Keeping it Real

Sept 12, 2021 – Weekly Comment

“When you corrupt the most important pricing mechanism of money, the most important asset in a commercial economy, then by definition you mis-allocate every other investment based on price.”
–from friend RH Bailin  I think this line succinctly captures the big YOU ARE HERE arrow on the economic map.

In this thread Keith Weiner of Monetary Metals argues that Central banks, by suppressing interest rates, have substituted the siren’s song of rising asset prices for the fundamental benefits of capital allocation to productive growth, which are afforded by unmanipulated rates.  Here’s an excerpt:

But higher [asset] prices do not compensate for zero yield. Think of it this way… Falling yields are cyanide, the literal poison that Central Banks have introduced in markets. Rising prices are cherry flavoring. Cherry flavoring don’t change the fact you’re drinking cyanide!

Here’s a tweet and chart from Althea Spinozzi:

US high-yield corporate bonds’ real yield turned negative

Ms Spinozzi is using CPI, which comes out on Tuesday and is expected 5.3% yoy with Core 4.2% from 4.3% last.  The Financial Times notes the same thing:  “Real yields on European junk bonds go negative for first time in hunt for returns.” 

The implications are obvious: Borrow and buy.  Hoard.  The poorest credits can borrow at rates below which the prices of things are increasing.  It’s absurd. 

There was also a White House economic blog release on September 9, ‘Housing Prices and Inflation’ by Bernstein, Tedeschi and Robinson.  Here’s an excerpt:

Over the last 12 months, the Case-Shiller U.S. National Home Price index has risen by 18.6 percent, the strongest year-long growth in the history of the series…. Meanwhile, asking rental prices, as measured by the Zillow Observed Rental Index (ZORI), initially fell during the pandemic but have since recovered and now exceed their pre-pandemic trend.  [and will likely accelerate faster with the end of rent moratorium]
Because of the way shelter costs enter into the CPI, these increases in owned home and rental costs have not yet contributed much to overall inflation.
Our analysis, however, suggests that these higher shelter prices are likely to soon show up more clearly in the monthly CPI, potentially adding several more basis points… to monthly inflation than they do now.

The spin is that they add “…forecasts, including our own, show overall price growth decelerating in coming quarters.”  I personally don’t find that particularly reassuring.  Here’s another government official expressing reservations about the spending bill:  Democrat Rep (FL) Stephanie Murphy speaking about the House-advanced $3.5 trillion budget resolution: “As we begin the multi-day markup of this historic legislation, I don’t know how much we’re spending, how much we’re raising, how we’re spending some of the money, how we’re raising any of the money.”

We are about to get much higher inflation prints based on shelter prices that have not yet fed into data.  At the same time we are on the verge of a Fed taper.  I believe consensus is that taper will begin in November at a pace of $15b per month, ending in the middle of next summer.  The potential withdrawal of liquidity at the margin seems to have cast a shadow on the equity market this week.

I watched an interesting interview of John Paulson by David Rubenstein from earlier this month.  Several lines struck me.  First, when talking about MBS pricing before the housing bubble, Paulson said while it was true there hadn’t been a default, “…underwriting quality had never been as poor.”  Second, he mentioned at that time in 2007, the MBS market was larger than the treasury market.  Third, that in the current environment, “…the area that is most mispriced is credit.” Finally, he said there is a “supply/demand imbalance in gold.” 

In my opinion, due diligence as relating to underwriting quality might be at an all-time low, not in the mortgage market, but across the economy as a whole. Prices are based on suppressed rates.  When your core assumption of an argument is incorrect, the argument ultimately fails.  On Paulson’s second point, if one refers to the Fed’s Z.1 quarterly report, it’s true that in 2007 the Household Home Mortgage amount outstanding was $10.625T.  Federal debt was $6.074T.  Latest data is $11.071T for HH mortgages and more than double that amount in Federal Debt, $24.007T.  Is credit mispriced?  See real yields, above.  And that brings us to an imbalance in gold. 

Friend JJ Johnston writes, “The gold we trade is not gold anymore. it is an entirely financialized collection of derivatives (futures, ETFs and options on both). And in my most humble opinion it is not a free or fair market. You can still buy coins at absurd premiums but any other iteration of gold, so called, is a neutered illusion.” 

Is it fair to conclude that there is a supply/demand imbalance?  If a huge new seller of GLD calls pounds the market, pushing down the price of GLD, in effect new gold supply has entered the market.  In turn the premium for physical might rise, but at a lower spot price.  Could we be approaching the time when “the physical” begins to drive all markets, rather than the derivatives?  


Auctions went great last week but yields edged a bit higher.  EDZ1/EDZ2 calendar moved back above ¼% to 26, from 23.5 the previous Friday.  Jan’22/Jan’23 Fed Fund spread settled 19.5, still only projecting one hike over that time frame. 

This week’s CPI data may be quite important as shelter prices start to seep in.  Retail Sales on Thursday. 

A week ago Friday VIX closed 16.4 and last week at 20.95.  Last week I wrote, “Seems like insurance is relatively cheap, as is the case with interest rate vol.  50-day historical vol on TY is just under 4%, which is where I marked TYZ on Friday.”  Treasury vol became slightly cheaper this week.  Below is 30 yr bond, which is actually a bit higher than indicated on the chart, but clearly at the low end.  I marked USZ at 7.8 Friday after taking out weekend time value.

UST 2Y20.621.50.9
UST 5Y78.481.43.0
UST 10Y132.4133.91.5
UST 30Y194.3193.2-1.1
GERM 2Y-70.7-70.40.3
GERM 10Y-36.1-33.03.1
JPN 30Y64.665.61.0
CHINA 10Y283.3287.13.8
EURO$ Z1/Z223.526.02.5
EURO$ Z2/Z355.557.52.0
EURO$ Z3/Z438.038.50.5
CRUDE (active)69.2969.720.43

Posted on September 12, 2021 at 9:29 am by alexmanzara · Permalink
In: Eurodollar Options

Leave a Reply