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Friday, 7 June 2013

Back to the Old Normal ?

A very ugly close, for a payrolls number which shouldn't have been that bad for fixed income. Look at the rolling 6th vs 10th contract (ie EDU4/U5) back to early 2009 :

Where we are now - about 50bp - was the floor until mid-2011, since when it has been the ceiling. (Incidentally you get the same picture, with the same dates, if you look at 10y yields or 30y yields - we're talking about the entire treasury market here, not just one obscure spread). I think that until mid-2011 most people believed we were still operating in the Old Normal, and the US would get a standard recovery (remember all that U/V/L debate ?). If you suggested that the US was in a Japanese style slump (L-shaped), people laughed at you. After mid-2011, with the extended period commitment for zero rates, Op Twist and open-ended QE3, L-shaped has become conventional wisdom, and the world has invested accordingly.

So *if* the labour market, retail sales and private capex hold up in the face of the sequester etc, then it seems that we're crossing from the New Normal (L) back into the Old Normal (U or even V). In that case this spread ought to head towards 100bps - which funnily enough is where the front calendar spread traded in Japan as they exited ZIRP in 2006. Hilsenrath's article today suggests that the Fed is going to taper in Sep or Dec, and the market will extrapolate that into rate hikes a year later.

We're basically at the cusp between two entirely different views of the world, and so vol will go through the roof. A couple more decent US numbers and they'll be throwing in the towels thick and fast.

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