High long treasury rates achieve 1)Restraint on inflation 2)Headwind against stock gains leading to consumption 3)Crowding out of private sector borrowing 4)Accommodation for domestic buyers to fund the deficit
October 22, 2023 – Weekly comment
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It has been an extraordinary rise in the US ten year yield since May. The low in May was 3.34% and Friday it was 4.92%, a surge of 158 bps. The largest retracement over that period was in July, from 4.07% on July 7 to 3.75% on July 19, 32 bps. This week the yield was up 29 bps while the two-year yield was up just 3 bps to 5.082%. 2/10 treasury spread closed at a new high for the year at -16.4, up 26 on the week!
The ‘wait-and-see’ message by Fed officials regarding the November 1 FOMC, punctuated by Powell’s comments last week, caused FFX3 to settle exactly at the Fed Effective Rate of 5.33%. In other words, by the end of the week no Fed action was priced for the November meeting. FFF4 settled 9462 or 5.38%, indicating a 20% chance of a hike at the December meeting.
As everyone knows, and as Powell overtly stated (again) last week:
It’s not a secret. We know that we’re on an unsustainable path fiscally. It’s not that the level of the debt is unsustainable. It’s not. It’s that we’re – the path we’re on is unsustainable, and we’ll have to get off that path sooner rather than later.
There was also an interesting speech from Richmond Fed President Tom Barkin last week. He noted unevenness in both the economy and pricing pressures. In perhaps an underappreciated aspect of inflation, he cited one of the draining aspects: “Inflation is exhausting. It takes effort to shop around for better prices or to handle complaints from unhappy customers.”
A couple of additional clips:
Supply chains have largely opened up. Labor force participation has rebounded. And gas prices have fallen from last year’s highs. [all three of those are again at risk]
The data will tell you that demand is not weak. GDP remains solid, growing 2.1 percent in the second quarter. S&P Global forecasts a remarkable 5.2 percent in the third quarter. That growth has been in no small part due to the consumer who has continued to spend down pandemic-era savings and benefit from higher wages and rising stock prices.
A Bloomberg article cites a lower Q3 growth expectation of 4.3%. Atlanta Fed’s GDP Now is 5.4%. (Q3 GDP release is Thursday). Barkin goes on to say that what he is “hearing on the ground” is a different drumbeat that shows slower growth, better balance in labor markets, and construction backlogs being worked down.
If you’re Powell, how do you navigate the path forward? The primary goal remains getting inflation to target. In part, referring back to subtle references by Barkin, that means throttling back both labor and stocks as a way to slow activity by both lower and higher-end consumers. But Powell must also feel some pressure to accommodate fiscal supply. As foreign buyers of US debt have pared back, in part to support their own weakening currencies, the Fed knows that the domestic buyer is left to fill the gaping deficit hole. A positive yield curve could go a long way in helping. What if the Fed continues to talk tough on raising the FF rate, but signals to major banks and asset managers that funding rates will be kept steady for the foreseeable future allowing the curve to go positive. Is Waller saying, “Clearly issuance has to impact yields” part of that messaging? Is the recent ‘news-plant’ focus on “term premium” part of that messaging? What if the Fed quietly promises banks NOT to invert the curve again? Domestic financial institutions would have an incentive to lever up and buy treasuries with positive carry. Higher long rates thwart inflation and siphon money out of stocks. Banks can re-build capital. It’s the positive side of ‘crowding out’ the private sector.
This week includes:
2,5,7 year auctions Tuesday, Wednesday, Thursday
Monday: Chgo Fed Activity
Tuesday: S&P PMIs
Wednesday: New Home Sales; Powell delivers brief opening remarks
Thursday: Q3 GDP
Friday: PCE spending and income. PCE prices yoy expected 3.4% with Core 3.7% from 3.9
OTHER THOUGHTS/ TRADES
My note last week focused on gold. GCZ3 went from 1941.5 to 1994.4 Friday to Friday, a rise of 2.7%. SPX fell 2.4% on the week.
I continue to watch SFRM6/SFRM7 spread. Last week I wrote: “Early in the week it traded 10.5 to 11.5 but settled at just 4.5. I still favor buying in the low single digits.” This week the low settle was 3.0 and Friday was 10.5. Still looking for a test of the year’s high at 19.
SFRH4 9550/9600/9637.5 broken fly settled 0.75, down from 1.5 last week.
BBG article notes that Subprime auto loans which are 60+ days overdue hit 6.91%, the highest since 1994.
| 10/13/2023 | 10/20/2023 | chg | ||
| UST 2Y | 505.2 | 508.2 | 3.0 | wi 505.0/04.5 |
| UST 5Y | 464.2 | 486.0 | 21.8 | wi 485.0/84.5 |
| UST 10Y | 462.7 | 491.8 | 29.1 | |
| UST 30Y | 477.7 | 507.8 | 30.1 | |
| GERM 2Y | 313.9 | 312.2 | -1.7 | |
| GERM 10Y | 273.7 | 288.9 | 15.2 | |
| JPN 20Y | 151.7 | 163.1 | 11.4 | |
| CHINA 10Y | 268.0 | 270.6 | 2.6 | |
| SOFR Z3/Z4 | -83.5 | -78.5 | 5.0 | |
| SOFR Z4/Z5 | -57.0 | -39.5 | 17.5 | |
| SOFR Z5/Z6 | -3.0 | 9.0 | 12.0 | |
| EUR | 105.11 | 105.96 | 0.85 | |
| CRUDE (CLZ3) | 86.35 | 88.08 | 1.73 | |
| SPX | 4327.78 | 4224.16 | -103.62 | -2.4% |
| VIX | 19.32 | 21.71 | 2.39 | |
