Isn’t that Treasury yield curve pushing up relentlessly? The 10-year is all of a sudden zooming in hard on the 3%, almost touching it during the overnight session, and trying to test the 2014 highs just above that level. At the beginning of the month, we were still faced with a different scenario. Macro numbers happened to be inconclusive, and wage growth hence inflation tended to show their weak side. 10-years fell to 2.71% back then and were on course of testing 2.60% rather than performing such a u-turn.
You can no doubt watch all the Cassandras having crawled back out from under their rocks and resuming their battle cries in favour of shorting the bond market. The move is unexpected by this space and in fact bemusing, as there hasn’t been any recent acceleration in the economy. Neither have we seen that promised pickup in inflation. And all of a sudden the yield move is being accompanied by a stronger dollar, an otherwise historical pattern that has so far defied the laws of gravity.
In the absence of fundamental reasons, what then causes such move? Well, there is a chance that people have taken heart in Washington’s recent softer tone on trade. Steven Mnuchin’s apparent willingness to go to Beijing and sort things out has it appears provided some relief with regards to the dollar and growth expectations, hence currency strength and long rates up. But such trade talks, should they materialise, may not yet get us closer to any resolution.
Apart from that however, I can only scramble a couple of my thoughts here. For one, it may finally have sunk in that the US is likely to add an incredible 3 trillion+ in national debt in coming 3 years. Trump’s prospective consecutive budget deficits are poised to outshine anything we have ever witnessed in fiscal history. I think it’s fair to say that the investing community has so far lived in denial on this pending issue.
The yield spike may well be a puke on the basis of it. Donald Trump has already been presiding over the national debt breaking above 21 trillion. Who is to say he won’t accelerate the total to 25 trillion even before his term expires? And what if he gets voted into office again? And where is the Republican party’s reaction to all this? I believe such prospect must be sending the shivers down people’s spines, and they are apparently voting with their feet, at least for now.
Secondly, and not being very closely observed at this point, the Fed has progressed with its tapering course, albeit in mini-steps up to this point. As of the latest data release on April 18, the Fed’s Treasury holdings shrank by a total of 52.7 billion dollars, to the latest balance of 2.41 trillion. To be sure, this only represents a drop in the ocean in the scheme of things, but fact remains that the Fed is retreating from markets and from October there hasn’t been any new net liquidity flowing into the system.
It will still not make a huge difference in the foreseeable future, but if the Fed is true to its intentions, 2019 reductions will be a lot more massive. By the end of next year a total of 600 billion will have gone missing from the Fed’s balance sheet, Treasuries and mortgages combined. This could be seen as a game changer by the many. The money system is being drained while Trump is spending/ will be spending like there is no tomorrow. You wait until the defence bill comes around.
Thirdly, Jay Powell is holding a pretty hawkish course for his circumstances. The Fed chair keeps drumming up more rate hikes, neglecting any indicators that point to a reversal of economic fortunes. He better beware. Any weakening across the macro scene could come back to bite him and his colleagues in the ivory tower. Eventually, we may all realise that the Fed balance sheet simply cannot materially be wound back, unless monetary authorities want to risk a meltdown.
Until such point however, and in the absence of any reconciliation by Powell, bond investors will want to be on the safe end of that equation. How far people will drive markets before it dawns on Trump, Powell, and Co that ends can no longer meet we will have to see, but the fact is we are starting to sail very close to the wind. A substantial move above 3% in 10 years will have budget deficits revised higher and the stock market correcting a lot more. No beauty in the eye of the beholder.
