"If Tuesday Was Market Chaos, Wednesday Was Chaos On A Trampoline On Drugs"

By Michael Every of Rabobank

*Another* pause that doesn't refresh

If Tuesday was market chaos, Wednesday was chaos on a trampoline on drugs.

The polite version is that weaker US labor market data (ADP employment +89K vs. 159K expected, and median pay up ‘only’ 5.9% y-o-y) saw the market reverse some of Tuesday’s bond sell-off and ‘pause’ to see what comes next. The ruder version is best summarized by the disturbing graphics in my 2023 outlook ‘The Pause That Doesn’t Refresh’ with its 1950’s-advert style ingredients: “INCLUDES: Geopolitics! Inflation! Policy errors! Recession! NO RATE CUTS!”, and its health warning: “This product does not contain: hopium, copium, asset-rich-income-poor, gold, crypto, or Petroyuan. Shake yourself well before use.”

To summarize, US 10-year yields started at 4.80%, pushed up to almost hit 4.90%, then, just as key bond metrics were finally flashing inflation concerns, and long before the ADP data, this move was reversed, and once we got the ADP data, yields closed lower on the day. Moreover, as we got a staggering 5% drop in oil prices(!) to boot, those yields ended at 4.72%, so a near 18bp intra-day round trip. At the short end of the US curve, 2-year yields went to over 5.17% and then dropped back to 5.05%. Further down the curve, supposedly above this fray, 30-year yields soared to over 5.01% and then collapsed to 4.86% within a few hours. Just to underline, this is the primus inter pares of global bond markets which everyone everywhere in the world has to look to for the cost of borrowing: and it’s trading like a penny stock.

If that doesn’t give you pause for thought, not refreshment, then there is something wrong with you, even if you think lower yields are ‘better’ than higher (i.e., you are a borrower not a saver, or you work in financial markets).

To emphasize my point, back to oil. This is still the lifeblood of the global economy, and again one perhaps dodgy data point from increasingly erratic US sources saw a staggering decline of $5 in one day. That, more than anything, is what brought down bond yields, not the ADP.

So what actually happened? First, I don’t know. Second, nobody knows. That’s how markets work. We can all write clever analytical notes after the fact, but given we can’t write them in advance of facts tells you something about just how good our methodologies actually are.

To my mind, what we just saw speaks to the fact that with current volatility, market liquidity may have been lower than normal; that bond positioning had switched to net short from net long; that we may have seen intervention from a central bank (and the list of potential offenders is short, and starts with ‘B’); and that this required immediate short covering. Then the data gave some cover to ‘reassess’ a position they had been so sure of hours earlier.

Yet the crash in oil speaks to broader market themes that get even less press because our methodologies are even worse at predicting them. On one hand, the fear of global recession, more reversal of market positioning after some had been calling for $150 oil. On the other, the Fed’s push-back against shadow banking, which wants low rates, and the global Eurodollar complex that dwarfs the US financial system, which wants low rates too; and the push-back against oil producers cutting supply, and a linked shadow-banking drift to collateralising their commodities as a global funding alternative to Eurodollars.

In short, all kinds of things started to break yesterday in a global financial architecture fit for breaking. Indeed, if just one number in a third-rate data series can push key bond yields down 18bp intraday and oil down 5%, imagine what a weak, or strong!, print in US payrolls or inflation might achieve. Or, starting today, what about weekly initial claims? And, given our increased headline sensitivity, what about 75,000 US healthcare workers going on strike, and the White House cancelling a further $9bn in student loan debt, so adding more marginal consumer demand?

The scale of the market volatility being seen already rivals some of the worst in recent years. The scale of the losses in ‘safe’ long bonds was, until yesterday, rivalling the worst in stocks during the dotcom bust. And the scale of the problems still ahead of us regardless of what we do now is so large that most refuse to try to grasp it.

If commodities go up, not down, 5% in a day, then bond yields can’t go down across the curve for long. Wait and see what oil producers do next. That means rates need to stay high for now.

If yields go back up again and rates stay higher for longer, the economic and market damage will be epochal: how can it not be with debt so high and so much asset-based nonsense after years of low-rates lunacy?

If yields fall further, and oil and other commodities in tandem, we are staring down the barrel of collapse in the real economy in an already-angry world that needs ammunition and nutrition, not larger digits on a screen for a lucky few, or more unaffordable housing for the many. Thinking there would be long-term sustainable upside for assets and financialization just because yields drop is wildly optimistic.

Either way we are likely to get more, and more overt, intervention in markets from worried governments and central banks, throwing extra volatility into the mix. Most are uninformed of the real scale of our problems; or are ideologues who think their cookie-cutter solutions will always work; or, in some cases, they grasp what is to come, and are desperate to kick the can down the road. Combining all three, US Treasury Secretary Yellen yesterday said ‘higher for longer’ isn’t a given, and that the drivers of low inflation, like demography, are still “alive and well” – except it’s people not being alive or well that has helped tighten labor markets so significantly.

Relatedly, her ‘oops, monetary-policy!’ slips are now so frequent it’s clear she thinks she’s still running the Fed as well as the Treasury: is that a bug or a feature? Indeed, if you think the White House and Fed are truly aligned, or other major governments and their central banks are, what colour is the sky in your world? Of course, this also implies vastly higher volatility ahead.

To summarize, we just had another ‘pause’, as lazy analysts will put it. And yet it still won’t refresh.