Taper groundwork is set
August 26, 2021
–As expected, Bank of Korea raised its base rate from 0.5% to 0.75%. Concerns about hot property prices and growing debt outweighed covid concerns. The same financial stability issues face the Fed. Having done considerable groundwork to lay the foundation for the start of taper, I expect Powell to move forward, delivering a slightly hawkish presentation. Delivery delays and shortages ARE inflation, and they don’t seem to be abating. I even saw a story * gasp * that golf clubs were in short supply. Yesterday the market traded according to this outlook, with tens rising 5.5 bps to a yield of 1.342%. The curve steepened with 2’s essentially flat. EDZ’22/EDZ’23 calendar spread rose 3.5 bps to a new recent high of 59. The peak remains the one-year calendar just in front, EDU’22/EDU’23 at 63, up 3 on the day. The weakness on the ED curve was beyond EDH’23. All contracts in front were +0.5 to -0.5. From EDZ’23 back they were -4 to -6.5.
–With robust repo facilities having been put in place, and a probable delay of taper until November, (when treasury will already be trimming issuance) a withdrawal of Fed support for the treasury market is at the other end of the spectrum from the Biden administration’s implosion in Kabul. The Fed is NOT shrinking the balance sheet and hiking as occurred in 2018. The Fed is simply slowing GROWTH in the balance sheet, having already created huge incentives for others to fill the buying gap. Powell’s main task is to separate tapering from hiking…in other words, to guarantee positive carry for private buyers. He has already ensured repo with no hiccups like the shock repo surge in September 2019. The negative brunt of taper will be evident in stocks, not bonds. That’s not to say there couldn’t be volatility in treasuries, it’s simply that with stocks at all-time-highs and credit spreads near lows, the adjustment will be in equities.
–A friend sent a great old documentary on Paul Tudor Jones discussing the parallels of 1987 and the late 1920’s. This was filmed before the 1987 crash (Dow fell 22.6% in one day on Oct 19). The line that really stood out for me is at the 14 minute mark. “The last guy that buys a share of stock when the Dow is at 3000 or whatever number it is, he’s buying it because the fact he thinks it’s going to 6000 because it’s been reinforced in his mind over the past however number of months years or decades that stocks can’t go down. [Reincarnation is David Portnoy]
