First Rule Of Bond Market: You Do Not Talk About Keynes?

Our friend David Janny at Morgan Stanley insisted we bark up the NIRP tree. As Dave is an amiable chap, affable gent, and most congenial, we endeavor to oblige... carrying on (pun intended) from A Negative Disposition? and A Wayward Italian in Kansas?...

The 1st rule of bond market? You do not talk about bond market? No seriously, one should not be ashamed if they cannot comprehend negative yields or their nuance and meaning.  Not surprisingly, the special population of negative yield challenged includes the STIR ignorant public, and sadly many "credentialed" economic and financial professionals.

Disclaimer, what we know is little, what we do not know immense. I make no claim to being any kind of expert, and consider myself strictly a somewhat "useful" idiot. Speaking of which, for the ADD and Twitter afflicted crowd... 

Is there anybody in there? Still thinking McFly? Didn't follow the breadcrumbs from our earlier missives? What else happened in Oct 2018? Coming full circle...

At the ultra short end: o/n GC repo; t/n Yen; t/n Euro all inverted with the 10 briefly in January 2019 and went full tilt boogey in March 2019.  Is this "condition" what really prompted the Fed to pause and cut? - That's The Signpost Up Ahead?

Now, a complete refresher of our September 16th uber timely Nattering's of stealth inversions...  Back up to OCTOBER 2018, the yield on the YEN hedged 3mo-10's carry inverted (Japanese UST buyers) to negative, EURO followed in January 2019, the ultra short end followed in March 2019, and the rest is history for UST FX hedged margin buyers. 

more so than flight to safety, UST's are coveted bank balance sheet "lite" tools, due to LCR more balance sheet lite than holding cash.  But due to FX hedged costs (especially JPY and EUR of late) many foreign investors only want to rent them in reverse repo. Nattering for another day?

And now this...

Above, and noting in particular the large spike since October 2018: Why would one buy UST Bessie and carry FX hedge cost, when one can rent her for less in reverse repo? Answer: unless obliged to purchase (primary dealer), they would not, and have not. Moving West...

In order to limit our Nattering in this three part series (to date) we attempted to explain four causes of NIRP, one in particular motivated by an ARB and maturity transformation, facilitated by synthetic derivative. 

We attempted to partially explain the mystery of negative bond yields, and in doing so we witnessed how FX rates, in the form of a synthetic arb (swap), can and do influence bond yields. - A Wayward Italian in Kansas?

Speaking of which... The convexity (bond, bias, hedging) trade (positive, negative) which asset-liability managers, insurance companies and pension funds engage in, can be a contributor via swaps and UST purchases to perturbations in the curve or "convexity events" which push yields down, and into negative territory.  Along those lines...

The 1st rule of bond market? You do not talk about Keynes demand for money where convexity is present viz. one should not attempt to apply a "investment-savings" (IS) and "liquidity preference-money supply" (LM) construct viz. (Keynes Liquidity Preference Theory of Interest Rate Determination) in a market where convexity and maturity transformation is in play. 

The latter two can throw wicked term structure "curve balls" which lead to "seemingly" unexpected results. When combined with Keynes demand for money (false doctrine) which conflates the difference between demand for money and demand for loan funds, this can easily lead the uninitiated astray with regard to causality viz. "seemingly" counter-intuitive results as opposed to what the supply demand construct might predict.  

To be sure, the 1st rule of markets: Interest rates are the price of loan funds and never to be conflated with the price of money, which is reflected in FX indices and pairs. Low rates or prices for loan funds can indicate low demand, viz low expectations for growth and aggregate demand.  Lower prices can compress NIM, encourage leveraging, arbitrage, yield chasing, and effect balance sheet capacity. Moving West...

Convexity (bond, bias, hedging) is a contributor to negative rates, while collateral specials (negative repo) and the long term transposition of the savings investment channel, are Nattering for another day.

A synthetically inverted yield curve enhances a long standing savings investment channel transposition which has deleterious side effects on capital, monetary and economic flows. The 400 Phd's at the Fed who have never accurately predicted a downturn, saw NIRP coming right? Along those lines...

Said ZIRP targeting, QE purchases, CCR's can and do modify market participants (in a search for margin and yield) investment strategies and behaviours viz. [affect and effect] market distortions in asset valuations, desirability of collateral, disintermediation of certain market making participants, liquidity preferences, all of which can necessitate financial alchemy for arbitrage, all of which can set the stage for ZIRP.  - A Negative Disposition?

If one thinks that rate cuts and QE4 ("to ensure ample reserve levels") will save the day, those tools didn't work then, won't work now, and will only make matters worse. The definition of insanity applies? like Tyler Durden...

More to come, as the Man with No Name returns with more news on the repo ruckus in A Dollar To Die For? Stay tuned, no flippin.

Recommended reading:
A Negative Disposition?
A Wayward Italian in Kansas?
A Fistful Of Dollars?
For A Few Dollars More?
The Good, The Bad And The Ugly?
A Coffin Full Of Dollars?
NIRP: The Marshmallow Test?
Trading Sardines: The Case Of Currency Hedged Negative Yielding Bonds
Convexity Hedging: What Is It And Why Does It Matter
Never Mind Yield Curves: What's Negative Convexity?