Good morning, unless you are long and wrong as bond yields continue to drift higher:
They say, ‘the trend is yer friend, ‘til it bends’ and while 10yy appear overSOLD (daily momentum — ie stochastics, bottom panel), perhaps we’ll need some sort of cathartic event which rinses OUT weaker handed longs and make folks re-think the narratives marketplace and then, once last man standing is OUT (or flipped short), THEN rates will rally? That will be THEN and this is now and so … here is a snapshot OF USTs as of 705a:
… HEREis what this shop says be behind the price action overnight…
… WHILE YOU SLEPT Treasuries are lower and the curve is flatter as EU and UK bond markets again lead to the downside this morning. DXY is lower (-0.12%) while front WTI futures are higher (+0.75%). Asian stocks were mostly lower (Japan out on holiday), EU and UK share markets are all in the red (SX5E -0.75%, SX7E -1%) while ES futures are modestly higher (+0.12%) here at 6:55am. Our overnight US rates flows were muted with Japan out. In duration, our London desk saw modest selling in 2yrs alongside continued steepening curve interest. Overnight Treasury volume was ~55% of average across the curve.
… Treasury 10yr yields: Sitting right on major range support near 4.34% as we write- after taking a peek above the support earlier this morning (see zoomed-in shadow box). Some have asked what next support would be on a breakout above 4.34% and our best guess would be that the 2006-2007 10yr rate range (roughly 4.45% up to 5.25%) might be a next target with support beginning at the bottom of said range (4.45%). That's just a low-confidence guess. Most importantly, longer-term bond bulls will definitely want to see the incumbent bear trend taken out and that trend intersects at ~4.10% today... So some work to do for that to even be tested.
… 10-year real yields (TIPS): They took a brief look above multi-month range support (2.00%) this morning, sitting at 2% as we write. We have little idea where next support would be above 2.00% because of the big gyrations around the level back in 2007-2008.
THEIR visual of 10yy much better than mine … and for some MORE of the news you can use » The Morning Hark - 18 Sept 2023 and IGMs Press Picks (who CONTINUES to be sportin’ that new, fresh look) in effort to to help weed thru the noise (some of which can be found over here at Finviz).
From some of the news to some of THE VIEWS you might be able to use … here’s SOME of what Global Wall St is sayin’ (in addition to THESEwhich were offered over the weekend) …
Apollo - Broadway Attendance Slowing (hmmm, an interesting and different source of data sought and found in support of a thesis …)
The number of people going to Broadway shows has in recent weeks been falling faster than normal, see chart below. We will over the coming weeks be closely monitoring whether Broadway attendance picks up like it normally does in the fall. For markets, this is important because consumer services continue to be the key reason why the economy, despite significant Fed hikes, is still holding up.
BNP - Sunday Tea with BNPP: The sense of an ending (sounds so final … but in a good way when yer talkin’ CB hike cycles…)
KEY MESSAGES
Last week may have seen the end of the European Central Bank’s hiking cycle. We like to sell EUR FX gamma, and favour short-vol and range-trades in EU rates.
In the coming week, we expect to see the end of the Bank of England’s hiking cycle, and confirmation that the Federal Reserve is unlikely to hike again. But we do not think it is time for the Bank of Japan to make changes, yet.
Ends of cycles have ushered in low market volatility, and we like to position long risk and long carry in the near term. While we do not think options are ‘cheap’ here, we like to seek out low-premium long-convexity hedges as the next stage of the cycle approaches.
Crescat Capital - Redefining 60/40 Portfolios (because I’M not a fan does — think GOLD > bonds — does NOT make this less readable)
We believe conventional investment strategies are poised to undergo a significant restructuring, placing a prominent emphasis on investments in hard assets. As illustrated in the accompanying chart, the valuation history of 60/40 portfolios unfolds through extended cycles, and we are currently experiencing another critical juncture in this dynamic.
In August 2021, the combined valuation of overall equities and US Treasuries had reached its most expensive level in 130 years. To put the current valuation imbalance into perspective, its recent peak was a staggering 61% higher than its previous peak in the early 2000s. Although prices have corrected somewhat, particularly in the Treasury market, today’s elevated multiples still bear resemblance to periods that preceded significant economic downturns, such as the Great Depression of 1929 and the Tech Bust of 2001.
The rise in popularity and the success of these traditional investment strategies in recent decades can be credited to a period characterized by disinflation, fostering one of the most speculative environments in the history of financial markets. It is highly unlikely that equities and bonds, given their current inflated prices, will together yield substantial returns over the next decade. This is particularly the case in a world where structural inflationary forces continue to evolve in the system, while the cost of capital is expected to exceed historical norms.
Treasuries: No Longer the Safest Alternative The shifting dynamics of capital moving away from crowded equity and fixed-income holdings, as investors seek new investment opportunities, could have profound implications in financial markets. This is where gold and overall commodities are poised to play a significant role during this transitional phase.
As is widely recognized, the 40% segment of these conventional portfolios, mainly comprised of fixed-income assets, has been facing substantial challenges. This has led to fundamental questions about the potential need to restructure these allocations. The main reason why investors include this portion in their portfolios is primarily because they are in search of safe-haven assets with minimal downside volatility, especially those that tend to perform well during economic downturns. Nevertheless, institutions should deeply reflect upon this crucial analysis:
For the first time in 45 years, US Treasuries have exhibited higher downside volatility than gold…
… An Important Market Divergence
10-year Treasury prices are decisively breaking below the levels that triggered the recent banking issues. The inflated valuation of financial assets hinges on a low cost-of-capital environment, a circumstance that no longer holds true today.
Investors are starting to grasp the significance of structurally elevated discount rates but there is a long way to rectify these deeply ingrained valuation imbalances.
MS - Sunday Start | What's Next in Global Macro: This Time IS Different for Real Yields (most dangerous 4 words in all of finance … NOW being used to support a bullish bond thesis SO, i’m interested … )
"This time is different" might be the four most dangerous and regretted words in macroeconomics and markets. The phrase sometimes lures investors into thinking that market prices reflect something about the future that most don’t fully appreciate yet. We think the current level of real yields represents a difference from the past, but not in the same way many investors see it. The perspective we share below supports our highly bullish view on government bonds.
Many investors think "this time is different" because yields – real yields in particular – have continued to rise despite the approaching end of central bank tightening cycles. The common view holds that markets increasingly price higher equilibrium real interest rates than those of the pre-pandemic decade. This rise stems from higher fiscal deficits and productivity growth rates – two topics at the top of investors' minds today.
… Today, 10-year TIPS offer real yields near 2.0% against a real economy that recently grew at 2.5%. Even the target fed funds rate range today, 5.25-5.50%, is similar to 2006. This market pricing hardly seems that different to the period before the 2008 financial crisis – but it is, in important ways.
Most obviously and most discussed, the yield curve is much flatter than in 2006, in both real and nominal terms. The 2-year Treasury note offered the same yield as the 10-year note in mid-2006. Today, the 2-year yield stands 70-100bp above the 10-year yield. Many thought the severity of the yield curve inversion in 2022 signaled a recession in 2023. We didn't. The bottom line of our Living with Yield Curve Inversion note began, "An inverted US yield curve is coming, but without a US recession close behind."
… Adjusting for the size of the Fed’s balance sheet, real yields today may be much higher than their levels prior to the global financial crisis. So, while we may have discounted the meaning of the inverted yield curve last year, we aren't discounting the levels of real yields this year. After all, if real yields today are much higher than they appear, investors and policymakers may need to pay more attention, given the implications for economic risks and future bond market returns.
MS - The Weekly Worldview: A Slippery Slope? (from famous words to an economic theory …)
Last week, the ECB raised its policy rate again. We had expected them to leave rates unchanged, but President Lagarde reiterated that inflation is too high, and that the Governing Council is committed to returning inflation to target. She specifically referenced oil among rising commodity prices that pose an upside risk to inflation. From the summer lows of around $70/bbl, the price of Brent oil has rising to over $93/bbl. How much should oil prices figure into the macro debate?
In previous research, our economics team has tried to quantify the pass through of oil prices to inflation in different economies. One key takeaway is that for DM economies, the pass through from oil prices to even headline inflation tends to be modest, on average. In the quarter following a 10pp increase in oil prices, headline inflation rises about 20bp on average. For the euro area in particular, we have estimated that an increase like we have seen of $20/bbl should result in about a 50bp increase in headline inflation. For core inflation, the pass through tends to be less, about 35bp. Especially given the starting point, such a rise is not negligible, but the effect should fade over time. Either the price of oil will retreat, or over the next year the base effects will fall out.
But energy prices can also affect spending, as well. Recent research from the Fed estimates the effects of oil prices on consumption and GDP across countries. They estimate that a 10% increase in oil prices depresses consumption spending in the euro area by about 23bp. What is the mechanism through which oil price shocks affect consumption? Consumer demand for energy tends to be somewhat inelastic—that is it is harder to substitute away from buying energy than other categories of spending…
Uncertainty about where we are in the cycle remains high with price action having an even greater influence on sentiment than normal—typical of late cycle environments. Today, we explore the sustainability of the recent relative outperformance of value and Energy, in particular.
Thoughts from the Road...After spending the past week with clients across Europe, we conclude that sentiment is quite similar to that of US investors. Many are grappling with the uncertainty of where we are in the economic cycle and the narrowness of performance that is making it challenging to keep up with benchmarks. As such, most are wondering if the rest of the year will bring more of the same (mega cap growth leadership) or whether markets will pivot and broaden out to areas that have underperformed YTD—i.e., value and small/mid cap stocks…
UBS (Donovan) - Politics and oil, while waiting for the Fed (don’t worry, it’s different this time … seriously, though, did I miss the memo it’s suddenly become OK … downright EXPECTED these days …?)
The Federal Reserve is not expected to raise rates this week, but after Fed Chair Powell’s June 2022 policy errors trashed forward guidance nothing can be certain. Data dependency does not help when data itself is unreliable (and potentially politically biased).
The US NAHB housing market index is due. Fed rate hikes have not impacted existing homeowners, nearly all of whom locked in mortgage rates and have barely noticeable monthly payments. However, new home owners are facing higher borrowing costs, especially relative to weaker consumer spending power…
… Oil prices are likely to continue to be a focus for investors—Brent crude is still over USD90 per barrel. This is a different situation to the start of the war in Ukraine in 2022. Then, consumers in the US and Europe were (effectively) able to transfer pandemic era savings to oil producers to meet the higher prices without cutting non-oil consumption. With savings depleted, higher oil prices today are more likely to be growth deflationary.
The federal budget deficit has been on a rollercoaster ride over the past few years. The deficit widened from 4.6% of GDP in fiscal year (FY) 2019 to 15% in FY 2020 amid the economic carnage of the pandemic and the enormous fiscal aid distributed in response. The robust economic recovery and expiration of many pandemic-era fiscal initiatives helped push the deficit back down to pre-pandemic levels in FY 2022.
The moderation in the budget deficit ended this year. Today, the federal budget deficit is an eye-popping 8.6% of GDP, or 7.1% of GDP when adjusting for the Supreme Court's decision to strike down President Biden's student loan forgiveness plan. What is driving this deficit widening?
Receipts have fallen from supercharged levels (~19.5% of GDP in FY 2022, near the highs of the 1990s tech boom) back toward their long-run average of 17.4% of GDP. Tax revenues from workers' paychecks and corporate profits have held up well, but declining receipts from capital gains income, surging business tax refunds and falling Federal Reserve remittances have driven much of the 10% decline in receipts this year.
On the outlays side of the ledger, there is no one single driver that has pushed up non-interest spending relative to before the pandemic. Outlays for entitlement programs such as Social Security and the major health care programs, national defense, veterans and several other spending categories have grown at a steady clip.
Interest spending has jumped amid much higher rates. The federal government spent about 1.8% of GDP on interest expense in FY 2019. Through the 12 months ending this June, net interest costs had risen to 2.3% of GDP. The good news is that this remains below the highs seen during the 1980s and 1990s despite a debt-to-GDP ratio that is much higher today. The bad news is that interest costs are likely to keep rising in the near-term as maturing debt is steadily reissued at today's higher rates.
On balance, federal budget deficits in the range of 6-7% of GDP appear likely for at least the next few years. If realized, this would put the annual budget deficit as a share of GDP about two percentage points wider than it was before the pandemic and nearly double the average deficit over the past 50 years.
Large budget deficits may put upward pressure on Treasury yields. A general rule of thumb that emerges from the research literature is that a one percentage point increase in the structural budget deficit is associated with an increase in longer-term yields on Treasury securities of roughly 15-30 bps, all else equal. Higher Treasury yields would in turn increase borrowing costs throughout the economy.
Of course, Congress could act to reign in the projected budget gap, either by increasing tax revenues, reducing spending or some mix of the two. But, the prospects for that seem unlikely between now and the 2024 election in our view, meaning 2025 is perhaps the earliest we might see some meaningful efforts at fiscal consolidation.
Fortunately, the United States' ability to finance these deficits is supported by the world's largest economy, which generates $27 trillion of GDP annually and possesses over $150 trillion of household net worth. The U.S. dollar remains the world's reserve currency with no obvious alternatives in sight, and the market for U.S. Treasuries is the world's deepest, most liquid bond market. These factors seem unlikely to change anytime soon, but the sizable medium- to longer-run fiscal imbalance poses a potential structural headwind for the U.S. economy.
… Interest Spending: The Latest Fiscal Challenge Federal interest spending has garnered a significant amount of attention this year, and understandably so. The federal government incurred about $375 billion of net interest costs in FY 2019, about 1.8% of GDP. Through the 12 months ending this June, net interest costs had risen to $616 billion or 2.3% of GDP (Figure 11). The good news is that this remains below the highs seen during the 1980s and 1990s despite a debt-to-GDP ratio that is much higher today (95% today compared to an average of 38% from 1980 through 1995). The bad news is that interest costs are likely to keep rising in the near-term as maturing debt is steadily reissued at today's higher market-prevailing rates. We expect net interest outlays as a share of GDP to be between 2.50% and 2.75% by year-end 2023.
For 2024 and beyond, the outlook for federal interest spending is highly sensitive to assumptions about where interest rates will settle. The Congressional Budget Office's projections are illustrative in this regard. In its February 2023 budget and economic outlook, CBO's baseline projections assumed that short-term interest rates would gradually decline to 2.5% by 2025 and hold near that level in the years to follow. For longer-term rates, such as the yield on the 10-year Treasury security, CBO assumes a much higher rate of about 3.8% on average over the next decade. If realized, and when holding CBO's other economic and fiscal projections constant, net interest costs would rise to 3.6% of GDP by FY 2033. Scenario analysis from CBO suggests that if rates were instead one percentage point higher on average, net interest costs would rise to 4.9% of GDP by 2033, well above the highs seen in recent history (Figure 12). If instead interest rates were one percentage point lower, net interest costs would remain a more manageable 2.4% of GDP. Even in the latter scenario, which includes low rates more in line with the Treasury yields that prevailed in the 2010s, interest spending as a share of the economy would be above last decade's levels given the higher debt burden today.
September is usually a nice month weather-wise. After the dog days of summer, the temperature starts to cool with occasional hot spells reminiscent of the summer. On the other hand, the month can be a rough one for stocks. The S&P 500 is down 1.3% mtd so far. That's not so bad. Then again, the month's worst performing sector is Information Technology, down 4.3% (table below). The S&P 500 has been hovering around its 50-day moving average for the past couple of weeks (chart).
The stock market might continue to drift sideways for a few more weeks. There are lots of uncertainties. How long will the UAW strike last? Will there be a government shutdown at the end of the month? How much higher is the price of oil likely to go? Will the 10-year Treasury bond yield break out above 4.35%? If the Fed doesn't hike the federal funds rate next week, will Fed officials suggest that they might hike in November? Might their Dot Plot show that there may be fewer rate cuts next year than investors expect? …
Pretty good analysis of the US Interest Expense Problem....
But those Expenses will soon jump because of the 500 bps increase that the FED has done
over the past 1.5 years.......
Also a Recession would certainly make the Annual Deficits larger and the problem worse....
Saw one estimate that by 2030, 20% of the Federal Budget will be Interest Expense.
My own Estimate is that by 2030, the US National Debt will be 40 Trillion.
Saudi Arabia and China have reduced their purchases of US Treasuries in recent years.
The US is on a very Risky and Dangerous Path.
The Supporters Of Modern Monetary Theory are badly mistaken.
The US can't Finance UNLIMITED DEBT, without risking a Crisis, that could lead to much
Higher Interest Rate and Onerous Financing Costs.
$ 40 T @ 4% = 1.6 T Interest Exp.
$ 40 T @ 5% = 2.0 T Interest Exp.
$ 40 T @ 6% = 2.4 T Interest Exp.
And these are Low Interest Rates........
Hell, the Current US Federal Budget is only around $ 6 T, in 2023.
We're at $ 33 T National Debt , now.
Have the Wall Street people become Kamikazes ????
It's INSANITY !!!!!!!