Now that the midterm elections are over (except for counting of million of mail-in ballots, a massive moral hazard risk), President Biden has proclaimed that he isn’t changing any of his horrid policies. And apparently, neither is The Federal Reserve.
As I told my Chicago, Ohio State and George Mason University finance and real estate students, repeatedly, “Watch out when The Fed begins to tighten monetary policy. It will be a bloodbath for taxpayers.”
Well, here we are. I argue that Biden’ green energy knucklehead policies are driving inflation, or it could be the insane level of Federal spending that Obama economist Larry Summers warned us about, or rising wages (in part due to Federal spending) is to thank for inflation. Or all of the above.
Regardless of the cause, the bond market is enduring its worst selloff in a generation, triggered by high inflation and the aggressive interest-rate hikes that central banks are implementing. Falling bond prices, in turn, mean paper losses on the massive holdings that the Fed and others accumulated during their rescue efforts in recent years.
Rate hikes also involve central banks paying out more interest on the reserves that commercial banks park with them. That’s tipped the Fed into operating losses, creating a hole that may ultimately require the Treasury Department to fill via debt sales. The UK Treasury is already preparing to make up a loss at the Bank of England.
The Reserve balance has crashed into negative territory.
And Fed losses are skyrocketing.
Agency MBS prices are up today, but are down since August 2022. But risk measures duration and convexity are zooming upwards.
Alarm! US home prices are decelerating as inflation rages and The Fed tightens.
Home price growth in the US slowed the most on record as a doubling of borrowing costs (thanks to the US Federal Reserve) has sapped demand.
A national measure of prices increased 13% in August from a year earlier, but is down from 20.79% in March, the S&P CoreLogic Case-Shiller index showed Tuesday. That’s the biggest deceleration in the index’s history.
The housing market has started to slump as the Federal Reserve hikes interest rates to curb the hottest inflation in decades. Even with the deceleration, prices remain high compared to last year. Coupled with mortgage rates that are edging closer to 7%, many would-be buyers have been shut out, while some sellers have retreated.
While 13% growth sounds good, it is not good for renters looking to buy a home.
According to S&P/CoreLogic/Case-Shiller, Southern (red) cities Atlanta, Charlotte, Dallas, Miami and Tampa all still grew at over 20% YoY. Other cities like blue cities Detroit, Minneapolis, Portland, San Francisco, Seattle and Washington DC are grew at UNDER 10% YoY.
On related news, I always said in my classes that +/- 10 basis point in the US Treasury yield is a big deal. This morning, the US Treasury 10-year yield is DOWN -16.1 bps. In fact, the 10-year yields are down across the board globally.
Things are getting interesting in DC, to say the least. The US is 100% likely to face a recession in the next 12 months while The Federal Reserve is on its crusade to fight inflation caused by … The Federal Reserve, Biden’s green energy shenanigans and massive, irresponsible Federal spending that even Former Obama economist Lawrence Summers warned would cause inflation. So what will The Fed do? Lower rates and expand their assets purchases to fight the impending recession OR keep tightening to fight Bidenflation? But where we are now is that the fixed-income market could be in big, big trouble.
For months, traders, academics, and other analysts have fretted that the $23.7 trillion Treasuries market might be the source of the next financial crisis. Then last week, U.S. Treasury Secretary Janet Yellen acknowledged concerns about a potential breakdown in the trading of government debt and expressed worry about “a loss of adequate liquidity in the market.” Now, strategists at BofA Securities have identified a list of reasons why U.S. government bonds are exposed to the risk of “large scale forced selling or an external surprise” at a time when the bond market is in need of a reliable group of big buyers.
“We believe the UST market is fragile and potentially one shock away from functioning challenges” arising from either “large scale forced selling or an external surprise,” said BofA strategists Mark Cabana, Ralph Axel and Adarsh Sinha. “A UST breakdown is not our base case, but it is a building tail risk.”
In a note released Thursday, they said “we are unsure where this forced selling might come from,” though they have some ideas. The analysts said they see risks that could arise from mutual-fund outflows, the unwinding of positions held by hedge funds, and the deleveraging of risk-parity strategies that were put in place to help investors diversify risk across assets.
In addition, the events which could surprise bond investors include acute year-end funding stresses; a Democratic sweep of the midterm elections, which is not currently a consensus expectation; and even a shift in the Bank of Japan’s yield curve control policy, according to the BofA strategists.
The BOJ’s yield curve control policy, aimed at keeping the 10-year yield on the country’s government bonds at around zero, is being pushed to a breaking point.
Well. Bidenflation certainly isn’t helping, but Statist Economist and Cheerleader Janet Yellen can’t bring herself to blame green energy policies, rampant Federal spending or irresponsible Federal Reserve policies for the crisis.
You will note the differences between today and the financial crisis of 2008-2009. The financial crisis gave us a massive surge in government securities liquidity thanks to then Fed Chair Ben Bernanke imitating Japan’s Central Bank and buying US government securities. Fast forward to today and the liquidity index hasn’t budged much since 2010 (except for a little blip around the Covid Fed intervention of early 2020), but we are now seeing near 40-year highs in inflation and a barely declining Fed balance sheet. And M2 Money YoY (mostly commercial bank deposits) are crashing.
I am guessing that The Fed will pivot given that stock futures are way up for Monday. The Dow Jones mini is up 770 points and the S&P 500 mini is up 88.75 points.
Bond market futures (specifically the US Ultra Bond) is down for Monday, meaning yields will be climbing.
I remember giving a speech at The Brookings Institute in Washington DC. Talk about stranger in a strange land. One person who I was debating got frustrated and said “You are such a … Republican!!!” As if that was the worst slur he could throw at me.
Bloomberg’s recession probability over next 12 months is … 100%.
And how about the Conference Board’s Leading index of 10 economic indicators YoY? Third negative read ALWAYS followed by recession.
The Federal Reserve may be forced to pivot. This may be one reason why the Dow is up 565 points today (+1.86%) as recession and pain become ever more likely.
Look at commercial banks deposits. Wonder why liquidity is drying up?
Model is down 20% this year, its worst return since 2008
Yet routs could allow model to ‘rise from the ashes’
(Bloomberg) Blame the Fed, war and fiscal profligacy all you want. But big trouble was lurking in many widely followed portfolio strategies long before those threats took hold (because of the Fed).
That’s the upshot of new research that uses a yield-derived valuation model to show the famous 60/40 allocation reached its most expensive level in almost five decades during the Covid-19 rally. The situation has reversed in 2022, which is now by some definitions the worst year ever for the bond-and-equities cocktail.
The data is a harsh reminder of the primacy of valuation in determining returns. It may also pass as good news for the investment industry, suggesting logic rather than broken markets is informing the current carnage. Leuthold Group says the hammering has been so brutal that valuation is apt to become a tailwind again for a portfolio design many seem willing to leave for dead.
It’s worth considering the heights from which 60/40 has fallen. Yields on the Bloomberg USAgg Index slid in 2021 to 1.12%, while the earnings yield on the S&P 500 dropped to 3.25%, one of the lowest readings in the last four decades. Taken together the levels had never implied a more bloated starting point for cross-asset investors.
To be sure, the 60% stock, 40% bond mix did a good job of protecting investors against market swings in the past. This year has been different, with stocks and bonds falling in tandem amid stubbornly high inflation and the Federal Reserve’s whatever-it-takes approach to bringing it down. A Bloomberg model tracking a portfolio of 60% stocks and 40% fixed-income securities is down 20% this year, a hair away from topping 2008 as the worst year ever and only the third down year since Bloomberg started tracking the data in 2007.
The co-movement of equities and bonds has tightened “decisively” in 2022, with three-month rolling correlations jumping to a 23-year high of 45%, versus the 10-year average of minus 25%, according to Mandy Xu and Frank Poerio at Credit Suisse Group AG. In other words, both are selling off in tandem, with the two recently posting 11 consecutive days of moving together, a streak not seen since 1997. And their performance is twice as bad this year as it was in 2002 when stocks posted a similar drawdown.
“We were coming off historically high valuations for both equities and fixed income,” Marvin Loh, senior macro strategist at State Street Global Markets, said in an interview. But the strategy could soon start to do what it’s supposed to do, he added, “because you’re getting in with fixed-income valuations that make a whole lot more sense. There’s a lot more natural buyers for a 4% 10-year than there is for 0.3%.”
Plenty of others have taken this view as well — cross-asset strategists at Morgan Stanley said over the summer that the 60/40 portfolio was merely resting and not yet dead, while researchers at the Independent Adviser for Vanguard Investors said it was a bad time to “steer a new path” and abandon the balanced approach.
Elsewhere, exchange-traded fund investors are preparing for the possibility that peak bond pain has passed, with investors scooping up call options on products like the iShares 20+ Year Treasury Bond ETF (ticker TLT) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).
Let’s see how it all works out as M2 Money YoY crashes with Fed tightening.
Diesel, the lifeline of the shipping industry, is UP 100% under Biden (that is, diesel prices have doubled) while the inventory of diesel fuel has declined by -37.5% under Biden.
The US 30yr Mortgage rate just hit a new high since 2000 as The Federal Reserve counterattacks the highest core inflation rate (6.60%) since 1982.
According to the Taylor Rule (which The Fed has chosen to ignore), a 6.60% core inflation rate implied a Fed target rate of 12.40%. Not likely since Fed Funds Futures data points to …
A maximum target rate of 4.963% at the May 2023 FOMC meeting, significantly lower than the needed rate of 12.40%. The Fed is like the world’s worst bar bouncer.
Rather than accepting blame for the horrific inflation rate crushing the American middle class and low wage workers, Biden is twisting the night away.
* Fed Swaps Lean Toward Back-to-Back Three-Quarter-Point Hikes * Hotter-than-expected September inflation data spark shift
(Bloomberg) — The market for wagers on the Federal Reserve’s policy rate is leaning toward pricing back-to-back 75 basis point rate hikes in the next two central bank meetings after consumer prices rose more than forecast in September.
The rate on the November overnight index swap contract rose to 3.86%, more than 75 basis points above the current effective fed funds rate, while the one referring to December climbed to 4.50%. A total of 142 basis points of rate hikes are now priced in for the next two policy meetings, just short of consecutive three-quarter-point hikes.
Prior to the inflation data, OIS markets were leaning toward the central bank cooling the pace of tightening to a 50 basis point move in December. At Wednesday’s close, swaps priced in around 130 basis points of hikes over the remaining of the year, which is equivalent to 55 basis points for December.
The market also priced in a higher eventual peak for the policy rate, with the March 2023 contract touching 4.864%.
The CPI data was “clearly a shock for the markets and the markets are off because of it,” Seth Carpenter, chief global economist at Morgan Stanley said on Bloomberg television. “There is persistence, particularly in the services side of inflation.”
Excluding food and energy, the Consumer Price Index increased 6.6% from a year ago, the highest level since 1982, Labor Department data showed Thursday. From a month earlier, the core CPI climbed 0.6% for a second straight month.
The Fed has raised its policy rate five times since March, most recently to a range of 3%-3.25% in September, after dropping the lower bound to 0% two years earlier at the onset of the pandemic.
The Fed Funds Futures data is pointing further Fed rate hikes with a turnaround in March 2023.
And with that awful inflation report and the likely Fed counterattack, the two year US Treasury yield has risen to 4.4361%, the highest since The Great Recession and banking crisis.
Fed Fireball! Comin’ at ya!!
Biden and Powell should appear on Saturday Night Live as the joint Debbie Downer. Or Democrat Downer.
To begin with, headline inflation remains high at 8.2% YoY while CORE inflation (headline less food and energy) rose to 6.6% YoY.
Meanwhile, REAL average weekly earnings growth YoY further declined to -3.8% YoY.
On the bond front, the Bank of America ICE bond volatility index rose to Great Recession/banking crisis levels (also achieved during the Covid government shutdowns).
But back to the low-ball BLS inflation data. The biggest gain in price is … fuel oil at 33.1% YoY. Food at home rose 13.0% while gasoline rose 18.2%. Rent, according to the BLS, rose 6.6%.
Biden has probably been told by Ron Klain and Susan Rice that this is a good report.
Confounded Interest - Anthony B. Sanders 
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