Debt Sustainability
August 8, 2024
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–Uninspiring 10y auction yesterday, which resulted in a three bp tail; yield at cut-off was 3.93% and actual auction was 3.96%. As suggested yesterday, demand might not be as hearty at these (relatively) low yield levels. At the margin, buying predicated on funding in yen has likely evaporated. (JPM says 75% of the yen-carry trade has been unwound). In my opinion, it’s going to become increasingly necessary for the US to fund its debt domestically, which will be a lot easier if US funding rates decline below long-end yields (or if longer yields RISE above funds). The attached chart showing 2/10 at a new high is a good start; at -4 bps it’s the highest it has been since July of 2022 (the first hike was in March 2022). In my opinion, “debt sustainability” is going to course through the financial market lexicon the same way that “climate change” does on a Public Television nature series.
–Thirty year auction today. One other bit of lagged news concerns yesterday’s Consumer Credit release. Revolving fell by 1.7 billion. The amazing thing is that revolving has been growing at all, given credit card rates of over 21%. On the other hand, those balances compound pretty quickly. We’re seeing it in delinquency rates, and of course, banks are shutting off the spigots. So, take out a school loan if possible… In a way, that’s the story of ‘debt sustainability’ at the ‘stretched consumer’ level: rates high, delinquencies up, credit availability getting shut down. With respect to the biggest debtor of all, the US Federal Gov’t, the issue of debt sustainability might manifest itself in the form of really bad auctions. However, if long end rates are somewhere between 4 and 5.5%, and the Fed cuts to 3% and implicitly (explicitly to Jamie Dimon) guarantees positive carry for the foreseeable future, then maybe the Fed won’t be forced to monetize the debt. Domestic banks and funds will be glad to milk the positive carry, which will help absorb increased consumer and corp delinquencies.
–Jobless Claims and 30y auction today. Claims expected 240k from 249k last. After the 10y auction, both stocks and bonds slid. At futures settle tens had risen 8.4 bps to 3.966%. On the SOFR curve, Z4 was +2.5 at 9582, Z5 -4.5 at 9677.5, Z6 -7.5 at 9680.5 and Z7 -8.0 at 9671.0. So if we jumped in the time machine and shifted a year forward, Dec’25 contract is only 3.25% and we could fund longer dated paper with positive carry…
Just a couple of trades from yesterday, new buyer of about 25k SFRU4 9506.25p for 3.5 and a seller of 20k SFRU4 9525c at 8.5 covered 9520.5, 40d. SFRU4 settled 9520. The Sept FOMC is Sept 18, options expire Sept 13. The Fed is not going to emergency-cut unless a nuclear bomb is detonated. They’re ready for small bank failures, etc. So, absolute certainty of 50 bp cuts on both Sept 18 and Nov 7 would probably see a final U4 settle at 9530 -35 (on Sept 13). But if Powell dialed it back to 25 at Jackson Hole, it wouldn’t be surprising to see the 9506 strike in play.
