Tag Archives: #risingyields

Waters, Uncharted

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Last quarter, chair Jay set the stage
For yields to go on a rampage
Now, Q4 has started
And, waters, uncharted
Seem dead ahead in this new age

Both oil and dollars are rising
And bond yields worldwide keep surprising
By rising as well
With efforts to quell
Those hikes what CB’s are devising

As we begin the fourth quarter it appears the trends that had been quite clear for most of Q3, rising oil prices, rising bond yields and a stronger dollar, all remain intact. Historically, when this condition has prevailed, it has been a negative, and frequently a very large negative, for risk assets.  This begs the question, is something going to change or is it different this time?  Now, we all know that it is ‘never’ different this time, the cycles of financial markets have repeated constantly throughout history with pretty clear causes and effects.  In the current circumstance, the combination of these three indicators rising simultaneously is going to reduce the ability of non-USD economies to access necessary commodities as their prices are rising even more in local terms than in dollar terms, and the rise in interest rates is forcing them to pay more interest on their outstanding debt.  And every developing country has lots of outstanding debt, so this is a universal issue.

If we work under the assumption that this time is NOT different, then the question is, what is going to change and when might that occur?  This goes back to the idea that the Fed will raise rates until something breaks.  As of now, while a few things have broken (UK insurance companies, some regional US banks, Credit Suisse) it appears the economy continues to perform at a higher level than virtually everybody had anticipated it could.  As of yet, the most highly anticipated recession in history has still not occurred.  In fact, the soft-landing narrative, where the Fed manages to reduce inflation without pushing the economy into recession, has become the consensus view (alas this poet disagrees with that view and fears a much deeper recession is coming our way.)

So, what might change?  Well, last night the BOJ indicated that they are going to be performing an extra round of JGB buying in Q4 as they are growing increasingly concerned about the rise in JGB yields.  Last night, 10yr JGB’s moved up to 0.76%, after touching 0.775%, the highest level in more than a decade.  So, more QE is a clear possibility.  Now, we all know that the Fed is continuing its QT process, having reduced its balance sheet by a shade under $1 trillion so far and claiming they will continue to allow bonds to roll off without replacing them for quite a while yet.  The ECB is also engaged in this process and the BOE actually increased its target, now planning to sell £100 of gilts in 2024, up from the previous amount of £80 billion.  Will the central banks be able to continue these policies if the economy does tip into recession?  I think not, but they have maintained that the balance sheet issue is separate from their policy framework.

A direct impact of the QT programs is that bond yields are rising because of the absence of demand from what had been price insensitive buyers (aka central banks) which forces the private sector to absorb all the new issuance and they are requiring higher yields to take the paper.  Given the extraordinarily high levels of debt that exist, both on government and private balance sheets, it certainly seems like we might soon reach a breaking point here.  However, until that point is reached forcing a reversal in central bank views regarding their balance sheets, I anticipate yields will continue to rise.

The direct corollary to rising yields, especially rising Treasury yields as they are leading the way, is that the dollar is following along for the ride.  If you are looking for the dollar to reverse course, you are, almost by definition, looking for the Fed to reverse course.  Yet, there is no indication that is the case.  In fact, the only central bank that has demonstrated they are willing to end the tightening cycle is the BOJ, and let’s face it, they haven’t really started a tightening cycle, the market is simply anticipating that one is coming soon.

Oil, meanwhile, remains exogenous to the central bank story and is an OPEC story.  The poohbahs there meet this week in Vienna but there is no expectation of a change in their current production policy.  This means that the supply of oil is unlikely to rise anytime soon while demand, given the more robust than expected economic activity, continues apace.  Nothing has changed this story that a decade of misguided ESG policies has created a structural supply deficit of oil and the price is destined to continue to rise going forward.

Alas, the upshot of this set of conditions as we enter Q4 remains risk assets are likely to remain under pressure until whatever that something is finally breaks and the central banking community, notably the Fed, changes their tune.  Keep your ears peeled for that change in tune.

Now to today’s markets, where equity markets in Asia that were open, notably Japan, were a bit softer while China is on their Golden Week holiday so markets are basically closed all week.  That said, we did see their PMI data released on Friday night and Saturday and it was slightly stronger than expected, and for the first time since March, all the readings were above 50.0, albeit just barely.  Nonetheless, a positive sign.  As to Europe, weakness across the board is the description of the day, with the major bourses lower by between -0.3% and-0.6%.  US futures, which had been barely positive earlier in the evening session, are now slightly softer as well, -0.3% or so at 8:30.

Bond yields are rising again with Treasuries higher by 6bps and back above 4.60% while the bear steepening continues with the 2yr-10yr spread now “just” -47bps.  As well, throughout Europe we are seeing sovereign yields rise about 3bp-4bp across the board as this trend of still high inflation, rising oil prices and ongoing QT is working its ‘magic’.

Speaking of oil, it is back on the rise with WTI up 0.5% and above $91/bbl this morning as we have seen consistent drawdowns in inventory for the past several months as the OPEC supply cuts have really started to bite.  One thing that we need to keep an eye on going forward is NatGas, which as we come into winter and the colder weather, could well see a lot of upward pressure, especially in Europe.  Looking at the metals markets, the combination of rising prices in oil, yields and the dollar is really starting to weigh on this sector with gold down another -0.75% and getting closer to $1800/0z, down more than 5% in the past month.  Copper (-1.6%) and aluminum (-0.3%) are also under pressure today and both are feeling the weight of developing downtrends.

Finally, the dollar, which sold off slightly on Friday into month-end, has reversed course and is stronger across the board this morning with the DXY up 0.35% while some outliers are ZAR (-1.1%) and MXN (-0.7%), both suffering from the strong dollar disease.

On the data front, the PMI data from Europe was still awful, with Germany still sub 40.0 and the Eurozone at 43.4.  As to the rest of the week, we get important things culminating in Fridays NFP report.

TodayISM Manufacturing47.7
 Construction Spending0.5%
TuesdayJOLTS Job Openings8.83M
WednesdayADP Employment160K
 ISM Services53.6
 Factory Orders0.3%
ThursdayInitial Claims210K
 Continuing Claims1678K
 Trade Balance-$64.6B
FridayNonFarm Payrolls163K
 Private Payrolls160K
 Manufacturing Payrolls5K
 Unemployment Rate3.7%
 Average Hourly Earnings0.3% (4.3% Y/Y)
 Average Weekly Hours34.4
 Participation Rate62.9%
 Consumer Credit$12.5B

Source: Tradingeconomics.com

As well as all this, we hear from nine different Fed speakers across eleven events including Chairman Powell this morning at 11:00am.  And that is just what is on the schedule, I expect we will hear some BBG interviews or things like that as well.  

The question remains, is something going to change, either because of the data or the tone of Fed speeches?  There is no indication the Fed is changing their attitude and I expect that will remain the case until the data changes.  I have maintained for more than a year that the NFP report is critical to Powell and friends as it is their CYA document.  As long as the Unemployment rate remains lower than 4.2% or so, and NFP is positive, nothing will deter them on their mission against inflation.  And that means the dollar will remain underpinned.

Good luck

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Like Goldilocks?

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For assets so safe and secure
It seems bonds have lost their allure
Yields worldwide are rising
And it’s not surprising
Since ‘flation, we all must endure

The question is, what about stocks?
Are they set to soon hit the rocks?
Or will they remain
Resistant to pain
If growth behaves like goldilocks?

Certainly, yesterday was a pretty bad day for risk assets as equity markets in the US sold off aggressively along with commodities.  The thing is it was a pretty bad day for haven assets as well with Treasury yields rising sharply.  And right now, just before 7:00am in NY, those trends remain intact.  In fact, the only thing that seemed to perform well yesterday was the dollar.

So, what gives?  Many will point to the downgrading of the US credit rating by Fitch as the proximate cause of things, and it may well have been an excuse for some selling, but despite the logic I detailed yesterday, the impact on markets should be di minimis.  After all, Treasuries are used for two things largely, either as investments in their own right, or as collateral for other financial transactions.  Regarding the first point, nobody is actually concerned that the US will not repay their debt, so if the yield is attractive, investors will still buy them.  As to the second point, this could have been an issue but since the S&P downgrade in 2011, collateral agreements have been rewritten to accept not only AAA securities, but also US government securities, with no mention of their rating.  So, there is no change in the collateral situation.

If it was not the downgrade, then what has driven the recent upheaval in markets?  Arguably, this has been building for quite some time and was looking for a catalyst to get things started.  I think there are two ways to consider the situation.  For the bears out there, watching equities rally daily despite what appeared to be softening margins along with tightening monetary conditions didn’t make sense.  But the rally has been so relentless that the bears have largely capitulated on their views.  It seems the key lesson is that the timing of monetary policy transmission is much slower than it had been in the past, or at least that’s what it feels like, and so despite the Fed’s aggressiveness, it hasn’t had nearly the impact anticipated.  

To this point, remember, while the Federal government didn’t take advantage of ZIRP to term out its debt, homeowners and corporations did just that.  This has resulted in a lot of borrowers with a long runway before needing to refinance their debt and left them somewhat impervious to the Fed’s recent moves.  We have all heard that > 50% of mortgages outstanding are at rates < 4.0%.  This has resulted in an unwillingness to move and reduced existing home inventories and sales.  But all those people have not been impacted by the rate hikes, at least not on their largest single interest payment.  And the same has been true for many corporations who termed out their debt in 2020-2021 and even the first half of 2022.  While much of that debt will eventually be refinanced, it may be another 5-7 years before we start to see companies feel any stress there.  Consider, too, how this has helped lower rated companies, who, if forced to refinance today would see yields in the 8%-12% range but were able to borrow at 5% or less.  Of course, that debt was likely 5-year tenor, so that comeuppance is likely to arrive in 2025 or 2026.  And maybe that is when we should be looking for the first real problems.

The Fed’s Loan officer survey showed that conditions are continuing to tighten in the bank market, which means that smaller companies are going to be stressed, but the large cap companies that issue debt directly are sitting pretty.

Therefore, if it is not the downgrade, what other reasons could there be?  The first thing to remember is that there doesn’t have to be a specific reason for markets to sell off.  Markets that are overbought (or oversold) can reverse without any particular driver.  Historically, August has been a more volatile and weaker month for equities, often attributed to vacation schedules, with investors and traders both taking their summer trips and leaving skeleton staffs of junior people on the desk.  This will result in reduced liquidity and any outside selling impetus can have an overly large impact.  Remember, though, a rational look at equity markets indicates that on a historic basis they remain quite richly valued with the Shiller Cyclically adjusted P/E ratio at 31.1, well above its long-term median of 15.93.  However, what is typically true is that when an overvalued market starts to correct, it can continue doing so for quite some time until it reaches a more rational valuation.  If the bears have all given up, and the bulls are all on vacation, who is left to buy things?

All this is to say that, while the recent equity market weakness may not make sense specifically, there is nothing to say that it cannot continue for a while yet.  Turning to bonds, though, that is a different story.  Yields around the world are rising and, in many cases, rising sharply.  While the BOE just raised rates 25bps this morning, as largely expected, they are simply catching up to the rest of the G10.  However, 10-year Treasury yields are +6.7bps as I type (7:20) and now trading at 4.14%, their highest level since last October.  My sense is that this move is all about two things, concerns that inflation has seen a local bottom and the dramatic increase in supply just announced by the Treasury.  As discussed yesterday, yields above 4% have led to things breaking, so the question is what is set to break now?  Perhaps, the stock market selling off will be this breakage, or perhaps there will be some other crisis that flares up.  Maybe another large bank going to the wall, or a large corporate bankruptcy in a key sector.

We have discussed rising oil prices and you are all aware of rising gasoline prices every time you go to fill the tank.  Headline CPI, when it is released next week, will be well above last month’s 3.0%.  Too, yesterday’s ADP Employment number was much stronger than expected for a second consecutive month.  If the no landing scenario is correct, then inflation is likely to remain far more stubborn than currently expected and Chairman Powell will not be thinking about thinking about cutting rates any time soon.  In fact, at this point, if the Fed starts to think about cutting rates, that likely means that the economy has reversed course and is clearly headed into a recession.  Be careful what you wish for.

Summing up, I would be wary of reverting to the buy the dip mentality that has prevailed for more than a decade.  The underlying economic and financial situation is changing pretty quickly and that implies previous strategies may not perform that well.  Do not forget last year’s market performance.

I would be remiss if I didn’t mention that the BOJ was back in the market again last night, buying an unlimited amount of JGBs as they try to smooth the rise in JGB yields, which are now up to 0.65%.  This did help the yen a bit, which has rallied slightly on the day, but overall, the dollar remains much stronger.  My take is that we are seeing investors who are uncertain about the medium and long term, buying dollars to buy T-bills, earn a nice piece of interest and reconsider their next move.  One thing to note is that the yield curve’s inversion is lessening quite quickly.  Last Monday, the inversion was -104bps.  This morning it is -75bps.  That is a remarkably fast move in a short time.  It also implies that the demand for 10-year Treasuries is a little soft right now.  As I have written, this inversion could resolve with higher long rates, not lower short rates, and that is not something for which the market is prepared.  I believe that would be a clear equity negative.

There is a lot of data this morning starting with Initial (exp 225K) and Continuing (1708K) Claims, Nonfarm Productivity (2.3%), Unit Labor Costs (2.5%), Factory Orders (2.3%) and then ISM Services (53.0) at 10:00.  But this is all a lead-up to tomorrow’s NFP data.  Fed speakers have been fewer than usual, but we do hear from Richmond’s Thomas Barkin this morning.  I see no reason to believe that there will be any new dovishness upcoming.

To my mind, yields are going to continue to rise, equities are going to remain under pressure and the dollar, overall, is going to remain stronger rather than weaker.  We will need to see big changes in the data to change that view.

Good luck

Adf

Nowhere Near

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Charles Evans, on Tuesday, explained
Inflation can well be contained
In fact, his concern
Is prices could turn
Back lower ere targets are gained

“I’m going to be very regretful if we sort of claim victory on averaging 2% and then we find ourselves in 2023 with about a 1.8% inflation rate, sustainable, going forward. That would be a challenge for our long-run framework,” he [Evans] said. “We ought to be willing to average inflation above 2%—frankly, well above 2%. [author’s emphasis]”

One cannot overstate the hubris associated with the above quote from Chicago Fed President Charles Evans.  The fact that he legitimately believes the Fed’s powers are such that they can fine-tune a $24 trillion economy to the point that measured estimates of particular features of that economy are able to be managed to a decimal place of an annualized percentage outcome is extraordinary.  It is the perfect illustration of the fact that the Fed is completely out of touch with the economy in which you and I live and completely ensconced in a model driven framework where data represents reality.  But it is exactly this hubris that has resulted in the policy decisions that have brought the world negative interest rates and a defense of debt monetization.  As long as central bankers, notably the Fed, continue to believe that their models are the economy, rather than a simplified representation of the economy, they are likely to continue to make decisions with significant unintended consequences from which we all will suffer.

This morning the market awaits
The latest inflation updates
What’s patently clear
Is they’re nowhere near
An outcome to end the debates

Speaking of inflation, this morning brings the latest CPI data with expectations running as follows: Headline (0.5%, 5.3% Y/Y) and ex food & energy (0.4%, 4.3% Y/Y).  Both of those forecasts are slightly lower than the prints seen in July, and if realized, you can be sure that we will hear a chorus of FOMC members highlighting the transitory nature of inflation.  Of course, if the outcomes are higher than forecast, something we have seen in each of the past twelve reports, we will also hear a chorus of FOMC members explaining that this remains a temporary phenomenon and that inflation is transitory.  [Perhaps when Ralph Waldo Emerson wrote in 1841, “a foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines,” he was anticipating the Fed.]  However, financial markets may not be quite as sanguine over the results, especially if they continue their year-long streak of outperforming the median estimate.

Markets, of late, have been starting to discern between those products that will benefit from altered policy and those products that will suffer.  Nowhere is this clearer than in the US equity markets where we have seen the NASDAQ underperform its brethren indices.  Recall, given the NASDAQ’s strong bias toward high growth (and low profit) companies that benefit greatly from extremely low interest rates, the index behaves very much like a very long-duration bond.  So, in a scenario where inflation is rising and market expectations are for tapering of asset purchases to begin soon(ish), it should be no surprise that the NASDAQ falls alongside the price of bonds.  At the same time, if the implication is that rising inflation is being caused by rebounding growth, rather than supply-chain blockages, there is an opportunity for more mundane, value-type companies to outperform.  Hence, the differing performance of the DOW vs. the NASDAQ.
Of course, the place where inflation is likely to have the most direct effect is the bond market, where long-term yields are theoretically supposed to reflect inflation expectations.  And while we have certainly seen yields rise over the past week, there is no way they currently reflect those expectations.  They cannot do so as long the Fed continues to buy all the new issuance, and then some, thus artificially driving up prices and driving down yields.  Ask yourself this, does it make sense that US 10-year yields are at 1.36% if inflation is at 5.4%?  Of course, the answer to that is a resounding ‘No!’  Yet, that is the current situation.  To observe the bond market and believe it is not artificially inflated (everywhere in the world, mind you) is akin to believing that the moon is made of green cheese.  It just ain’t so!

At any rate, ahead of this morning’s CPI release, investors have generally been biding their time as they wait to determine if they need to adjust their world view.  Equity markets are generally a bit firmer as Asia mostly eked out some gains (Nikkei +0.6%, Hang Seng +0.2%, Shanghai 0.0%) with Europe following suit (DAX 0.0%, CAC +0.3%, FTSE 100 +0.5%).  US futures are split with the NASDAQ (-0.2%) slipping following yesterday’s losses, while the other two main indices are essentially unchanged.  All in all, it appears that there is some hope that CPI prints on the low side to allow the Fed narrative to continue apace, and therefore to allow rates to remain lower for longer.

Bond markets, though, are starting to get a bit antsy these days with Treasury yields edging higher again (+1.7bps) with similar type gains seen throughout Europe (Gilts +1.4bps, OATs +1.8bps, Bunds +0.8bps).  At this point, 10-year Treasury yields have risen 0.25% in the space of a week, which is a very substantial move, especially when considering that the base at the beginning was just 1.12%.  One has to believe the Fed is watching extremely closely as they do not want to see the market run too far ahead of their mooted tapering and create Taper tantrum #2 inadvertently.  It is here where a higher than forecast CPI print could have quite an impact and which may force the Fed to reconsider the idea of tapering.  After all, they cannot afford for 10-year yields to rise to 2.0% while they are still purchasing $120 billion per month of paper.

Commodity prices are mixed today with oil (-1.1%) feeling the pressure of higher yields while gold (+0.5%) seems to be ignoring that same pressure.  Of course, gold was just subject to a significant sell-off, so this could easily be a simple trading bounce.  As it happens, both agricultural and base metal prices are showing a mixture of gainers and losers and no real underlying theme.

Finally, the dollar is definitely stronger again this morning.  While the movement vs. its G10 brethren has not been large, it is unanimous, with all currencies in the red today.  A particular shout-out goes to the euro, which is trading just pips from the key support level of 1.1704.  Watch that carefully as a break there is likely to open up much lower levels.  In the emerging markets, KRW (-0.6%) has been the laggard, followed by TRY (-0.5%) and HUF (-0.4%).  The won has been suffering from a combination of rising covid cases, with a record high 2200 reported yesterday, which has been encouraging the liquidation by foreign investors of Korean equities.  Meanwhile, TRY is under pressure as traders are concerned the President Erdogan will once again interfere in the central bank’s business and prevent them from raising rates at tomorrow’s meeting.  Finally, the forint seems to be suffering for the sins of its neighbors as concerns over German growth, a key market, and Polish politics, a close neighbor, have encouraged selling.

And that’s really it for today.  All eyes will be on the CPI at 8:30. More than just watching the tape, I always pay attention to @inflation_guy on Twitter as he does an excellent job breaking down the drivers of the number and offering insight into how things may evolve.  I highly recommend following him.

As to the dollar, the slow grind higher continues and as long as US rates are rising, I think so will the dollar.  If we break the 1.1704 level in the euro, look for a bit of an acceleration.  But don’t be surprised if we reject the move given it is the first test of the support level since it was established back in March.

Good luck and stay safe
Adf