Reading the Tea Leaves when there is No Tea

Everyone is trying to figure out what is going to happen next. Investors are looking clues and signals as to the next big move. The problem is that liquidity is so poor, moves that might normally signal a shift in sentiment or risk, are now just noise.

We can look at 10 year Spanish yields. Definitely a useful signal, but back to exaggerated moves on little volume. Liquidity is abysmal.

Things like the EUR/USD basis swap was once an indicator, but how useful is something when the Fed has provided unlimited swap lines and banks are encouraged to use them. Hardly an indicator of anything, though I would argue any weakness in the face of all that central bank effort is more meaningful than signs of strength.

It was easy when the EUR/USD rate itself was a key indicator. Sometimes it still is, sometimes it isn’t. It is flow driven, but the flows are confusing as some money is just being shifted from one Eurozone country’s bonds to another’s, and there is growing confusion over what it means that each country’s debt is being held in an ever greater proportion by its own banks.

For myself, I’m looking more at yield curves than any particular bond. The curve flattening is still a bearish indicator, though Spain is a weird one today, where currently the 2 year yield is higher, the 5 year yield is better, but the 10 year is higher, though all have rebounded significantly.

CDS seems to remain a better indicator of the true state of the credit market, though the technicals from any potential “whale” trade unwind are hard to account for. I am seeing bid/offer spreads normalize in the U.S. which is a good sign, but they are still wider than normal in Europe. IG18 is basically unchanged on the day, in spite of the moves in stocks, another sign that the rally isn’t very deep yet.

The size of the moves in all markets is getting scary. We have now seen stock futures move more than 1% today from their overnight lows. Were the retail sales data really that good? Some of it looked strong, but the “core” numbers were less compelling. Empire manufacturing was bad. We are quickly heading back to a period where you need to have small positions, because news that would have caused a 0. 5% move in the market a couple of weeks ago, is now moving it 1%. Maybe today is somehow a turning point, but I don’t think it is, so we will see selling pressure into every rally as total return players have to “rightsize” their positions for the increased volatility. This is the real intraday volatility that investors experience as they do their intraday P&L estimates, not VIX or any other form of implied vol.

With no liquidity be careful reading too much into any move (positive or negative) but expect some weakness as these moves will force investors (hedge funds in particular) to make smaller bets.

Twitter: @TFMkts