The bond drama has shifted to Europe

Outlook

Bloomberg’s headline writers are sometimes a little too cute but often nail it. This time it’s “Tech slide and oil rally spur flight to Treasuries.”

First, from the summary:  “Hedge funds have loaded up on shorts, pushing bearish bets near a five-year high and raising the risk of a sharp squeeze if markets rebound. Short sales have exceeded long purchases by a ratio of roughly five to one across global equities, with short leverage sitting in the 99th percentile over the past five years. Global fundamental long/short funds are down 2.5% in October, with funds focused on technology, media and telecommunications down 7.4% so far this month.”

But there is a third problem, too—France.

The bond drama has shifted to Europe. French Oats retreated from eye-watering levels but then bounced up again to 5.098% this morning, according to Trading Economics. The reporting on Oats is pitifully hard to get if this is such a big deal. 

The spread with Bunds widened again to 175 bp, the highest since 2011.

Bloomberg reports “There are few obvious triggers to restore confidence, with worries including the cost of living and the potential for Germany to subsidize other governments.” Germany subsidize? Well, the French crisis is dragging Italy with it and some feel it’s not so silly and remote an idea. The article breaks off without discussion and this may be the idea of one analyst.

We say from decades of watching the northern EU counties refuse to subsidize the southern tier, which is why there is no EU wide unemployment plan, that there is zero chance of Germany rising to the rescue. Remember Nobel-winning economist Joseph Stiglitz wrote a book about why the euro would fail and former TreasSec Summers agreed. We spent months writing about it.

Then along came Draghi with “whatever it takes” and that worked for quite a long time. Greece got its act together and later, Spain rejected his terms for a bailout.

It’s important to note that these crise and recoveries took a very long time—months, not days.  We wrote The FX Matrix with co-author Schmelzer as the Greek saga was playing out.

On top of France’s budget issue, next week (or possibly tomorrow) Moody’s will likely downgrade French paper. ING reports it foresees A1 fromAa3 with a stable outlook. Stable? “This would bring its rating into line with those of Fitch and S&P, which both rate France A+ with a stable outlook. However, a negative outlook following the downgrade cannot be ruled out. This would signal that a further downgrade could follow in the relatively short term.”

Note: the 20-year Treasury auction yesterday didn’t deliver any useful information, or if it did, we don’t know what it was. Granted, the yield went to 5.469%, the most since the 20-year came back in 2020. This is higher than the 30-year at 5.399%, which is odd but since the 20-year is unpopular, we don’t know what to make of it. The big-to-cover was okay but only 58.2% of indirect bidders wanted it (includes foreign central banks). The 10-year ticked up a little but nobody infers it was because of the auction. We are still at sixes and sevens about what comes next.

Another Note: We find it amusing that analysts are starting to apply standard financial criteria to the tech sector. You know, sales plus cost of goods, gross and net margin, etc. Then there is the total capital that will be needed to do a full build-out of data centers—in the trillions. The sector deserves a shake-out. This was always going to happen and it’s funny that only a few forecast it.Does it burst the bubble? Yeah, probably, but as Sorkin says, we don’t know when. If you haven’t read his book 1929, run out and get it. One big difference—the level of incompetence and corruption today is far higher than it was then.

Forecast

The 10-year yield chart shows a strong tendency to the downside but it has stopped and is now going sideways. A tendency is not trendedness. We need confirmation in order for our pretty scenario to resume—lower yields, lower dollar.

Instead we are getting resumption of risk aversion and that is dollar-supportive. Oil prices and the war probably lead, if it’s true that Trump is going to assault Iran again. Of equal weight would be a bigger tech sell-off, but that’s still not yet known. And third is France, where we can expect from experience that it’s going to last a very long time, even after the April election. As noted before, contagion is not well understood and we may see some weird and unexpected outcomes.

These factors point to a resumption of flight to safety—the Treasuries and the dollar. It’s “premature” from a chart cycle point of view, but cycles are inherently unreliable anyway. They imply a form of predestination that is unproven historically. Shocks are more likely. This time we have three Shocks, so it’s hard to stick to a destination suggested by chart indicators.

We may be eating crow over the buy signals.