due to its image of being a tax haven for the wealthy. 

Nestled in the heart of Europe, the Swiss are known for their excellence in chocolates and cheeses but more notably their innovative ability in the fields of manufacturing and pharmaceuticals that play a vital role in ensuring a healthy trade balance that's the envy of other nations. The country has however suffered from protracted periods of appreciation in the Swiss Franc, it's local currency with the severity of sentiment having been tested in January 2015 when the Swiss National Bank president Thomas Jordan announced a surprise decision to remove a floor that had been placed on the Franc against the Euro stopping it from appreciating further.   

Besides this event, the nation has also found itself in the grasps of a battle to produce meaningful inflation following the lack of demand both locally and internationally which has eventually led the SNB to drop interest rates below zero (one of the first nations to do so) with imminent signs of continuing on this path as the latest economic data indicates the country is far from where it would like to be. 

The SIX Swiss Exchange in Zurich plays host to some recognisable multinational companies some of which are; 

• Glencore 
• Compagnie Financiere Richemont SA
• Credit Suisse Group
• Nestle SA
• UBS Group
• Swatch Group SA
• Novartis AG
• Zurich Insurance Group 

Let's get to the charts: 

Quarterly

An appealing chart at quick glance considering the volatile price moves that have been experience over the past decade. Although it must be noted that the timeframe is a quarterly, there remains distinct technical features that provide us with clues to what we can expect to see happen in the future. 

The index shot up to 9 500 during the year of 2007 followed by the slump most world markets went through occurring between 2008 and 2009. I've touched on this extensively saying that the similarity of technical damage incurred by market indices from the same event does stress the significance of its doing. The previous highs leading up to the bubble bursting played a pivotal role in dictating the direction of world stocks by providing overhead resistance that's stopped most indices from marching ahead and at the same time denting confidence when considering investment into equities. 

I made the resistance line of 9 500 bold because it marked an important level traders and investors needed to pass in order to be satisfied that the current bull run that's been in place since 2012 will remain intact and energetic enough to settle the index at higher levels. This hasn't materialised with the resultant action being the retest of the line of polarity highlighted in red. 

Again, I saw this as a crucial point in the bull run where it represented a step higher in its pursuit to the resistance level and higher.  The level of 7 500 was broken during 2008 but overcome five years later with the bulls setting themselves up for a good run. However observing the price action you'll notice the tails to the bottom were small then began expanding as the price got closer to 9 500. This would indicate heightened volatility at elevated levels spelling uncertainty. 

The area of interest will take place at 7 500, so don't be surprised if this level is well contested in the second half of the year. Depending on the sentiment world markets take on, it could prove either distressful or supportive of price going forward. 

Monthly

I've introduced a 50 SMA to clarify the bias price currently holds with the observation being critical in the tipping point of this chart. Price sits below the moving average having broken down in recent months. The moving average does however exhibit a positive gradient making things hard for traders to decipher the direction. 

Although the technical formation isn't perfectly aligned, the basis of the shape does help us understand what price action may be suggesting. The flat floor together with an upward slope along the highs building up to 9 500 confirms the volatile nature the quarterly chart had indicated, telling us that the level of uncertainty in this area remains high. 

The support between 8 200-8 300 has broken downward with price desperately trying to hold onto newly formed resistance. The RSI has generated a favourable indication for the bears by showing the momentum shifting below the 50 level after last being there in 2012. This suggests that the momentum from the sellers is much stronger than it had been while they were fighting for territory in the area between 8 200-9 500. 

 

The setup seems perfectly positioned for the trade with good risk to reward ratios.