A NOT SO BEAUTIFUL MIND
On May 4th, 2024 Jeff Snider put out a video that can only be described as losing touch with reality. This is not the first time he has exhibited delusional tendencies. Strolling down the delusional walkway with Jeff Snider,......
How many times has he said inflation was not inflation it was all supply shock, nevermind the reality that the USG maintained demand with all those stemi checks, when under a more normal circumstance demand would have fallen off with unemployment especially due to shutdowns.
Once he conflated the words bespoke and fungible in an entire video and we all know how much he loves to hear himself talk. BTW,....bespoke means tailor-made while fungible means interchangeable, so the exact opposite of one another.
What about when talking about a Treasury auction he made the case that demand was so great people were bidding zero interest on a T-bill auction implying winning bidders were actually awarded an allotment at zero interest. This demonstrates his complete lack of understanding of how a Dutch Auction works. The description is right there on the Treasury's website.
Or how about when he invokes Milton Friedman's "interest rate fallacy". It is clear this is not what MF said or meant
Then there is Irving Fisher's "interest rates are the result of growth and inflation expectation". That is not what Fisher said at all. Fisher theory was based upon the real rate being stable at 2%. What Fisher did say was real rates plus inflation expectations and a term premium would equate to current yields.
Fisher was a mathematician and not an economist when in 1907 he set out to prove that a "general equilibrium" could be achieved mathematically if he could just figure out a way to stabilize money. Fisher led the way for the State to create a central bank to manage the quantity of money. When it came to interest rate policy Irving Fisher got his understanding of interest from Bohm-Bawerk, even though Bohm-Bawerk missed the mark with his own theories. Fisher eventually had to admit he hadn't included the "time" component in his theories. So every time Jeff Snider invokes the name of Irving Fisher (or Milton Friedman for that matter because he was Fisher disciple) or states that yields are a function of growth and inflation expectations he is confirming his delusions as a Quantity Theorist. If you don't know what I mean by Quantity Theorist read my article "A Tell of Two Eras".
Jeff Snider has been so wrong for so long he has spawned a cottage industry of taking the other side of the trade on anything he mentions. Not sure how effective it is, but traders I have spoken with swear by it. Any rational person at some point would wonder, how could I be so wrong for so long,...nope, not Jeff Snider. In his delusional mind everyone else in the world is just too stupid to understand how brilliant he is! In my opinion,....Jeff Snider lacks the mental acuity to separate his delusions from reality and is suffering from his own personal form of schizophrenia?
It has always fascinated me that John Nash, as depicted in the movie "A Beautiful Mind", was able to rationalize his delusions from reality by the fact that the charterers in his delusions never aged. Although this is Hollywood's adaptation of John Nash's experience he did write in 1994; "gradually I began to intellectually reject some of the delusional influenced lines of thinking which had been characteristic of my orientation. This began, most recognizably, with the rejection of politically oriented thinking as essentially a hopeless waste of intellectual effort. So at the present time I seem to be thinking rationally again in the style that is characteristic of scientists."
Accordingly here is the most recent delusion rant from Jeff Snider on May 4th;
"Are interest rates going to crash? We do have a way to answer that question using the tools we already have at our disposal and those tools show that not only do interest rates want to go lower, as they were starting to do at the end of last year, they'd already be there if it wasn't for the Federal Reserve and its interference at the short end of the curve. Take away that interference [and] suddenly treasuries rally and I don't just mean the last couple days or back to last year's levels. The fundamental picture behind[the] market interest[rates] suggests that 10-year rates would be maybe a two or one handle."
Wait,.....What?
When Jon Gruden left the sidelines for the broadcast booth he would often state; (me paraphrasing).
"People, I hate to tell you, but there are only five eligible receivers on the field at one time".
Did Coach Gruden really need to state the obvious? To my point, does Jeff Snider really need to state the obvious regarding the Fed's interference in the bond market? But would rates go to 1 or 2% if the Fed weren't present? This is no evidence to suggest this as a possibility or reality. To state the obvious, it was the Fed's presence in the market that drove rates so low to begin with? The reality is the 10 yr did not break below 2% until 2011. So even in the aftermath of the GFC,..... in what could only be described as the worst economic fundamentals conditions since the Great Depression and the Fed's historic interference could not push yields below 2%. In fact had the Fed not interfered in the rates market by taking a hose to the fire sales there is really no telling how high yields might have gone. (This is just a fact that escapes Jeff Snider's reality).
But he goes on, and on and on;
"Now just a couple weeks ago the very idea of something like that sounded preposterous because everyone said the US economy was booming and booming so much it was in danger of becoming even more inflation[ary]. Then there had been more rate hikes,.... higher for longer,.... all of that, but then recent data specially on the US Labor market,.... we got jolts, the unemployment rate, the ISM non-manufacturing employment shocker[and] even the establishment survey finally stumbled. and Suddenly the soft landing isn't so settled after all. Plus we've still got [to] factor [in] global troubles that aren't getting any better, we've got commercial real estate to work through with any number of dangers there and we might not yet be done with US Banks,... you put all of these things together and the monetary fundamentals don't seem so out of line after all.
"What are those monetary fundamentals? Well we start with interest rate swap spreads,....[the] 10yr swap spreads and 30-year swap spreads in particular. They've been compressing which means becoming more negative over the last several months. and The 30-year spread has been compressing, becoming more negative going back to last December,.... almost five months of relentless compression,.... more negative, that's not a good sign. Already we're in negative territory, literally negative territory but profound[ly] negative territory. Beyond just the actual spread itself and so with the 10 year moving lower since February 7th and the 30-year spread relentlessly compressing, those are really bad signs,... now what is a swap spread? A swap spread is simply the difference between the fixed leg price of the swap and the same maturity US Treasury. Now normally (me; spuriously stating) the US Treasury would yield less than the fixed rate part of the swap because if you're choosing to invest in an interest rate swap and receive fixed, why would you choose to receive less than you could get on this US Treasury?
Here is how the negative swaps spread is recognized by a Staff report referenced by Jeff Snider titled;
Intermediary Balance Sheets and the Treasury Yield Curve (conclusion)
"We have documented a regime change in the U.S. Treasury bond market. Prior to the 2008-2009 financial crisis, dealers were net short-sellers of Treasury bonds, swap spreads were positive, and covered interest parity (CIP) violations were small. Following the GFC, dealers became net buyers of Treasury bonds, swap spreads turned negative, and CIP violations emerged. Our analysis ties these observations together by constructing arbitrage bounds, the net short and net long curves, and providing evidence of dealers-as-arbitrageurs in the Treasury market."
"We then discuss the causes and consequences of this regime change. We view the large increase in Treasury supply ( Me; from 4T in 2005 to 22T in 2020) and the tightening of leverage constraints (me; Basel 3) on dealers as the primary drivers of this regime change. Using a stylized static model, we have argued that this regime shift has amplified the effects of quantitative easing and of the yield curve slope on borrowing spreads. In the post-GFC dealer-long regime our model predicts tighter dealer balance constraints in response to Fed quantitative tightening and a flat or inverted Treasury yield curve, and more elevated financial intermediation spreads. Our analysis suggests that other policies, including the use of swap lines and of exemptions to SLR calculations, can help offset these effects."
What comes next is a huge dose of conjecture with no real analysis from Jeff Snider. Why do I say this,...well because primary dealers are the underwriters for the Treasury's debt market. At auction whatever doesn't get awarded to the direct bidders (think large pension funds and insurance companies) and the indirect bidders (think foreign agents with no access to the auctions) is left to the dealers to absorb by law. Typically the portion that is left to the primary dealers will range from 10 to 20% of any particular auction. The Primary Dealers are in the moving business not the storage business, as Zoltan Pozsar would say,...,meaning they silo treasuries on their books using a "matched book strategy" long enough to move them. To reduce exposure, they hedge in whatever strategy is the most profitable.With the supply of treasuries going from 4T in 2005 to 22T in 2020,... the sheer volume would bring a rational person to think the primary dealers are having to deal with a lot more supply.
But wait there's more, and more and more,....really (Delusions and disorganized thinking and speech underlined).
"U.S. treasuries is[are]risk-free but ever since the 2008 crisis, there's your first clue, swap spreads have been persistently negative confounding mainstream analysis because they can't figure out why. There would be deflationary signals in a world with so many darn Bank Reserves, there's an answer to that question already, but essentially the fact that the negative swap spread exists is already telling you something substantial. Because to begin with,.... the market isn't saying that the US government is more risky now....than getting a paid fix from the other,.... from a financial counterparty on the other side [of the trade],....that's not what's happening. What it's saying is that dealers in particular are balance sheet constrained,.... because for one thing you can arbitrage a negative swap spread and make free money all over the place,... on both sides. You could pay the fixed rate[by going] go long a US Treasury receiving the US Treasury coupon which is more than the fixed payment that you're making,..... at the same time you take that Treasury and funded[it] in repo,... therefore you're paying the repo rate which is less than the floating rate you're going to be receiving for the swap and you're making money on both sides." (this is not necessarily true because of the interest rate risk of the floating rate and repo rates are usually higher than the floating rate).
"The fact that not no one but not enough of the marketplace is doing this [arbitrage] shows us that already something is wrong. Here dealers who would be arbitraging this must be increasingly balance sheet constrained,.... that's a deflationary signal. As they become more and more constrained for whatever reasons,... and we'll get into some of those in a minute,... they require more and more of a return to allocate scarce balance sheet capacity to enter into the swap."
"Which means they're going to pay lower and lower on the fixed rate therefore the spread between the fixed rate and the nominal US Treasury yield gets bigger and bigger and bigger so a more a[nd] more negative swap spread. [This] is an indication of exactly what we're talking about here,....which is why when we see this dependable correlation between any of these signals that suggest dealer constraints and deflationary outcomes,.... deflationary money becoming negative pressures headwinds all across the global economy,.... the euro dollar cycles."
With that being said there used to be a rule of thumb that interest rate policy was said to be neutral(a general equilibrium, if such a thing even exists) when the 10 year treasury rate was about the same as nominal GDP. Last check, real GDP was 1.5% and YoY CPI at 3 to 3.5%,so we should be looking at a 10 yr yield of 4.5 to 5%. The rule of thumb seems pretty darn close. At this point Jeff Snider still hasn't offered any real proof to his claim that rates would or could ever reach a 1 or 2 handle, but not for the lack of trying!
Again,...Jeff Snider rambles on and on and never really pays off with any real analysis,....which tends to confuse the viewers,.... because he talks a lot but doesn't really say much(disorganized thinking and speech). Gobbledygook has a formal meaning; "language that is meaningless or is made unintelligible by excessive use of abstruse technical terms; nonsense. The vernacular today is word salad! In the past he has made these statements to exemplify that he's the smartest guy in the room but this time he is trying to pass off his gobbledygook as analysis. This video is a perfect illustration that he engages in the worst kind of sophistry.
Chatham Financial has to be one of the most credible sources on forward curves;
"Many assume that the forward curve represents the market’s current expectations or prediction for future interest rates. It is more accurate to think of the forward curve as the equivalent of a betting line for future settings of a base rate like SOFR. It shows the levels for a future base rate which drives supply-demand equilibrium today for financial contracts and instruments tied to those settings. Said another way, it represents the market's net position or indifference between fixing and floating for various terms. The forward curve is live and will shift as market forces move, especially at points farther along the curve."
Swaps are a zero-sum game and when traders engage in swap they face a central clearing principle (CCP). A notional amount is used as a reference. At inception no cash changes hands between counterparties. At inception the swap is priced at zero when the NPV of both cash flows equal and the value of contract only changes with market changes. One party's profit will be the counterparty's loss similar to a futures contract. This does not mean there is no cost incurred at inception,... it means the counterparties do not have any out of pocket expense to each other. The parties post initial margin and pay something akin to variation margin with market movements to a CCP.
To get to zero at inception a discount rate (X) is calculated. Depending on a number of factors X represents what brings the contract at inception to zero to each counterparty. At one time (before CCP's) default risk was a factor that would represent the logic of a positive swap spread, this no longer exists. Another factor of solving for X is a normal or inverted term structure. When solving for X,....this is not the swap spread calculation, this is the term structure calculation. This is the betting line referenced by Chatham Financial. The swap spread calculation, like Jeff Snider says, is the difference between the yield of the same maturity and the fixed payments of the swap contract. Thinking rationally anything that affects the term structure can have a knockoff effect of the spread structure.
One of those knockoff effects is that Primary Dealers use a "matched book strategy" where hierarchy of returns is not always the motive, sometimes they have to act by law. Think of it this way, banks mostly care about the spread between the cost of capital and the return on capital, so net interest margin. The level of interest rates is largely irrelevant. The Primary Dealers have a gross exposure and a net exposure. The more they match gross exposure the less net exposure they have that requires financing.
The swap market is an off balance sheet tool that reduces gross exposure therefore reduces the use of balance sheet space. When the swap rate is positive, they are looking for a way to hedge it lower, because a positive swap rate is a negative carry trade to them. A negative swap rate is a positive carry trade but the cash long position of the treasures is an on-balance sheet item, therefore they need a higher discount factor to equal the trade at inception,.....a more negative spread. There is no good or bad here, it is just what it is,.... but it is a meaningless indicator regarding the future path of interest rates.
Are the primary dealer's balance sheets constrained? Maybe,...but not specifically,... but by association,... so,..yes. Because of the treasury cash portions of their matched book, the marks are against their parent or the banking holding company(BHC's) since Basel 3 took effect. Basel 3 combined the balance sheets of all the subsidiaries of the BHC's, of which the primary dealers are one of them. The BHC are constrained by the leverage, liquidity and SLR ratios. The BHC's are being more discreet where they allow scarce balance sheet capacity to occur. So in order to be profitable the more negative swap spread reflects the new regulatory cost of doing business,......it's that simple and once again has zero implication of future path of interest rate or future economic activity.
In the second paper referenced by Jeff Snider in this video titled Negative Swap Spread there is a chart that depicts the Return of Equity of a 1% to 6% SLR. ROE plummets from 35% to 6%, respectively. This paper by the way is a very good paper if you want to know the mechanics and balance sheet effects to a primary dealer of a swap transaction. It identifies the four players involved when arbitraging, the dealer, CCP, repo dealer (secured financing for long treasury position) and overnight index swap dealer(OIS used unsecured financing haircut),...there is a fifth player when the dealer's are acting for a client.
What he is trying to imply is that the swap rate has a predictive power of the future path of rates. In reality there are no reliable indicators of the future path of interest rates, especially when the central authority resorts to strong-arming it's bank rate on the market.
Jeff Snider then throws in a chart of the negative swap rates against the copper to gold ratio and implies that because there is correlation to real world markets therefore it has to be causation. Once again this is sophistory at best. He is planting a seed of dishonesty to come later. The Gunlouch indicator as it is called, the copper to gold against the 10yr yield, is what has been studied, not the 30 interest rate swaps! I have to say that a regression analysis was performed on the copper to gold ratio and it was pretty weak at only 26%, while a regression of the 10 yr to the dollar represented a 86% correlation.
At this point he turns to his standard motive of these videos, being so obtuse and condescending. So the rest of the world or anyone that does not agree with him is just plain stupid.
"The very idea that dealers are getting stuck with treasures that they don't want,... that they then have to involuntarily hedge through more expensive swaps and derivatives just doesn't stand up to just common sense scrutiny. Think about it this way,....there's a correlation between interest rate swap spreads going more negative which suggests that dealers are getting stuck with treasuries and nominal US Treasury yields,..... nominal US Treasury yields are going down. As swap spreads are compressing which means US Treasury prices are going up,..... so dealers are not getting stuck hoarding treasuries that they don't want,..... they're doing it because they choose to. If they didn't want the treasuries [with] the prices of the marketplace strongly suggest that dealers could just sell the stupid,.... the instruments,.... if they don't,.... if they don't want them. If there's too many of them,... they just sell them,..... market prices are going up and at times like we saw in 2019 market prices get so extreme the yield curve inverts,.... which is an extreme level[of] an indication of extreme level of demand. Dealers are not getting stuck with treasuries they're choosing to hoard them but we can see that relationship consistently swap spreads go more negative as nominal treasury rates go down,.... growth and inflation expectations, so an indication of deflationary money [as] in negative swap spreads getting more negative,.... flight to safety, flight to collateral, lower growth in inflation expectations,.... nominal yields go lower. Already the idea of too many treasuries is completely debunked".
The highlighted portion in the previous paragraph is a meretricious statement,.....Jeff Snider quotes from two papers from the Federal Reserve where they make the point that the primary dealers are having to absorb the burden of "too many treasuries" which Jeff Snider claims as ridiculous. THIS IS THE POINT HE IS TRYING TO MAKE WITH THIS VIDEO, debunking a point that is barely even suggested, but just observed as pointed out earlier.
The two papers cited are Intermediary Balance Sheets and the Treasury Yield Curve (2022) and Negative Swap Spreads (2018). These are good papers explaining the situation and show the lengths of the sophistry Jeff Snider goes to make a point that does not exist...."dealers becoming constrained and when dealers become constrained that means money and credit does not circulate through the global system in the way we need it to".
Intermediary Balance Sheets and the Treasury Yield Curve (2022)--This result is important from a general equilibrium perspective. Dealers are never on net long or short a large quantity of Treasury bonds relative to the overall Treasury supply. Dealers moved from a net short of roughly 100 hundred billion in 2005 to a net long of 200 hundred billion in 2020. The overall supply of Treasury securities rose from 4 trillion to 22 trillion over the same period. However, dealers intermediate repo and reverse-repo for their levered clients in much greater quantities– on the order of trillions each day.
This first paper also goes into the knockoff effects of the leveraged clients (hedge funds) with regards to the regulatory constraints they put on the primary dealers. None of this, or let's say very little of this, has anything to do with the flow of goods and services. This is about the leveraged maturity transformation trade and financing the bloated spending habits of the State, the government. A little history here, this is what Adam Smith was writing about regarding the Scottish banks back in the day. He (AS) was intrigued by the fact that the smaller Scottish economy was more robust the than the English economy. What was happening was the Scots were engaging in what is called "accommodation paper". It's hard to believe this passed the smell test (like some of the aroma that comes from the fixed income market today) but what happened was one person would loan to another person, and that person would then loan back to the first person and because the loans were offsetting and therefore deemed secured, they could then take the documentation to another person and use it as collateral for a real cash loan. This is what financialization of the economy looks like. This has been well documented in several books, including a 1909 banking book by Charles Conant (if you don't know this name you should because he was instrumental in bringing you the Fed) and an 1866 book by Professor Harry Macleod, The Theory and Practice of Banking,....neither of which Jeff Snider will ever read.
(As a side note,.... an image of Jeff Snider's member only service flashes across the screen at the 4:45 mark. Careful examination of this shows just how bad his material really is,.... in my opinion. He shows deposits as liabilities and cash as assets, but in the interbank market no cash is changing hands (they engage in accommodation paper). How many times has Jeff Snider told you the Eurodollar market is a cashless system? Also, how ironic is it that the only thing Jeff Snider gives Zoltan Pozsar credit for is his mapping of the asset backed credit market and Jeff Snider is charging for something that he got from Zoltan Pozsar for free).
Here are a couple of excerpts from the two papers mentioned. Jeff Snider uses some of this, but only to imply that the authors have it all wrong and much smarter than those "idiots" at the Fed.
Intermediary Balance Sheets and the Treasury Yield Curve---Pre-GFC, primary dealers maintained a net short position in the Treasury bonds, and the swap-Treasury spread was positive. Post-GFC, primary dealers switched to holding a net long position in Treasury bonds and the swap spread became negative. Our results therefore imply that, pre-GFC, dealers were expected by the market to maintain a net short position, and that following the GFC, this expectation flipped and the market now anticipates dealers maintaining a net long position going forward.
Negative Swap Spreads---Historically, most swap spreads have been positive. A market participant may be able to narrow a positive spread (me;a goal of matched book) by paying the floating rate Libor on an interest rate swap, receiving the fixed rate, and selling short a Treasury bond of the same maturity by lending cash against it in a reverse repurchase agreement (reverse repo). However, Libor generally exceeds the interest rate earned in the reverse repo transaction, making the overall trade uneconomical. Thus, what makes negative swap spreads puzzling is that, when the swap spread is negative, a pure “carry” yield can be earned by paying the fixed rate on the interest rate swap, receiving the floating rate on the swap and holding a long Treasury bond of the same maturity. If interest rates were the only risk factors in this trade, holding to maturity would represent an arbitrage opportunity.
The balance sheet impact of the interest rate swap, in which the dealer pays the fixed rate and receives the floating rate at the trade’s inception, the fixed rate is set such that the fair value of the swap is $0. As the three-month Libor reference rate fluctuates, the market-clearing fixed rate fluctuates as well. Thus, the fair value of the dealer’s interest rate swap changes, which translates into either an increase in the “Derivatives with a positive fair value” line on the asset side or the “Derivatives with a negative fair value” line on the liabilities side.
Although we cannot precisely measure the costs SLR capital requirements impose, it appears that executing swap spread trades is now more expensive for dealers than in the past largely because of the amount of capital that dealers must hold against these trades. The amount of capital required is driven principally by the cash product position of the trade rather than the derivatives portion. The SLR requires that the entire repo-financed Treasury position be recognized, while the derivatives portion is recognized only up to the margin posted on, and the potential future exposure of the position. As a result, while current negative swap spread levels may have presented attractive trading opportunities in the past—which would have reduced deviations from parity—our analysis suggests that, given the balance sheet costs, these spreads must reach more negative levels to generate an adequate ROE for dealers. This may represent a shift in the spread levels considered attractive for trading, suggesting there may be a “new normal” level at which dealers are incentivized to trade.
To continue for the next 15 and half mins on what can be only explained as losing his freaking mind. I will paraphrase what he is saying and add the transcript so you can read this insanity for yourself. Jeff Snider lept to the oil market and how the 30 yr swap spread is so closely correlated. But what the hell, if he can make a chart of the copper/gold ratio look plausible, why not a WTI to the 30 yr swap rate? So ramble on and on about the supply of oil causing the prices to fall, but really folks, he doesn't think the supply of treasuries has any effect on yields,......really.
Jeff Snider trots out his crappy charts,and reads out loud his script of his Eurodollar cycles, as proof that when the swap spread goes low,... oil could go to 40 bucks. What world is he living in? And of course since he can make it look like what he wants it to look like (read my Tell Us What You See article) he can rationalize his opening statement,......yields are going to 1 or 2 %!
Also when the charts are on the screen when overlaying the WTI he is constantly stating "the swap spreads" but on the charts written as a ledger are 10's(Libor),.....30s (Libor),..which would imply a term structure spread, not a swap spread, which is a bit confusing. I have to ask if this is intentional,....maybe, just maybe the swap spread doesn't actually match what he is trying to say, I wouldn’t put it past this guy.
Continuing from earlier where I left off
"Already the idea of too many treasuries is completely debunked",.....
but we can go a number of steps further,.... including crude oil. Let's bring in a real world commodity,... a crucial real world commodity into the same mix here. and I've already done this to an extent with copper to gold but that's a little more esoteric. This one's easy to understand. What would the price of oil have to do with the US government issuing too many treasuries that dealers can't sell to the secondary market? Because there is a strong correlation between oil prices going down when swap spreads do and nominal treasury yields do together,.... these Euro dollar cycles. It doesn't make any sense it would have to be the most gigantic coincidence in the last 15 years,...cuz this is a persistent correlation. It would be completely random but it's not,... we know it's not. Because deflationary money that's indicated by negative swap spreads,... lower nominal US Treasury yields,... those both tell us something about risk perceptions,... which go along with lower demand in the economy. Therefore lower prices in oil,...goes down,... swap spreads compressed become more negative, nominal US Treasury rates go down,... all of it together. It's not too many treasuries starts with deflationary money and then the consequences of it so when you line up WTI Crude prices with the interest rate swap spreads. We're going to focus on the 30-year but I'm going to show you the 10-year too just to go so we can have a little bit of a guideline and plus it helps with giving you a little bit of reference. In the movements of some of these other prices but essentially we're going to focus on the 30-year and the relationship with all of these other indications. To it starting with again WTI but we should note that while the overall trends really fit pretty closely here a strong correlation between oil prices and swap spreads becoming negative or decompressing becoming less negative which would be a reflationary period,.... by the way if we were thinking reflation,.... negative swap spreads and becoming more negative are not the sign that you want to see,... for all of these same reasons but there are a couple of key divergences that we should use to help us calibrate what we think is going on in the marketplace. First one of those obvious,..[the] summer of 2008,... really late 200 7 into early 2008 but the summer of 2008 oil prices are skyrocketing at the same time the swaps market's like this isn't going so well,...so swaps are saying that the underlying monetary fundamentals were increasingly deflationary and there's a whole story behind how interest rate swaps and swap spreads behave in 2007 & 2008 which you can't get into here,.... but essentially that was a key indication that things were going very wrong,... which you wouldn't expect would be conducive to our oil prices going higher. But oil prices were going higher as we know because of supply factors,.... so it's deflationary money is a lot about demand but doesn't necessarily tell us about supply,.... so oil prices surged in 2008 based on supply but then demand fell off a cliff which is what the swap market was trying to tell us,.... that happened again late 2009 through May of 2011,.... which was really the first supply shock,... it's been forgotten long forgotten now,.... but there was a supply shock in the immediate after of the great not recession and that lasted until about 2011 as I said where oil prices were surging higher. Everybody was talking about inflation back then and yet the swap market really from the summer of 2009 was starting to pick up on the irregularities that became the European sovereign debt crisis,... because it wasn't really the European Sovereign debt crisis it was a second euro dollar shortage or euro dollar number two. So the monetary fundamentals were increasingly deflationary while consumer prices were pushed higher by the supply factor in oil prices,.. the supply premium. So oil prices diverge from swaps in 2010 and part of 2011 only to converge start to converge in 2012,... but they would really converge in during euro dollar number three,... when first of all the shale oil boom added to supply to correct that supply [im]balance and then euro dollar number three,... the deflationary money and all the risk perception that were picked up by the Euro dollar number three conditions. They thought the legs right off of oil demand,... so oil prices crashed and converged back down to where the swap market was suggesting. That oil price should be without that supply factor and then the two would correspond very closely over the next seven years,...this is not some random accident or coincidence this is a fundamental picture of monetary conditions which also reflect factors that will end up end up affecting demand in the oil market and the general economy. The next time we see a major divergence between oil prices and interest rate swaps of course that's late 2021 in really March of 2022 the Russian invasion of Ukraine oil prices surged not because demand picked up but because supply was then again a major factor in the oil price. At the same time interest rate swaps were suggesting more deflationary monetary conditions given everything that was happening,.... especially in 2022. Not rate hikes but fears over some major crisis spillover,..... potential energy in Europe,....problems in the United States and we had the technical recession which suggested a substantial slowdown in the economy. Maybe that was going to be a big issue. There was stuff with China and lockdowns there's any number of any number of reasons that would that would valid the the perceptions in the swap market being increasingly risk averse,.... including the oil shock itself because history shows oil prices that soar like that are not inflationary. They tend to have a harmful impact on the economy but even with the supply premium in oil prices that showed up in early 2022 you can see by the middle of 2012 factoring that supply premium the oil market goes back to trading in very close proximity to swap spreads. The relationship comes back even though oil prices are higher than they otherwise would have been which was again the supply factor there are two further exceptions to two smaller exceptions where swap spreads are moving lower compressing and oil prices are moving higher and those are of course the most recent supply shocks. Last summer and the current one that we're experiencing or maybe that one is past tense too. So oil prices they continue to get variable supply premiums but at the end of the day the economic fundamentals that's where the swap market is suggesting and so for oil prices using the 30-year swap spread as a guide,... that would suggest that the fundamental demand side perceptions and future forecast and how things are going to develop would put oil somewhere around the 50s maybe even the 40s. Now just to be clear this is not a prediction it's not saying that oil prices are going to go to $40,... what it's saying is that the fundamentals that is indication that we can tell from the swap market would put oil somewhere around $40. I mean we can't ignore supply factors those are those are legitimate reasons to for prices to be higher than what the demand side would be of course that Saudi Arabia knows this,... so this is not a prediction about where oil prices would go it's saying what what is the underlying shape of the economy and monetary system and what would oil be if allowed to price more on those fundamentals,... it would be somewhere around $40. Doesn't mean that the oil is going to go to $40 but we have the economy for $40 oil. So moving over to US treasuries nominal US treasuries we saw nominal US Treasury yields very close to the 30-year swap spread with a couple of divergences along the way as well. The first one 2009 QE the treasury market gave QE more credit than the swap market did which actually makes more sense because you can't get away from the money when your balance sheet constrained. Whereas in[the] treasury market you can have people be more optimistic maybe this QE stuff could possibly work,...which would be interest rate positive(????) interest rates go up growth and inflation expectations go higher so the treasury market in 2009 was saying maybe QE will work,....let's start selling our safe and liquid assets while the swap market said,... not really seeing it too much here and that divergence would continue. It actually get worse later in 2009 as I mentioned before with WTI swap market began to pick up the monetary deflation conditions associated with not the European sovereign debt crisis,... but euro dollar number two where at the same time US treasuries were given QE the benefit of the doubt. Up until April 2010 nomal US Treasury yields converging again with swaps and then get us another divergence with QE2 because the treasury market at least lots of people in the treasury market were willing to give the FED another shot at it growth in inflation expectations go up less demand for safety and liquidity,....but the swaps Market saying no no you're going to regret that choice and eventually of course US Treasury yields fell where down to where the fundamentals in the monetary system were priced into swap spreads and in fact US treasuries would actually overshoot the downside because of how serious the euro dollar number two crisis actually came to be,... despite the fact that there was 1.6 trillion in Bank Reserves in the system. Bank Reserves are worthless. The next major Divergence treasury yields and swap spreads were pretty closely aligned over the years in between but the next major divergence came around 2017 and really January of 2018. We had another selloff in treasuries not because of a QE or even really better growth in inflation expectations,....[BUT] this time because you guessed it the Federal Reserve under Janet Yellen and the Jerome Powell were becoming increasingly Hawk hawkish and raising short-term interest rates. So now short-term interest rates become like supply factors on in terms of oil,....short-term interest rates become the premium that pushes treasury yields above the fundamental value pictured from the swap market,... now the swap market you still see spreads decompressing in the first half of 2018 but not nearly as much as as treasury yields were rising. But then the swap spreads turn around between May and June and July when a whole bunch of stuff dollar stuff started to happen,.. dollar shortages indicated,... euro dollar futures inverted all of that stuff,... swap market spread start to go lower while nominal treasury rates continue higher. The divergence was the Federal Reserve interfering at the short end of the curve but as we know,..[the] swap market was right,... deflationary money ended up happening and eventually the FED got out of the way first the FED pause in 2019,... then Fed rate cuts later on and what happens to US Treasury yields, they converge once again with the swap market. They converge to where the monetary fundamentals suggest interest rates should have been,... essentially longer term treasury rates and swap spreads again very closely aligned through 2020 on into 2021 and just like oil there starts to be a divergence late in 2021. But really around March of 2022 again the oil price shock but in this case we also have to consider the FED begins to hike its interest rates so while the swap market is pricing an economy that isn't going well,... a monetary system that is full of imbalances and disorder and disruption and chaos and collateral and everything else,... interest rates,... nominal rates are pushed higher because Jerome Powell wanted them to go higher. He was seeing inflation,... the market was seeing the opposite, a supply shock and they have this divergence developed that that was maintained over the last couple years because of the Fed's interference at the short end of the yield curve. but what would the US 10-year treasure be without the FED if if the if the 30-year swap spread continues to be our fundamental guide? What it suggests especially as swap spreads have been compressing again for really going back almost the year to last July,... a huge relentless compression since December it suggests that that the US 10year Treasury yield without the Fed's interference would be or should be somewhere around,.... get ready 1%! Fundamental picture from the swap market of monetary conditions as well as economic potential suggests that rates need to be a lot lower and they would go there if it wasn't for the Fed's continuously interfering at the short end of the curve,... by either keeping rates higher or promising to keep rates higher or not being clear about whether or not they will or can keep rates higher. Fundamental picture of interest rates from the swap market suggests they need to be and are likely to go a lot lower,... like I said in the introduction that seems preposterous to many people at least it seemed a couple weeks ago but since then we've got a rash of economic data that the maybe the soft landing isn't so assured,... maybe the labor market in the United States is in more trouble than we imagine,.. plus we also have to consider everything else from commercial real estate, to trouble in China, a European recession that isn't getting any better, not to mention maybe we aren't done with the banking system. The swap spreads they're a good fundamental picture of monetary conditions which take into account all the information from the economy as well as financial stuff that's going on and they sound esoteric and complicated and they are,.. but it's really it's really pretty simple. Swap spreads go down like China's Yuan down,.. spreads equals bad and that is corroborated by a number and we didn't get,.. we didn't get into half of the indications that we have that go along in the same way that show these euro dollar cycles sprout spreads are going down. Copper to Gold signals deflation,.. US Treasury nominal yields go down,.. lower growth and inflation expectations,... flight to safety,... crude oil prices, the real world critical energy, all of that stuff. Swap spreads go down that suggests nothing good but we do have to consider these other fact factors in oil prices that's the supply side in interest rates,.... that's the Federal Reserve but take away the FED,.. take away the supply,... the fundamental picture of money finance and economy shows oil would be around 40 and US Treasury 10 year maybe around 1%. I briefly mentioned that there are links between the interest rate swap market and swap spreads and collateral conditions. I did a video on that earlier this year,.. that's the one I've got linked below as always I thank you very much for joining me. Huge thank you EuroDollar University members and Euro Dollar University subscribers and until next time, take care.
If you have a real interest in understanding this material, I would suggest reading the material for yourself and not rely on Jeff Snider's understanding or more importantly his sophistry. He is not trying to educate you, he is trying to show you how smart he is.