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What if Markets Played in Bowl Games?

December 23, 2019

The 11th annual newsletter that answers the question no one asked – what if markets played in bowl games?  We also visit how we did on last year’s predictions, because who doesn’t like to see in writing how wrong they were?!  Just remember – 60% of the time, my predictions are right every time.  Cowboys fans, I’m sorry I wrote this before the game.  I wish we had more space dedicated to your season.  Buckle up, it’s a long one – let’s do this!


Citrus Bowl

Real Matchup – Alabama vs Michigan

Markets Matchup – Misery Index vs Inflation Expectations


Better known as the Failing to Live Up To Expectations Bowl, we have a surprise Bama entry this year.  Crimson Tide fans literally don’t know what it’s like to not have a playoff game.

How in the world is a two loss Alabama ranked 13th?  Thirteenth?!?!  They lost by 5 to the #1 team in the country and by three on the road to the #12 team in the country.  Tua was the best player in football and losing him is no doubt devastating, but 13th?!  That’s seven spots lower than a two loss Oregon team who took an L to Arizona State!  This is basically an NFL team that lost its starting QB, but who is still playing college teams.  And I hate that we have been robbed of a playoff with Tua.  I was drooling over a Tua vs Burrow title game.

There’s only one coach that is as inept against ranked teams on the road as PSU’s James Franklin, and that is Jim Harbaugh.  Michigan is doomed.  Do you think Harbaugh’s selling point on recruiting trips is, “If you want to finish 3rd in the Big Ten East, come to Michigan”?  Or, “No one can consistently lose to Ohio State as much as us, so you know you’ll be on TV.”   Plus, if you can fog a mirror, you can get into the Econ PhD program, so you know the standards aren’t the same as they were a decade ago.

There is only one way Michigan wins this, and that is if Bama is so disappointed in missing the playoffs that it forgets to play.  Bama wins in dominant fashion sleepwalking through the game, 34-17.  Nick Saban is still miserable after the win.

(sidebar – here’s my College Gameday sign from the PSU whiteout game against Michigan this year)

Nick Saban could find a way to drain the fun out of national championship Gatorade bath…oh wait, he has.  This guy makes me physically uncomfortable, and that’s when he’s winning.  Can you imagine how insufferable he must be right now preparing for a fourth tier opponent in a third tier bowl?  “Michigan?  They still play football?  I thought they only did intramural sports now?”

Fortunately for Jolly Old Saint Nick, there’s an index near and dear to his heart – the Misery Index.  It tracks unemployment and inflation to approximate how the average consumer feels about the economy.  Unlike Saban, the average consumer isn’t that miserable right now.  Nor do they make $8mm a year.  This index is near all-time lows, which might make Democrats miserable in November.

Source: Bloomberg Finance, LP

Like Harbaugh, inflation has been making a living off of expectations rather than reality.  “Another disappointing year, but next year it’s definitely turning around!”   Am I talking about inflation or Harbaugh?  You aren’t sure.  Fortunately, the University of Michigan also publishes an inflation expectations index.  This survey asks consumers about price expectations five years in the future, which in turn implies a level of inflation.  It hit an all-time low this month at 2.2%.  I suspect a graph of Harbaugh expectations likely also hit an all-time low this month.

Consumers are not worried about inflation, which frequently becomes a self-fulfilling prophecy.  If I think something will be more expensive in the future, I buy it now.  That drives demand, which drives up prices, which creates inflation.  The same is true the opposite direction and can result in a vicious cycle of slower spending and contraction.

Source: Bloomberg Finance, LP

Prediction – the Misery Index ticks up in the second half of the year, but consumers mostly still feel good this time next year.  Inflation expectations hover in the low 2.0%’s, keeping a lid on long term rates.  Nick Saban is still the most miserable happy person in the country, while Jim Harbaugh is the worst best coach in the country.


Alamo Bowl

Real Matchup – Texas vs Utah

Jk, no one cares.  Hope you enjoyed that fall back to reality Longhorn fans.


Sugar Bowl

Real Matchup – Georgia vs Baylor

Markets Matchup – Core PCE vs Unemployment


Few teams can achieve less with more than UGA.  They are one of the few programs that can field as much talent as the top tier teams, yet they can’t get over the hump.  They have so much talent that Ohio State Heisman candidate Justin Fields transferred from Georgia because he couldn’t get on the field.

Baylor is once again the best team in Texas, which offends UT, A&M, TT, TCU, SMU, Rice, Stephen F Austin (go Lumberjacks!), etc.  The state of Texas has enough teams to field its own conference, which would also help avoid playing Oklahoma every year.

Like committing to Urban Meyer, this looks good on paper, but Coach Kirby’s commitment to three yards and a cloud of dust likely make this a low scoring affair.  UGA has a tendency of disappearing in bowl games, so I’m picking Baylor in an upset, 27-24.

Like UGA, it just feels like inflation is on the rise.  Construction costs continue to climb, labor costs are up, it’s tough to pencil deals, etc.  Yet both continue to disappoint.  Core PCE, the Fed’s preferred measure of inflation, has struggled mightily to hit the Fed’s targeted 2.0% ever since UGA choked away the title game two years ago.  From current levels (1.6%), it would likely take at least six months to hit 2.0%, while it would likely take UGA twice as long to make us forget about another disappointing year.

There is a distinct lack of inflation despite historically low unemployment and a very accommodative Fed.  This is confounding experts and breaking economic models.

Source: Bloomberg Finance, LP

The lack of inflation is even more confounding given the low levels of unemployment.  The last time the unemployment rate was this low was 1952, when Michigan State (Editor’s note: not Michigan) won it all.  Hopefully by now any remaining Phillip’s Curve adherents have been ushered back to their wine caves.

We’ve all seen the historical unemployment rate graph, but one thing that has always jumped out at me is that once the unemployment starts climbing, it usually doesn’t stop.  Unemployment doesn’t achieve a soft landing.

This graph has a lot going on, mostly because I couldn’t figure out how to get rid of the little text.  It’s the unemployment rate back to 1950, but incorporates the % change of the UR once it started climbing.  On average, the unemployment rate climbs 82% from the trough.   A similar move today would put the unemployment rate at just 4.3%.

Source: Bloomberg Finance, LP

Over the last three recessions, the unemployment rate climbed 1.3% in twelve months once it started climbing.  If today represented the bottom, that would put the unemployment rate around 4.8% this time next year.


 Year      Start      1 Year Later         Absolute Change

2007      4.5%            5.3%                       0.8%

2000      3.9%           5.5%                        1.6%

1990       5.4%           6.8%                        1.4%


Prediction – Core PCE fails to hit 2.0% at any time during the year.  Something structural has taken place in the land of inflation and we are in the midst of a new normal.  The Fed is late to the party and likely examines whether a 2.0% target even makes sense anymore.  The UR starts to climb in the second half of the year and finishes the year between 3.5% – 4.0%.


Cotton Bowl

Real Matchup – Penn State vs Memphis

Markets Matchup – FOMC vs Recession


For a second straight year, PSU plays in a bowl game against a mid-tier opponent that will drum up about as much excitement as a Jim Harbaugh deciding which khakis to wear.  Whether or not they can wake themselves up after being snubbed by the Rose Bowl will decide this game.  Wisconsin lost to Ohio State twice by a combined 44 points and to a .500 Illinois team.  Penn State lost at Ohio State by 11 and at Minnesota by 5 after the Gopher’s bye week.  How that translates into a Wisconsin Rose Bowl bid is beyond me.  Go Ducks.

Memphis Head Coach Mike Norvell accepted the same position at Florida State, so he won’t be coaching.  And yet, somehow that is only the second most important news from the coaching staff headlines.  PSU’s Offensive Coordinator Ricky Rahne tricked Old Dominion into hiring him as their head coach!  You may recall that I have blamed Rahne for every offensive woe for the last two years (he got lots of space in this same newsletter last year).  After the Ohio State game, I bought and I didn’t even get to use it!  Maybe I can unload it to a Monarch fan in a few years when they tire of pass/draw/pass/punt.

This can only mean one thing – PSU is now free to play offense again!  Allowing fans to call the plays would be an improvement over Rahne.  My 12 year old could call better plays.  Letting the players draw up plays in the dirt like a backyard football game would result in better play calling.  Pulling plays out of a hat… you get the idea.  But if you need to run ineffective bubble screens a dozen times a game, he’s your guy.  Penn State wins going away, 97-21.

As it is wont to do, the Fed over-hiked in 2018.  But as it is not wont to do, the Fed backpedaled quickly enough to avoid a downturn (I hope you took the over on the # of times I would use ‘wont’ in this newsletter).  Fed Funds got up to 2.50% and the Fed was talking about 3.25% as the final landing spot.  Markets puked and Chairman Powell took the extraordinary step of reversing course.

The recent spate of good news, coupled with totally concrete and definitely not hypothetical progress on the trade war, has caused the market to mostly back out the 2-3 cuts it had priced into 2020.  Right now, there is only one meeting with more than a 50% probability of a rate change, and that is a cut at the December 2020 meeting.

The Fed has done a pretty good job of achieving a soft landing.  Given the low likelihood of much in the way of actual rate changes, expect the Fed to instead focus on messaging.  They will avoid calling the repo facility QE4, even though that is exactly what it is, because they want to keep ammunition for another large scale round of QE.

If the economy slows (GDP < 1.5%), I wouldn’t be surprised for them to send signals about being on hold beyond the end of 2020.  They will try to avoid sending signals about actual cuts, because that is a tacit admission that they may need to bail out the economy again.  But to send signals about flexibility and a commitment to propping up the economy is just as good as an actual rate cut.

Like Memphis, recession probabilities spiked this year from a combination of factors.  The St Louis FRED Smoothed Recession Probability Index spiked to 10%, its highest level in a decade.  While some of that is attributable to August’s yield curve inversion, the probability continued to rise in October and November.

The good news is that it really requires a probability of at least 20% before a recession is a leadpipe lock.  The bad news is that there has only been one time in the last 40 years that this index was at current levels and we did not have a recession – September 2005.

Prediction – bonehead Powell has done a good job of reacting to changing market conditions, but will the Fed really be on hold for all of 2020?  Probably.  But the focus will really be about Fed-speak.  What signals do they send about 2021?    Furthermore, the Fed may eliminate the 2.0% target altogether (if you can’t beat ‘em, join ‘em).

Recession probabilities will be elevated all year, but we won’t actually enter a recession.  That being said, 2021 could be interesting…


Peach Bowl

Real Matchup – LSU vs Oklahoma

Markets Matchup – LIBOR vs SOFR

Who knew someone other than a transfer Oklahoma QB could win the Heisman?  Instead, it was a transfer QB for LSU.  Burrow should serve as a cautionary tale for any 5 star recruit considering Ohio State…go there and wither on a vine.  Instead, pick PSU and wither on a vine.

Oklahoma is putting together one of the best runs that never ended in a national championship, but man are they fun to watch.  Perhaps more impressively, Oklahoma coach Lincoln Riley did what Barry Switzer never could – suspend a player before a big game.  That turns a two touchdown game into a three touchdown game.  LSU wins big.

LIBOR is too big to fail.  But as we see with JPM, BofA, etc, that alone is not enough for the Fed to wipe it out.

First, regulators are 100% right to be looking for an alternative.  There are very few actual LIBOR transactions between banks anymore, sometimes as few as one a month.  Yet this benchmark sets the rate for trillions of dollars of contracts.  Banks use their “expert judgement” each day to set LIBOR, which translates into a nice smooth index that tracks Fed Funds.

Andrew Bailey made headlines in July 2017 by making statements that the market interpreted as the prohibition of LIBOR.  But that’s not what he said.  He said that markets should begin making preparations for the transition away from LIBOR and that the regulators will not compel banks to submit LIBOR surveys.

That’s all fine and good, but what about the 2021 deadline?  Well, let’s look at what he actually said.

And a further lesson of the past few years is that work on transition is unlikely to begin in earnest if market participants continue to assume LIBOR will last indefinitely.  In Switzerland, for instance, it has been clear for some time that the TOIS reference rate would not survive.  But only once a date was agreed for its discontinuation – 29th December this year – did serious work on transition to the new reference rate, SARON, begin.

In other words, the market only began taking Switzerland’s transition seriously when a date was set.  So, he did the same for LIBOR.  And it worked!  Banks are scrambling to meet the deadline and we are talking about it, right?  But there’s no magic to 2021.  If the market isn’t ready, the regulators won’t yank the rug out from us.  They are committed to improved transparency and efficiency, not market shocks.

Below is a graph of SOFR this year.  Ironically, the very spike in September that makes us distrust SOFR is the reason we need a switch to SOFR.  LIBOR didn’t flinch when the overnight borrowing markets were imploding– that’s an issue.  SOFR reflected actual market issues and isn’t that better than a made up number?  I don’t doubt the regulators intent, I doubt their timeline.

Source: Bloomberg Finance, LP

Back in 2017, Bailey’s conclusion attempted to address some immediate concerns:

An obvious question is what happens to LIBOR after end-2021.  And what happens to legacy contracts that still reference LIBOR at that point?  The answer to the first question would be up to the benchmark’s administrator – IBA – and the panel banks. They could of course continue to produce LIBOR on its current basis if they wanted to, and were able to do so.

Maybe I’m crazy, but that doesn’t sound the same as, “LIBOR is being discontinued after 2021.”

Prediction – LIBOR stays flat or falls in 2020.  Most likely landing spot is unchanged or one cut.  Low end is 1.00%, while high end is no hikes.  SOFR preparations continue, but volume is not nearly enough to inspire confidence about a full transition by the end of 2021.  Next year I am writing about how the regulators are talking about extending the year end 2021 deadline.


Fiesta Bowl

Real Matchup – Ohio State vs Clemson

Markets Matchup – GDP vs Financial Conditions


The Dabos vs the Urbans.  I really really really hope this team is just Meyer residuals and Day can’t recruit like Urban going forward.  This is the first time that I thought, “Ohio State has as much talent as Alabama or Clemson.”

Dear Dabo – literally no one is disrespecting Clemson.  But if you can convince your team of that, I will find a way to admire you even more.  I don’t know how you could send your kid to play for Saban if Sweeney is also recruiting him.

GDP has been surprisingly resilient this year, averaging 2.4% in the face of some stiff global headwinds.  But can that momentum carry through next year?  Consensus forecasts are for 1.5% – 2.0%.

Source: Bloomberg Finance, LP

In this same newsletter last year, I wrote, “If you’re still reading this War and Peace treatise on markets and bowl games, write this down somewhere – Financial Conditions is going to be a YUUUUUUGE deal in 2019.  I can’t stress this enough.”

If you’ve read the newsletter this year, you have seen this graph a lot.  My complaint about Powell (slow to respond to market signals) led me to believe he would spend most of the year toeing the line.  This, in turn, would cause financial conditions to tighten and the economy to slow.  What I did not expect was for Powell to do a 180 on January 4th and fundamentally shift the narrative for 2019.  By suggesting the Fed might not hike any more and balance sheet normalization would end, he caused financial conditions to ease immediately.

Look at the graph below to see how much financial conditions have eased this year.  While a recession may be in the cards at some point, it is nearly impossible to be in a recession with financial conditions as loose as they are right now.  Keep in mind financial conditions reflect more than just monetary policy – things like commodity prices, volatility, and lending appetite contribute.

Source: Bloomberg Finance, LP

Prediction – like OSU benefitting from an unexpected transfer QB, GDP benefited from an unexpected Fed easing cycle.  GDP bounces around between 1%-2%, but takes its cues from financial conditions.

Financial conditions tighten marginally, but do not turn restrictive.  Financial conditions dictate how we feel about the business outlook in 2020, not GDP.


National Championship

Real Matchup – LSU vs Clemson

Markets Matchup – Fed Funds vs 10T


At the last meeting, the Fed said it expects to be on hold all of 2020, and then to begin hiking again in 2021.  This should be considered the best case scenario.  The odds of floating rates climbing during 2020 are basically 0% and will absolutely require inflation of some kind.  Super strong data without inflationary pressures will not be enough.

But don’t forget that at this time last year, the Fed was still predicting several hikes in 2019.  That tells me there’s a chance they are still being overly optimistic and will need to cut at some point next year.

While the Fed controls Fed Funds and LIBOR, here are three drivers of the 10 Year Treasury yield next year.


# 1 – Inflation

For most of the year, we have been trying to drive the inflation message as one of the primary driver of yields.  With a Phase 1 trade deal and a Brexit resolution, two of the biggest uncertainties were taken off the table this month and the 10 Year Treasury ran all the way up to… 1.95%.

Let’s assume inflation is the 0% return benchmark.  If your investment can’t keep pace with inflation, you are losing money, right?  Here’s the 10 Year Treasury minus Core PCE over the last 50+ years.  In other words, if I buy the 10 Year Treasury, what’s my return once I account for inflation?

Source: Bloomberg Finance, LP

Those returns have been on a steady decline over the last 30+ years.  In fact, this looks a lot like most other asset class graphs.  Any chance global central bank policy is having an impact here?  Have cap rates fallen while liquidity has spiked?  The money needs to go somewhere, so lower and lower returns are accepted.

If you buy a 10 Year Treasury bond today with a 1.90% yield and inflation suddenly spikes to 2.90%, you’re losing 1.00%, right?  So, what do you do?  Sell the Treasurys.  That causes 10 Year Treasury yields to rise.

The lesson – if inflation rises, 10 Year Treasurys rise.  If inflation lags, expect the 10 Year Treasury yield to remain low.  But if inflation expectations start to climb (stimulus package, tax cuts, etc), the 10T could climb.


# 2 – Global Yields

Global yields are another driver.  The amount of global negative yielding sovereign debt climbed to $17T.

Source: Bloomberg Finance, LP

Check out this 2019 graph of the 10 Year Treasury vs the German bund.  I’ve put the yields on two different axis to make the trend easier to detect.  It’s a little tough to spot, but it looks like the two might be correlated…

Source: Bloomberg Finance, LP

The German bund is the primary alternative to the 10 Year Treasury yield.  The yield on the bund got into the negative 0.70%’s this year.  It’s been so negative for so long I actually forgot that it started the year in positive territory.

Source: Bloomberg Finance, LP

Fears of a German economic slowdown have come true.  With Q2 GDP at -0.2% and Q3 at 0.1%, Germany narrowly avoided a technical recession of two consecutive quarters with economic contraction.

So why did the German bund yield start climbing in September?  Andy why did global negative yielding debt fall all the way from $17T to $11T since August?


#3 Central Bank Policy

Late summer, both the Fed and the ECB cut rates.  Long term fixed rates climbed because markets are addicted to love accommodation.  Here’s that same graph of the 10 Year Treasury and German bund, but with one key event highlighted.

Source: Bloomberg Finance, LP

Accommodation creates optimism.  The central bank put is still in place!  They aren’t hiking us into a recession!  Take risk!

With Sweden’s central bank hiking rates to 0% last week, they became the first bank in recent memory to attempt to exit negative rate policy.   Is this the start of a trend or just the first country to fail again at exiting negative rates?

Prediction – the Fed is on hold at best, and very well may cut rates once or twice in 2020.  If you have floating rate debt, you are safe through at least the next twelve months and could benefit from falling LIBOR.

The 10T is obviously much harder to predict.  On the one hand, accommodation creates a risk-on mentality and gives room for rates to move up.  On the other hand, the economy appears to be slowing and inflation is tepid.  Like Fed Funds, there’s probably a limit to how high the 10T can move while a sharp downturn could cause it to plunge.

Because I want to read how wrong I am a year from now, let me give some concrete forecasts:


Upper End           2.62%

Base Case            2.00%

Lower End           1.00%


That’s it! Happy holidays to everyone and we look forward to another year.  Keep reading if you enjoy egg on my face from last year’s predictions.  Oh yeah, LSU wins it all as I bet against Clemson again.


Last Year’s Predictions – 12.24.18


Current Inflation vs Inflation Expectations

Prediction – Core PCE struggles to break through 2.0%, but hovers around this level for most of 2019.   Inflation expectations will have a more volatile year.

Reality – Core PCE did not remain around 2.0%, it fell to 1.6%.  The St Louis FRED Forward Inflation Expectations Index at 2.10% and fell to 1.6%.

Grade – B minus


Reverse QE vs German Bund

Prediction – Reverse QE will continue to have some impact on Treasury yields, but not a dramatic one.  It will, however, have an outsized impact on financial conditions.  There will be a lot of market chatter about the Fed pausing its balance sheet normalization process, but they won’t actually do it in 2019.

The ECB will start discussing rate hikes at some point in the first half of the year, which could drive up the bund.  For the second year in a row, we are 100% confident the bund will finish the year above 0.60%.  On a long enough time-line, my predictions come true!

Reality – Reverse QE did have an outsized impact on financial conditions.  They tightened so much in fact that the Fed was forced to end balance sheet normalization in September.  Doesn’t sound like that big of a miss, except that Powell started discussing the end of balance sheet normalization on January 4th – just 11 days after I wrote that newsletter!  I did not realize Powell would backtrack so quickly.

And not only did the German bund not hit 0.60%, it actually hit negative 0.60%!  Its peak was just 0.28%.

Grade – not even a friendly UNC professor could save this one, I get an F minus only because there isn’t anything less than that.  Shame.  Shame.  Shame.


Republicans vs Democrats

Prediction – Trump will be impeached by the House.

Reality – Hey!  I’m back baby!

Grade – A++++ just to help offset the horrible bund prediction


Tightening Financial Conditions vs Recession

Prediction – Powell reacts to the sharp tightening of financial conditions and slows the pace of hikes while also sending the appropriate amount of dovish signals.  Financial Conditions level off and hover around neutral for most of 2019.

Powell has consistently been hawkish on the US economy, while highlighting the risks from exogenous shocks, like a trade war or geopolitical event.  In other words, if left alone the US economy is unlikely to experience a recession in the near future.  The US does not enter a recession in 2019, but we see more and more flashing yellow lights.

Reality – Not only did Powell slow the pace of hikes, he cut rates in the second half of the year.  Financial conditions eased all year following the market swoon in December.  The US did not enter a recession, but there are definitely more flashing yellow lights despite the recent positive news on the trade war front.

Grade – grading on a curve and giving myself a B+.  The Fed was still calling for 3-4 hikes in 2019 and we were skeptical.


Swaps vs Caps

Prediction – a year from now, a swap may outperform a cap in a similar fashion but to a smaller magnitude.  Current market pricing is exceptionally pessimistic.  If bad news fails to materialize, markets may have to correct over the course of the first half of 2019 and catch up to the Fed.  Locking a swap now could end up looking attractive.

But…but…but… if the Fed has to cut rates at some point in the next five years the cap could end up looking significantly better.

Reality – Caps for the win.  Swap rates fell all year and the Fed cut rates.

Grade – Incomplete.  I hedged my thoughts on hedging and covered my backside.  I can’t stand when I don’t take a stand.


2 Year Treasury vs Yield Curve Inversion

Prediction – The yield curve will invert in Q1 2019.  Powell will be too slow to send reassuring signals to the market.  Talking heads and Powell spend a lot of time explaining why this time will be different.  This time will not be different.  Cue recession in 2020 or 2021.

The 2 Year Treasury will finish 2019 below 2.75%.

Reality – the yield curve inverted, but not until August.  My only complaint about Powell in 2018 was that he was slow to respond to market signals.  I was totally unprepared for his course reversal on January 4, 2019 that lifted markets.  That delayed the inversion from Q1 to Q3.

The 2 Year Treasury is at 1.65%.

Grade – some people say, “I’m my own harshest critic.”  Not this guy.  I have no pride and grade myself on a severe state school curve.  A minus.


LIBOR vs 10 Year Treasury

Prediction – The Fed is done or nearly done hiking.  If it gets a hike in, it will be in June.  Powell needs to reassure markets before he moves again.  He finally threw in the towel after the markets spent two months puking over his comment about rates being a long way from neutral.  Now he believes rates are about neutral.  LIBOR finishes 2019 at 2.75%-ish.

The 10 Year Treasury was 3.25% six weeks ago, now the world is suddenly ending?  I don’t buy it.  More importantly, Powell has learned a valuable lesson over the last few months.  I am betting that Powell will ease up on the rate hike talk, which in turn will allow some risk-taking psychology.

The curve will invert in Q1, but Fed-speak will eventually allow the T10 to climb.  The 10 Year Treasury yield finishes 2019 between 3.15% – 3.35%.

Reality – faaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaaak.

Grade – This aged worse than Lindsay Lohan.  F minus. And that’s with a curve.  The real irony is that the world didn’t end, GDP and the labor market had reasonably strong years, yet rates plunged.


Click to Open: The Pensford Letter PDF