Crunch
July 30, 2023 – weekly comment
SUMMARY
Rates are restrictive and will eventually squeeze inflation lower (if maintained)
Lacy Hunt interview (Wealthion). GDI and GDP typically track though can diverge over the short term. GDI has been negative in 3 of the last 4 quarters. Q2 GDP primarily due to auto assemblies; won’t repeat. Gov’t has negative multiplier; deficit has been completely funded by domestic non-bank buyers (siphons money away from productive projects). Credit crunch is here. Consumer spending shift from discretionary to non-discretionary (food and energy).
https://www.youtube.com/watch?v=AQwJUkZGi-M&t=2596s
https://hoisington.com/pdf/HIM2023Q2NP.pdf
Base effects are going to be more challenging for inflation. RBOB gasoline at new high for the year and WTI crude is at the top end of the range. Falling energy prices were a large benefit in the inflation fight; likely over. High energy also acts as a “tax” on the US consumer.
BOJ. Tweet by @EffMktHype : US10s swapped back to yen yield ~0.056% currently. So you can start to see why allowing JGB10s to rise above 0.5% starts to become an attractive proposition for Japanese bondholders and a negative flow dynamic for ROW.
Powell noted inflation not likely to hit target until 2025. Obviously aware of base effects. He also noted SLOOS is out Monday (Sr Loan Officer Survey). Bank loans and leases have decelerated. Yellow Freight bankruptcy (that particular strike is settled). Rolling debt will become an increasingly large problem.
NFP Friday.
RESTRICTIVE
Below is a chart of PCE YOY CORE price index in blue and the midpoint of the Fed Fund target in red, over the past five years. The spread between the two is in the lower panel. The red shaded areas represent FFs being above this rate of inflation, which can be thought of as restrictive policy. As of December 2018, the last hike of that cycle, the move into restrictive territory was solidified. This time, it occurred in March 2023. Obviously, there are two ways to get to a restrictive stance, either the FF target is raised or the inflation rate is falling. Economic orthodoxy is that the former influences the latter. But once the FF target has become restrictive, it’s reasonable to think that inflation will have a tendency to decelerate. The critical points are, of course, how quickly inflation might subside and how long the Fed maintains a restrictive rate. The Fed is AT its destination.
In 2019, the Fed kept the rate restrictive for the better part of a year, even though the last hike (Dec 18) to the first ease (July 19) was only seven months. Thus far, the move to restrictive only occurred in March 2023.
I have also included a chart of the ten-year inflation-indexed note yield, often thought of as the “real” yield. I am positing that levels above 1% are restrictive, and that threshold was crossed in this cycle in September 2022. That is, by this measure of restraint, the duration has lasted longer, about eight months so far. The rate of change and magnitude is also important and the move from -120 bps to +170 bps is the most rapid in history. (In the US, inflation-indexed notes were first issued in 1997).
CRUDE OIL AND GASOLINE
RBOB in blue. WTI in black. New 2023 high in former
BOJ
10-yr JGB cap raised from 50 bps (now a soft cap) to 100 bps hard cap. Probably more important than the market currently thinks.
Yen futures Friday settles. JYU3 0.007148. JYZ3 0.0072525. Sell at Sept rate and buy back Dec implies loss of 1.46% over three months. Pretty high hurdle to fund USD investments in yen.
YELLOW FREIGHT BANKRUPTCY
Only about 30k job losses, but the implication is that debt can’t be rolled. From the NYT:
As of the end of March, Yellow’s outstanding debt was $1.5B, including about $730 million that is owed to the federal gov’t. [Covid bailout loan] Yellow has paid approximately $66 million in interest on the loan, but it has repaid just $230m of the principal owed on the loan, which comes due next year.
SLOOS is Monday. TBAC Financing Estimates Monday.
ISM Mfg Tuesday
NFP is Friday, expected 200k. Rate 3.6%. Avg Weekly Hours becoming more important, expected 34.4, same as last.
.
| 7/21/2023 | 7/28/2023 | chg | ||
| UST 2Y | 484.4 | 489.3 | 4.9 | |
| UST 5Y | 409.3 | 419.3 | 10.0 | |
| UST 10Y | 384.0 | 396.7 | 12.7 | |
| UST 30Y | 390.6 | 402.7 | 12.1 | |
| GERM 2Y | 309.3 | 305.1 | -4.2 | |
| GERM 10Y | 246.9 | 249.2 | 2.3 | |
| JPN 30Y | 132.5 | 138.5 | 6.0 | |
| CHINA 10Y | 261.5 | 266.3 | 4.8 | |
| SOFR U3/U4 | -106.5 | -91.0 | 15.5 | |
| SOFR U4/U5 | -84.0 | -86.0 | -2.0 | |
| SOFR U5/U6 | -17.5 | -20.5 | -3.0 | |
| EUR | 111.26 | 110.19 | -1.07 | |
| CRUDE (CLU3) | 77.07 | 80.58 | 3.51 | |
| SPX | 4536.34 | 4582.23 | 45.89 | 1.0% |
| VIX | 13.60 | 13.33 | -0.27 | |
https://www.bea.gov/data/income-saving/gross-domestic-income
https://www.federalreserve.gov/releases/g17/current/table2.htm
BOJ shot across the bow
July 28, 2023
–As leaked yesterday by Nikkei/Reuters, BOJ tweaked 10y JGB yield curve control, leaving a soft +/- 50 bps range, but a hard cap at 1%. JGB yield rose to 57.5 bps this morning. The BOJ news sparked huge moves across assets, but the ECB also raised rates yesterday morning as expected. From Lagarde: “Do we have more ground to cover? At this point I wouldn’t say so.” But she added that future decisions would be driven by data. EURUSD sank to 1.1009, and this morning is 1.0975, having been above 1.12 a couple of weeks ago.
–In the US the 30 yr yield ended (at time of futures settle) at a new high for this calendar year 4.058%. up 13.4 bps. Tens jumped 16.7 bps to 4,014%. Red, green and blue SOFR contracts fell 18 to 19 bps. SFRU4 settled at 9546, equaling the low close for the move from 7-July. SFRU3/SFRU4 spread settled at a new high of -88 (9458/9546), still significantly inverted but well off the recent low of -140. Implied vol was pumped across rate products. For example, atm TYU 111^ settled 1’53 or 7.4, from Wednesday’s 112.25 atm straddle at 1’43 or 6.5.
–Huge day in SPX with a key reversal: New high for the year at 4607, outside range day (and yesterday engulfed the range of the week so far), closed down on the day at 4537 (-0.64%). An indication that buying pressure has now been exhausted. This formation most likely signals that the highs are in for the near future. As an aside, I saw a snippet that Mastercard (MA) beat expectations with “better than expected purchase volume +13.5% to $1.84T vs expected $1.83T” (due in large part to travel and entertainment). However, this stock also made a new high for the year, but closed down 2% with an outside day. Am Express was down 2.5%, Discover down 2.1% and Visa down 1.1%. (AXP, DFS, V) Are these stocks telling us that this is as good as it gets, and that the consumer has topped out?
–Today’s US news includes the Fed’s preferred measure of inflation, PCE prices, expected 3.0% from 3.8 last, with Core 4.2% from 4.6%. Headline m/m expected +0.2%.
Employment Cost Index 1.1% from 1.2% last. Then U of M consumer and inflation expectations. Fed’s SLOOS (Sr Loan Officer Survey) is released Monday.
Restrictive but no recession
July 27, 2023
-As expected Fed hiked 25. Powell mentioned several times that policy is restrictive. but also said that Fed staff no longer forecasts recession. WSJ’s Timiraos asked about whether inflation projections in September’s SEP would come down (by 20 or 30 bps). In June PCE prices for end-of-2023 were marked down from 3.3% in March to 3.2%, while Core was raised to 3.9 from 3.6. PCE price data is released tomorrow. Another question centered on easing financial conditions (lower USD, higher stocks) and Powell noted SLOOS will be released on Monday (Sr Loan Officer Survey on Lending).
–Yields fell post-Fed. Tens down 6.3 bps to 3.847%. 2y down 6.4 to 4.827%. Red sofr contracts +10.5. August FF were unchanged at 9467.5 as yesterday’s hike had already been priced. The lowest contract on the FF curve is November which settled +1.5 at 9457.5, 10 lower than August, so the market still leans toward another hike at one of the next two meetings.
–When asked about the possibility of easing which has been consistently priced into the SOFR curve, Powell said the Fed is not likely to ease this year “I don’t think…” Quite surprising as he could have been more forceful and definite and said something like, “The Fed is not contemplated any easing in the near future; we need to maintain restrictive policy.” Obviously some members are leaning toward the idea of easing. I would note that SFRZ3/M4 6-month calendar settled -62 (9462/9524) which was down 3 on the day; 3 to 4 quarter point cuts being priced into the first half.
Lags
July 26, 2023
–FOMC today featuring a fully expected hike in FF to 5.25-5.50%. Fed Effective has been 5.08%, should now move to 5.33% and FFQ3 settled 9467.5 or 5.325%. The November FF contract is lowest on the curve and settled 9456 or 5.44%, not quite half-a-hike being priced over the next two meetings (Sept 20 and Nov 1).
–During the late 1990’s dotcom bubble I had a client who was fully loaded up long on speculative names. I expressed my concerns about higher interest rates and he told me it didn’t matter because these companies weren’t borrowing, they were raising funds through equity. Eventually, interest rates ALWAYS matter. At some point investors favor the certainty of high-paying notes rather than equities. It becomes a question of real rates and lags. Real rates are now positive and rising as FF are above all inflation measures. The question of lags has become critical and, in my opinion, will be the most important topic of the press conference. Powell and others have indicated that the Fed’s forward guidance speeds up the economic response and lags aren’t as great anymore. I.e. the economy has fully adjusted for hiking thus far and has easily absorbed recent hikes.
–However, there’s an interesting post on ZH citing Soc Gen’s Albert Edwards who notes that even with significant rate hikes, corporates net interest expense as a percent of profits has actually declined! From the article:
Edwards concludes, a sizeable proportion of the “huge, fixed rate borrowings during 2020/21 still survives on company balance sheets in variable rate deposits (see Z1 table L103)” meaning that corporations continue to benefit from locking in the ultra low rates of 2020 and 2021 even as their cash interest income are soaring. Indeed, as the SocGen strategist adds, “companies have effectively played the yield curve in reverse and become net beneficiaries of higher rates, adding 5% to profits over the last year instead of deducting 10%+ from profits as usual
| “Something Very Strange Has Happened”: Albert Edwards Stunned By “The Maddest Macro Chart I Have Seen In Many Years”ZeroHedge – On a long enough timeline, the survival rate for everyone drops to zerowww.zerohedge.com |
–So, companies locked in long term low rates and now are benefiting. Does it make sense that so many companies saw this coming but regional banks didn’t? I’m not sure of that, but what I do think is that the result would be LONGER and not SHORTER policy lags. Same is true for the lack of housing supply: people who have 30y mortgages locked in at sub-3.5% aren’t selling.
–DoubleLine’s Jeffrey Sherman yesterday said (BBG) “Markets should brace for a deep US recession that warrants a dramatic 1% interest rate cut by the Fed…” Rates matter. Coincidentally, there was a buyer of 10k SFRH4 9575/9675c spread yesterday, settled 9.25 ref H4 9484. Moving to lower strikes; there has already been a buyer of 100k + SFRH4 9600/9700cs.
Feed the Beast
July 25, 2023
“They stab it with their steely knives, but they just can’t kill the beast”
Eagles – Hotel California
— I saw a post yesterday that said Federal Tax revenues are actually decreasing. Charts below are from St Louis Fed Fred website, showing a high of $3.2T collected in 2022 and less than $3T now. I believe these are nominal numbers, surprising in the context of high inflation and booming employment. The lower chart is the y/y percentage change, now negative. In fiscal year 2022 the Fed’l Gov’t spent $6.27T.
–Here’s a helpful and mesmerizing debt clock to help visualize US finances and growing deficits. We must feed the beast.
https://www.usdebtclock.org/
–We can always issue debt to cover the deficit. Get your FIVE-YEARS here! Today only! You want ’em, we got ’em. USU down half a point this morning to new recent low 125-20.
–Rate futures traded heavy yesterday with red SOFR contracts weakest. SFRZ3 9462.0 (-2.5) SFRZ4 9595.0 (red, -6.0), SFRZ5 9652.0 (green -5.0) and SFRZ6 9667.0 (blue, -2.5). Ten year yield rose 1.5 to 3.855%. 2/10 treasury spread approaching new lows at -105 in front of tomorrow’s FOMC. Financial press this morning is supporting the idea of further hikes, FT: Fed to signal it is not done yet… WSJ: Why the Fed Isn’t Ready to Declare Victory on Inflation. There is a press conference tomorrow, but no update to dot plot. Several commentators have recently mentioned the upcoming Jackson Hole Conference as a looming event for Powell’s future guidance, Takes place Aug 24-26.
–MSFT, GOOGL and Visa today.
–The line from Hotel California supposedly referenced Steely Dan (go ahead, look it up). So….
When Black Friday falls/You know it’s got to be/Don’t let it fall on me
https://fred.stlouisfed.org/series/W006RC1Q027SBEA
Big tech and big Central Bank week
July 24, 2023
–Rates little changed on Friday. Ten year yield down 1.2 bps to 3.84%. 2/10 spread just under -100 bps.
–This week features FOMC meeting Wednesday. FFQ3 is priced at 9468.5 or 5.315%, indicating a lock for 25 bps hike. The lowest contract on the FF curve is November at 9459 or 5.41%; this contract captures two more meetings Sept 20 and Nov 1. It’s unlikely that odds move to more than 50/50 for another hike, so I would suspect a floor of 9452-54 on this contract. On the other hand, Powell will still maintain hawkish rhetoric to leave the option open.
–ECB on Thursday. BOJ on Friday. $/yen a bit lower this morning at 141.27. BOJ trying hard to manage expectations.
–GOOGL and MSFT on Tuesday. META on Wednesday. 2y auction today with 5s tomorrow.
–Interesting link by Praetorian Capital poses the question, what if US bond yields trade HIGHER in the next recession.
Conundrum
July 23, 2023 – Weekly Comment
**********************************
Below I have posted a couple of charts on the US 10 year yield. The top one is from the Fed’s 2004 to 2006 hiking cycle, when the Fed hiked 25 bps at every meeting from 1% to 5.25%.
It was February 16, 2005 when Greenspan gave his famous “conundrum” speech. By that time, the Fed had hiked by 150 bps. The ten-year yield was 4.15% and FF were 2.50%. Greenspan was confounded that rates on the forward part of the curve weren’t going up:
For the moment, the broadly unanticipated behavior of world bond markets remains a conundrum. Bond price movements may be a short-term aberration, but it will be some time before we are able to better judge the forces underlying recent experience.
[Speech is linked at bottom]
After Greenspan’s speech, tens did rise in yield to around 4.65%, but then fell back to new lows, sub-4%. It wasn’t until near the end of the hiking cycle, in March 2006, that yields broke out of the 70 bp range (3.95/4.65) of the preceding one-and-a-half years. In April the yield finally exceeded the high corresponding with the beginning of the hiking cycle. NOTE: high so far from last October is 4.245%
Below the longer time-frame chart which encompasses the entire 2004 to 2006 experience, I plot a rough comparison between the current 10y yield in white, starting in late July 2022, and in blue, starting from around February 2004. The current episode high was 4.245% in late October 2022, about 60 bps lower than the high in June 2004. In the nine months since November 2022, the ten year has ranged from around 3.35% to 4.05%, essentially the same 70 bp range as occurred during the conundrum years, though shifted 60 bps lower.
This rate hike cycle has been significantly speeded up. As Bernanke said, next week’s rate hike could very well be the last. Rather than a slow-drip two year grind, this one has taken only one-and-a-quarter years. Recall it was near the end of the 2004/06 rate hike episode that tens finally broke out to the upside. Will it be the same this time? There are certainly a lot of conundrums associated with markets in the current environment. What is worth noting is that the 2/10 treasury spread in 2006 was around 20 bps on either side of zero, bottoming in November at -19 (several months after the final hike). Currently 2/10 is near historic lows at -100 bps (4.84/3.84), so from that standpoint, the ten year yield has a LOT of upside room just to get back to the 2006 midpoint of zero (on 2/10) even if the two year yield declines somewhat. If we stick with the 60 bp differential from 2004/06 then the top yield would be 4.65 to 4.70.
Above chart is 10y yield through the 2004 hike cycle and just beyond, from Feb 2004 to July 2006, Below in blue is the 10y yield from Feb 2004 to Feb 2005, and the current 10y in white from July 2022 to now.
Although Greenspan mentioned “world bond markets” in his 2005 speech, it’s unlikely that any consideration was given at that time to China’s bond market. Rather there was this line: “There is little doubt that, with the breakup of the Soviet Union and the integration of China and India into the global trading market, more of the world’s productive capacity is being tapped to satisfy global demands for goods and services.” How things change.
In any case, I post here without comment, China’s ten-year yield at 2.61%. Near the 2020 low. Doesn’t exactly reflect economic vibrancy.
There has been a decent amount of consideration given to lags in the economy as described by Friedman. Both Powell and Waller have suggested that lags are much shorter now, and that adjustments occur based on the Fed’s forward guidance rather than actual official rate changes. Perhaps there’s a bit of truth to that, but also a modicum of hubris. Contrast that to Ueda, who facetiously suggested the lag in Japan’s case is about 25 years. In any event, here’s an example of what might be considered a lagged response to inflation’s resurgence:
From Bloomberg, July 20 (cited by Credit Bubble Bulletin)
“More than 650,000 American workers are threatening to go on strike this summer — or have already done so — in an avalanche of union activity not seen in the US in decades. The combined actors and writers strikes in Hollywood are already a once-in-a-generation event. Unions for United Parcel Service Inc. and Detroit’s Big Three automakers are poised to join them in coming weeks if contract negotiations fall through… And while logistics experts and financial analysts expected the Teamsters to reach a deal with UPS, their confidence has dwindled as the July 31 deadline approaches. ‘This will be the biggest moment of striking, really, since the 1970s,’ said labor historian Nelson Lichtenstein, who directs the University of California, Santa Barbara’s Center for the Study of Work, Labor and Democracy.”
Wage push inflation? 650k is a pretty large number.
This week:
Monday – global PMIs, Chgo FED Nat’l Activity. 2y auction
Tuesday – Philly Fed Services, Consumer Confidence. 5yr auction. Alphabet and MSFT report
Wed – New Homes, FOMC. Meta reports
Thur – ECB. Q2 GDP expected 1.8%. Job Claims. 7yr auction. META reports
Friday – BOJ. Emp Cost Index, PCE deflator yoy 3.0 from 3.8 and Core 4.2 from 4.6
| 7/14/2023 | 7/21/2023 | chg | ||
| UST 2Y | 474.7 | 484.4 | 9.7 | |
| UST 5Y | 402.9 | 409.3 | 6.4 | |
| UST 10Y | 381.6 | 384.0 | 2.4 | |
| UST 30Y | 392.1 | 390.6 | -1.5 | |
| GERM 2Y | 321.0 | 309.3 | -11.7 | |
| GERM 10Y | 251.2 | 246.9 | -4.3 | |
| JPN 30Y | 138.2 | 132.5 | -5.7 | |
| CHINA 10Y | 264.7 | 261.5 | -3.2 | |
| SOFR U3/U4 | -123.5 | -106.5 | 17.0 | |
| SOFR U4/U5 | -76.0 | -84.0 | -8.0 | |
| SOFR U5/U6 | -13.0 | -17.5 | -4.5 | |
| EUR | 112.26 | 111.26 | -1.00 | |
| CRUDE (CLU3) | 75.32 | 77.07 | 1.75 | |
| SPX | 4505.42 | 4536.34 | 30.92 | 0.7% |
| VIX | 13.34 | 13.60 | 0.26 | |
https://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm
FT: Japan’s inflation outpaces US for the first time in 8 years
July 21, 2023
–Surprising weight on rate futures yesterday, with the green pack (SFRU5, Z5, H6, M6) leading the way settling -16 on the day. Reds, 2nd year forward settled -12.875. Ten year yield jumped over 11 bps to 3.852% going into today’s August option expiration. There’s really no standout TY option strike with large open interest; the most of any strike is TYQ 112p with 57k, settled 6 ref 112-04+.
–Late in the day Bernanke echoed Pimco colleague Clarida in saying next week’s hike could very well be the last. And…another 30k SFRH4 9600/9700cs were bought. Settled 8.75 vs 9492.5, total position now about 110-120k.
–$/yen jumped from 140 to 142 as several stories suggest BOJ will keep yield control steady at next week’s meeting, but raise inflation projections. Japan Core Inflation at 3.3%, now 15 months above the BOJ’s 2 pct target. Reprieve for those funding in yen…for now. US stock index futures seeing small bounce after yesterday’s 2% decline in Nasdaq Comp.
–Baker Hughes rig count today. CLU3 trading 76.60 at the high end of the recent range.
–In yet another sign of the apocalypse, businessoffashion.com says “US fashion’s new hotspots are Dallas and Orlando, according to census data and real estate leasing rates.”
[has Orlando written all over it]
Black market for bread
July 20, 2023
–Quiet session in rates Wednesday. Curve became more deeply inverted with 2s essentially unchanged at 4.751% and 10s down 5 bps to 3.74%, bringing 2/10 spread just below -1% (-101 bps).
–Buying continues in SFRH4 9600/9700cs, 9 paid for 10k with total accumulation about 100k. Settled 9.25 (16.0/6.75) ref 9499.5.
–As next week’s FOMC meeting nears, market sentiment tilts to ‘more hiking now means more easing later’ (next year). Today’s news includes Jobless Claims expected 242k from 237k and Philly Fed, expected -10.0 from -13.7. Russia yesterday announced that since the Black Sea Grain Initiative was no longer valid, all cargo ships sailing to Ukrainian ports will be regarded as potentially carrying military cargo. Yesterday Sept Wheat closed up 57 cents to 727 3/4. CME reported that vol was sharply higher, closing at a 12 year high. Currently up another 15 cents.
–WSJ flags declining workweek hours today as a possible sign of recession. Last at 34.4 hours, doesn’t look particularly ominous.
Consumer spending easing
July 19, 2023
–Retail Sales lower than expected except for Control Group. Headline was expected +0.5 but actual +0.2. Control expected +0.3 but actual +0.6
“The control group is all sales excluding receipts from auto dealers, building-materials retailers, gas stations, office supply stores, mobile homes and tobacco stores.”
Industrial Production was -0.5%….it has contracted 6 out of the last 7 months.
–Yields were little changed, a bit higher in front with 2s up 2.3 bps to 2.753% and tens down 0.5 bp to 3.79%. SFRZ3/Z4 calendar nearly unchanged at -148 (9468/9616). This one-year calendar remains the lowest on the strip, and forecasts 1.5% of easing next year.
–MSFT exploded by 4%, adding over $100b to market cap as it revealed monthly pricing for Copilot, an AI productivity enhancement. Or gimmick. Take your pick. Starwood defaulted on a $212m mortgage backed by an office tower in Atlanta, as stress in CRE continues to build.
–20yr auction today, wi was 4.08% at the time of futures settlements. August treasury options expire Friday.
