Tag Archives: bond market

Emerging Markets Continue to Slide as Dollar Pressures $3.7 Trillion Debt Wall

Emerging Markets Continue to Slide as Dollar Pressures $3.7 Trillion Debt Wall

Emerging market stocks extended their declines Friday as investors continue to pull cash from some of the world’s biggest developing economies amid concerns that the greenback’s recent rally will pressure the cost of servicing some of the $3.7 trillion in debt taken on in the ten years since the global financial crisis.

Argentina has been at the forefront of the recent emerging market pullback this week, with the peso suffering its biggest single-day slump in three years — including a fifth of its value yesterday — before the central bank stepped in with a move to lift interest rates to an eye-watering 60% amid concerns that President Mauricio Macri’s efforts to cut spending and stave off a looming recession in South America’s third largest economy will ignite social unrest that could toppled his government.

“We have agreed with the International Monetary Fund to advance all the necessary funds to guarantee compliance with the financial program next year,” Macri said Wednesday in reference to a $50 billion support plan in the works. “This decision aims to eliminate any uncertainty. Over the last week we have seen new expressions of lack of confidence in the markets, specifically over our financing capacity in 2019.”

Those moves shadow a similar concern for the Turkish Lira, which resumed its slide against the dollar Thursday following a warning from Moody’s Investors Service earlier this week as the ratings agency downgraded its outlook on 20 domestic banks owning to the country’s slowing growth and their exposure to dollar-denominated debts.

The Turkish lira recovered from yesterday’s decline, but was still marked at 6.57 against the dollar, near to the weakest since the peak of its currency crisis in early August. Larger emerging market economy currencies were on the ropes Thursday, with the Indian rupee hitting a lifetime low of 70.68 against the dollar this week and falling 3.6% this month, the biggest decline since August 2015, while the Russian ruble bounced back from a two-year low to trade at 68.06.

The sell-off has also affected emerging market stocks, which continue to lag their advanced counterparts, with most major EM benchmarks either in or near so-called ‘bear market’ territory, which defines a market that has fallen 20% from its recent peak.

The benchmark MSCI International Emerging Markets index, for example, is down 0.4% today and more than 3% this month alone, extending its decline from the high it reached on January 29 to nearly 17%, while Reuters data notes that 20 out of 23 emerging market benchmarks are trading below their 200-day moving average, a technical condition that investors use as a signal for further selling.

Each of the three major emerging market ETFs, which collectively hold around $143 billion in assets — Vanguard’s FTSE EM (VWOGet Report) , and iShares’ Core MSCI EM (IEMGGet Report) and MSCI EM (EEMGet Report)  — have seen net asset values fall by an average of 15.3% since their January 26 peak.

The Bank for International Settlements, often described as the ‘central bank for central bank’s, estimates that emerging market countries are sitting on $3.7 trillion in dollar-denominated debt, all of which must be serviced in increasingly expensive greenbacks.

And while the dollar index is sitting at a four-week low of 94.60, it has risen more than 5% since the start of the second quarter and is expected to add further gains as the Federal Reserve signals future rate hikes amid a surging domestic economy, which grew 4.2% last quarter and is on pace for a similar advance in the three months ending in September, according to the Atlanta Fed’s GDPNow estimate.

“We look for the dollar to stay bid particularly against the emerging market FX segment where a meaningful decline in risky currencies is spilling over into the wider risk sentiment,” said ING’s Petr Krpata. “

Debt service costs aren’t the only concern, however, as many emerging market economies rely on the export of basic resources, such as oil and gas and other commodities, to fuel their growth.

With China’s economy showing persistent signs of a second half slowdown amid its ongoing trade dispute with the United States, many of those countries are seeing slowing demand, which is pressuring dollar-denominated revenues at exactly the time their needed to both support the value of their currencies in foreign exchange markets and make timely payments on the estimated $700 billion worth of debt that is set to mature over the next two years.

Source: by Martin Baddarcax | TheStreet.com

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Are Bonds Sending A Signal?

Michael Lebowitz previously penned an article entitled “Face Off” discussing the message from the bond market as it relates to the stock market and the economy. To wit:

“There is a healthy debate between those who work in fixed-income markets and those in the equity markets about who is better at assessing markets. The skepticism of bond guys and gals seems to help them identify turning points. The optimism of equity pros lends to catching the full run of a rally. As an ex-bond trader, I have a hunch but refuse to risk offending our equity-oriented clients by disclosing it. In all seriousness, both professions require similar skill sets to determine an asset’s fair value with the appropriate acknowledgment of inherent risks. More often than not, bond traders and stock traders are on the same page with regard to the economic outlook. However, when they disagree, it is important to take notice.”

This is an interesting point given that despite the ending parade of calls for substantially higher interest rates, due to rising inflationary pressures and stronger economic growth, yields have stubbornly remained below 3% on the 10-year Treasury.

In this past weekend’s newsletter, we discussed the current “bullish optimism” prevailing in the market and that “all-time” highs are now within reach for investors.

“Currently, the “bulls” remain clearly in charge of the market…for now. While it seems as if much of the “tariff talk” has been priced into stocks, what likely hasn’t as of yet is rising evidence of weakening economic data (ISM, employment, etc.), weakening consumer demand, and the impact of higher rates.

While on an intermediate-term basis these macro issues will matter, it is primarily just sentiment that matters in the short-term. From that perspective, the market retested the previous breakout above the March highs last week (the Maginot line)which keeps Pathway #1 intact. It also suggests that next weekwill likely see a test of the January highs.

https://www.zerohedge.com/sites/default/files/inline-images/SP500-Chart3-080318%20%281%29.png?itok=aOPYMJ1K

“With moving averages rising, this shifts Pathway #2a and #2b further out into the August and September time frames. The potential for a correction back to support before a second attempt at all-time highs would align with normal seasonal weakness heading into the Fall. “

One would suspect with the amount of optimism toward the equity side of the ledger, and with the Federal Reserve on firm footing for further rate increases at a time where the U.S. Government is about to issue a record amount of new debt, interest rates, in theory, should be rising.

But they aren’t.

As Mike noted previously:

“Given our opinions on the severe economic headwinds facing economic growth and steep equity valuations, we believe this divergence poses a potential warning for equity holders. Accordingly, we thought it appropriate to provide a few graphs to demonstrate the ‘smarter’ guys are not on board the growth and reflation train.”

In today’s missive, we will focus on the “price” and “yield” of the 10-year Treasury from a strictly “technical”perspective with respect to the signal the bond market may be sending with respect to the stock market. Given that “credit” is the “lifeblood” of the Government, corporate and consumer markets, it should not be surprising the bond market tends to tell the economic story over time.

We can prove this in the following chart of interest rates versus the economic composite of GDP, inflation, and wages.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-GDP-Composite-080618.png?itok=lcRcPHyd

Despite hopes of surging economic growth, the economic composite has remained in an elongated nominal range between 40 and 60 since 2011. This stagnation has never occurred in history and is a function of the massive interventions by the Government and the Federal Reserve to support economic growth. However, now those supports are being removed as the Federal Reserve lifts short-term borrowing costs and reduces liquidity support through their balance sheet reinvestments.

As I said, credit is the “lifeblood” of the economy. Think about all the ways that higher rates impact economic activity in the economy:

1) Rising interest rates raise the debt servicing requirements which reduces future productive investment.

2) Rising interest rates will immediately slow the housing market taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

3) An increase in interest rates means higher borrowing costs which leads to lower profit margins for corporations. 

4) The “stocks are cheap based on low interest rates” argument is being removed.

5) The massive derivatives and credit markets are at risk. Much of the recovery to date has been based on suppressing interest rates to spur growth.

6) As rates increase so does the variable rate interest payments on credit cards. 

7) Rising defaults on debt service will negatively impact banks.

8) Many corporate share buyback plans and dividend issuances have been done through the use of cheap debt, which has led to increases corporate balance sheet leverage.

9) Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs lead to lower CapEx.

10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

I could go on, but you get the idea.

So, with the Fed hiking rates, surging bankruptcies for older Americans who are under-saved and over-indebted, stumbling home sales, inflationary prices rising from surging energy costs, what is the 10-year Treasury telling us now.

Short-Term

On a very short-term basis, the 10-year Treasury yield has started a potential-topping process. Given that “yield” is the inverse of the “price” of bonds, the “buy” and “sell” signals are also reversed. As shown below, the 10-year yield appears to be forming the “right shoulder” of a “head and shoulder” topping formation and is currently on a short-term “buy” signal. Such would suggest lower yields over the next couple of months.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Weekly-080618.png?itok=astGcYCm

The two signals above aren’t a rarity. The chart below expands this view back to 1970. There have only been a few times historically that yields have been this overbought and trading at 3 to 4 standard deviations above their one-year average.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Weekly-Crisis-080618.png?itok=8OuknfhB

The outcome for investors was never ideal.

Longer-Term

Even using monthly closing data, which smooths out volatility to a greater degree, the same message appears. The chart below goes back to 1994. Each time yields have been this overbought (remember since yield is the inverse of price, this means bonds are very oversold) it is has signaled an issue with both the economy and the markets.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Monthly-SP500-080618-Crashes.png?itok=8bs9_JzH

Again, we see the same issue going back historically. Also, notice that yields are currently not only extremely overbought, they are also at the top of the long-term downtrend that started back in 1980.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Monthly-SP500-080618.png?itok=gJpuxCHG

Even Longer Term

Okay, let’s smooth this even more by using quarterly data closes. again, the picture doesn’t change.

https://www.zerohedge.com/sites/default/files/inline-images/Rates-Quarterly-SP500-080618-Crashes.png?itok=32JtcmDe

As I noted yesterday, the economic cycle is extremely advanced and both stocks and bonds are slaves to the full market cycle.

https://www.zerohedge.com/sites/default/files/inline-images/Historical-Recoveries-Declines-080518.png?itok=qWOsFTAd

“The “full market cycle” will complete itself in due time to the detriment of those who fail to heed history, valuations, and psychology.”

Of course, during the late stage of any market advance, there is always the argument which suggests “this time is different.” Mike made an excellent point in this regard previously:

“Given the divergences shown between bond and equity markets, logic says somebody’s wrong. Another possibility is that neither market is sending completely accurate signals about the future state of the economy and inflation. It is clear that bond traders do not buy into this latest growth narrative. Conversely, equity investors are buying the growth and reflation narrative lock, stock and barrel. To be blunt, with global central banks buying both bonds and stocks, the integrity of the playing field as well as normally reliable barometers of market conditions, are compromised.

This divergence between bond and equity traders could prove meaningless, or it may be a prescient warning for one or both of these markets. Either way, investors should be aware of the divergence as such a wide gap in economic opinions is unusual and may portend increased volatility in one or both markets.”

While anything is certainly possible, historical probabilities suggest that not only is “this time NOT different,” it will likely end the same way it always has for investors who fail to heed to bond markets warnings.

Source: ZeroHedge

Why You Should Care About The Narrowest Yield Curve Since 2007

Money manager Michael Pento is sounding the alarm because we are getting very close to something called a “yield curve inversion.” Pento explains, “Why do I care if the yield curve inverts? Because 9 out of the last 10 times the yield curve inverted, we had a recession… The spread with the yield curve is the narrowest it has been since outside of the start of the Great Recession that commenced in December of 2007… The last two times the yield curve inverted, we had a stock market drop of 50%. The market dropped, and the S&P 500 lost 50% of its value.”

For those who don’t have enough money to require professional management, consider storing water and food because that will never go out of style.

Source: by Greg Hunter | USAWatchdog.com

Bond Bear Stops Here: Bill Gross Warns Economy Can’t Support Higher Rates

Having thrown in the towel on his bond bear market call two weeks ago, Janus Henderson’s billionaire bond investor Bill Gross now believes that the most recent bearish bond price (rise in yields) will stop here as the economy cannot support higher yields.

As Gross said two weeks ago, yields won’t see a substantial move from here.

“Supply from the Treasury is a factor in addition to what the Fed might do in terms of a mild, bearish tone for U.S. Treasury bonds,” Gross told Bloomberg TV.

“I would expect the 10-year to basically meander around 2.80 to perhaps 3.10 or 3.15 for the balance of the year. It’s a hibernating bear market, which means the bear is awake but not really growling.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-03_7-29-30.jpg

Since then, yields have tested the upper-end of his channel and are breaking out today to their highest since 2011 (10Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-48-50_1.jpg?itok=fFNyLeBx

and back to their critical resistance levels (30Y)…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_5-50-55_0.jpg?itok=s6Hc1rhv

And now Gross is out with a pair of tweets (here and here) saying that the record bond shorts should not get too excited here…

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-13_9-26-13.jpg?itok=hqAROAA1

Bill Gross thinks they won’t be right. He highlights the long-term downtrend over the past 30-years, which comes in a 3.22%.

“30yr Tsy long-term downward yield trend line for the past 3 decades now at  3.22%, only ~4bps higher than today’s yield.”

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-39-58.jpg?itok=aNdSRwTH

“Will 3.22% be broken to upside?” he asks.

“I don’t think so. The economy can’t support yields higher than 3.25% for 30s and 10s, nor 3% for 5s.

Continuing hibernating bond bear market is best forecast.”

Asa ForexLive also notes, if he’s right it doesn’t necessarily mean the US dollar will reverse right away but it would be a good sign for stocks and would limit how far the US dollar might run.

https://www.zerohedge.com/sites/default/files/inline-images/2018-05-15_8-44-38.jpg?itok=MS3UBYGJ

So, will Gross be right? Is this latest spike all rate-locks on upcoming IG issuance? And will this leave speculators with a record short position now wondering who will be the one holding the greatest fool bag by the end of the year…

Well worth your time to hear what geo-economic consultant Martin Armstrong has to say.

Source: ZeroHedge

T-Minus… Prepare For Much Higher Long-Term Rates

It is late.  We have been crunching data for three days, and won’t bore you with too much prose.

We will be back to fill in the blanks in the next few days but will leave you with some nice charts and data to contemplate.  They may help explain why the stock market is trading so poorly even with, what appears, to be stellar earnings.

Determination Of The 10-year Yield

There will be many posts to come on this topic as we believe it is the most critical issue investors need to grapple with and get right over the next year.

What is the right price for the U.S. 10-year Treasury yield?

Moreover,  how is the yield determined, and how has it been distorted over the past 20 years by central banks, both foreign and the Federal Reserve?

What does the future hold?

Capital Flows

We agree that inflation, growth expectations, and other fundamental factors weigh heavily on determining bond yields but we always maintain, first, and foremost,

“asset prices are always and everywhere determined by capital flows.” 

New Issuance,  Foreign, and Fed Flows Into The Treasury Market

The following table illustrates the new issuance of marketable Treasury securities held by the public and net purchases by foreign investors, including central banks, and the Federal Reserve over various periods.

https://www.zerohedge.com/sites/default/files/inline-images/may2_flow-tables.png?itok=3SjVchCQ(larger image)

The data show since the beginning of the century, foreign investors, mainly central banks, and the Federal Reserve net purchase of Treasury securities, those which trade in the secondary market, is equivalent to 60 percent of all new marketable debt issued by the Treasury since 2000.

We do not suggest all these purchases were made directly in Treasury auctions, though many of the foreign buys certainly were.

From 2000-2010, foreign central banks were recycling their massive build of foreign exchange reserves back into the Treasury market.  During this period, the foreign central banks bought the equivalent of 50 percent of the new issuance.  Add foreign private investors and the Fed’s primary open market operations, and the total equated to 70 percent of the debt increase over the period.

Alan Greenspan blames the foreign inflows into the Treasury market during this period for Fed losing control of the yield curve, a major factor and cause of the housing bubble, and not excessively loose monetary policy.

Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have “prevented” the housing bubble. – Alan Greenspan, March 2009

Greenspan raised the Fed Funds rate 425 bps from June 2004 to June 2006 and the 10-year barely budged, rising only 52 bps.  More on this later.

Fed Plus Total Foreign Purchases

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_totalforeign_treasuryborrowings.png?itok=9f8p2oHc(larger image)

https://www.zerohedge.com/sites/default/files/inline-images/may2_fed_cenbank_treasuryborrowings.png?itok=-BvhQgmP(larger image)

During the Fed’s QE period,  2010-2015,  foreign investors and the Fed took down the equivalent of 80 percent of  the new debt issuance.

The charts also illustrate that for several of the 3-month rolling periods, net purchases were significantly higher than 100 percent of new supply, distorting not only the 10-year yield, but the valuation of all other asset prices.

Interest rate repression also cause economic distortions, which have political consequences.  Most notably, wealth and income disparities.

Rapid Technical Deterioration

Since 2015, flows into the Treasury market have deteriorated markedly, and the timing could not be worse as new Treasury issuance is ballooning with skyrocketing budget deficits.

During the past twelve months, for example,  net foreign and Fed flows collapsed to just 17.6 percent of new borrowings.  Even worse, the net flows were negative (we estimated March international flows) during the first quarter during a record new issuance of Treasury securities of almost $500 billion.

Can we say, “Gulp”?

Stock Of Outstanding Treasury Securities

Given the rapidly deteriorating technicals and fundamentals — rising inflation –, we believe the 10-year yield should be and will be much higher sometime soon.

That is we are looking for a “super spike” in bond yields, and expect the 10-year to finish the year between 4-5 percent.   The term premium, which has been repressed due to all of the above,  should begin to normalize.

Why is taking so long?

Aside from the record shorts and natural inertia of markets, the stock of Treasury securities remains favorable, as the bulk is still held by the Fed and foreign central banks, who are not price sensitive.

Debt Stock Shortage,  Debt Flow Surplus 

Ironically,  there remains an artificial shortage of the stock of  Treasuries but now a huge glut in the flow.   See here for a must read.

The Bund And JGB Anchor?

Treasuries are at almost at record spreads on some  maturities vis-à-vis the German bund, and foreigners are on a buying strike as the above data show.

How can an anchor be an anchor if there are no buyers?   One asset arbitrage?

It is also not normal for the 10-year to be trading in such a tight range with a record short position in the futures market.  The average daily move in the VIX has increased from 0.20 percent in 2016, to 1.37 percent in 2017, and shorts are now hardly spooked by a 500 point flop in the Dow.

Something must be going on beneath the earth’s crust.  We have our ideas.

Dollar Strength

The recent dollar strength may be a signal foreigners are getting yield-hungry again, however.   We are not so sure the rally has legs.

Market concerns over the political stability of the U.S may trump yield-seeking for the rest of the year.

How Foreign Flows Contributed To The Housing Bubble

We are not going to spend much time here but we are starting coming around to Mr. Greenspan’s reasoning.  The lack of response of long-term yields to a 425 bps increase in the Fed Funds rate from 2004-2006  greatly contributed to the housing bubble.  The 10-year yield only moved up 52 bps from when the Fed started their tightening to when they paused.

Take a look at the chart.

https://www.zerohedge.com/sites/default/files/inline-images/may2_mortgage-debt_gdp.png?itok=yzXhWh6T

The Fed’s interest rate hikes didn’t even put a dent in the momentum of the housing bubble. Household mortgage debt continued to rise from 60 to 72 percent of GDP from the first interest rate hike before the market collapsed on itself.

Bubbles are hard to pop.

https://www.zerohedge.com/sites/default/files/inline-images/may2_phases-of-housing-bubble1.png?itok=a2Dis-7Z

Why Long-Term Yields Didn’t Respond

Simple.

As, always and everywhere, capital flows or the recycling thereof.

The biggest economic event in the past 25 years, in our opinion, is the exchange rate regime shift that took place in the emerging markets in the late 1990’s.  These countries now refuse to allow their currencies to appreciate in any significant magnitude as the result of capital inflows.

They learned some hard lessons in the mid-1990’s with Mexican Peso and Asian Financial Crisis, and the Russian Debt Default.

Balance of payments surpluses are now reconciled with dirty float currency regimes, where central banks intermittently intervene if their currency becomes too strong.

The result was a massive build of global currency reserves, much of which were recycled back into the U.S. Treasury market in the mid-2000’s.

https://www.zerohedge.com/sites/default/files/inline-images/may2_cenbank_treasury_purchases.png?itok=imSym7al(larger image)

The chart illustrates that foreign central bank net purchases of Treasury securities, alone, were equivalent to the over 66 percent of net Treasury issuance during the Fed 2004-2006 tightening cycle.

International  Reserves Drive Gold

The gold price also ramped with international reserves during this period.

We believe the global monetary base, mainly international reserves,  is the main driver of gold.  See here.

Reserves have not been growing witness the punk trading range in gold.  This may change as the U.S. current account blows out again.

https://www.zerohedge.com/sites/default/files/inline-images/gold-and-monetary-base.jpg?itok=USqHmoCM(larger image)

Current Account And Trade Deficits

The Mnuchin crowd are wasting their time in China trying to negotiate lower trade deficits.  Trade deficits are the result of internal imbalances where investment exceeds savings.  See here for another must read.

Introducing trade distortions to artificially lower the external deficit will only accelerate stagflaton, which is already starting to take hold.  Then we will all be worse off.   See here.

Besides, where is Mr. Mnuchin going to obtain the financing for his proliferating budget deficits if his goal is to run trade surplus or balances with our trading partners?

We are all for better terms of trade and protecting are intellectual property rights,  but know and understand thy national income accounting before starting trade wars.

Upshot

We have laid out why we believe, and we could be wrong, long-term yields are unlikely to behave as they did during the last monetary tightening.   That is the a further collapse in Treasury term premia and a yield curve inversion until something breaks.

Unless the U.S. blows up its current account again,  credit expansion accelerates significantly, creating another blast of capital flows into the emerging markets, to be recycled back to the U.S,,  the foreign and Fed financing of the U.S. budget deficit is over.  Punto!

We are preparing for a significant move higher in bond yields.

What Is The Right Real Yield?

Do you really think with the deteriorating flows in the bond market, coupled with rising inflation warrant a 0.5 percent real 10-year yield?

Au contraire!   We believe a 2-3 percent real yield is closer to fair value.

Tack on another 2.5 percent for inflation,  generous as shortages seem to be breaking out everywhere,  and that gets the 10-year to at least 4 1/2 percent.

Timing

A little CYA.   Yields could move a little lower, maybe to 2.80 percent (a stretch),  given the dollar strength as Europe slows, and shorts get spooked.

Our suspicions, however, it is going to be a hot summer.  Higher interest rates and lower stock prices.

Disclaimer

Now let us add our disclaimer.

Even if all our facts are correct,  our conclusions may be completely wrong.

If you have been reading the Global Macro Monitor over the years, you have probably seen it several times.

To illustrate our point, we like to tell the story Abraham Lincoln used to persuade juries when he was an Illinois circuit court lawyer.

The story goes that Lawyer Lincoln was worried he had not convinced the jury during the closing argument of a civil case against a railroad.   The jurors had gone to lunch to deliberate.  Lincoln followed them and interrupted their dessert with a story about a farmer’s son gripped by panic,

“Pa, Pa, the hired man and sis are in the hay mow and she’s lifting up her skirt and he’s letting down his pants and they’re a fixin’ to pee on the hay.” “Son, you got your facts absolutely right, but you’re drawing the wrong conclusion.”

The jury ruled in Lincoln’s favor.

Stay Frosty, Oscar Mike!

Source: ZeroHedge

China’s Empty Threat of Dumping its US Treasuries

“We are looking at all options.”

In an interview about the trade sanctions that President Trump is throwing at China and at Corporate America – whose supply chains go through China in search of cheap labor and other cost savings – Ambassador Cui Tiankai defended the perennial innocence of China, as is to be expected, and trotted out the standard Chinese fig leafs and state-scripted rhetoric that confirmed in essence that Trump’s decision is on the right track.

Speaking on Bloomberg TV, he also trotted out all kinds of more or less vague and veiled threats – such as, “We will take all measures necessary,” or “We’ll see what we’re doing next” – perhaps having forgotten that China and Hong Kong combined export three times as much to the US as the other way around, and the pain of a trade war would be magnified by three on the Chinese side.

When asked about the possibility of China’s cutting back on purchases of US Treasuries – the ultimate threat, it seems, these days as Congress is piling on record deficits leading to a ballooning mounting of debt that requires a constant flow of new buyers – Ambassador Cui Tiankai said:

“We are looking at all options. That’s why we believe any unilateral and protectionist move would hurt everybody, including the United States itself. It would certainly hurt the daily life of American middle-class people, and the American companies, and the financial markets.”

So let’s dig into this threat.

China held $1.17 trillion in Treasuries as of January. That’s about 5.5% of the $21 trillion in total Treasury debt. So it’s not like they have a monopoly on it. These holdings have varied over the years and are down nearly $100 billion from November 2015:

https://wolfstreet.com/wp-content/uploads/2018/03/US-treasury-holdings-China-2018-01.png

So over the years, the Chinese haven’t been adding Treasuries anyway. Instead, they’ve been shedding some. At the moment, they’re replacing securities that are maturing and nothing more. So they could decide not to replace any maturing Treasuries or they could decide to sell Treasuries. How much impact would that have?

If China dumped its Treasury holdings, in theory, new buyers would have to emerge to buy them, and these new buyers would have to be induced by higher yields. Hence long-term Treasury yields would have to rise.

The vast majority of Treasury debt is held by pension funds of the US government and of state and local governments, and by Americans, either directly or via bond funds, or via stocks in companies like Apple and Microsoft, whose “offshore” cash is invested in all kinds of US securities, including large amounts of US Treasuries, and shareholders of those companies own those securities.

Then there’s the Fed. It holds $2.42 trillion in US Treasuries, or $1.64 trillion more than before the Financial Crisis as a result of QE. If push comes to shove, the Fed could easily mop up a trillion of Treasuries, as it has done before.

In addition, everyone is now fretting about an “inverted yield curve,” which is the phenomenon when long-term yields, such as the 10-year yield, fall below short-term yields, such as the three-month yield or the two-year yield.The last time this happened was before the Financial Crisis.

The Fed’s rate hikes, which started in December 2015, have pushed up short-term yields. For example, the three-month yield went from 0% in late 2015 to 1.74% today. But the 10-year yield, at around 2.2% in December 2015, then declined to a historic low. It has since risen, but only to 2.82% today. In other words, since December 2015, it has gained 62 basis points, while the three-month yield has gained 174 basis points.

What the Fed wants to accomplish with its rate hikes is push up long-term rates. But markets have been fighting the Fed so far. So a sort of a monetary shock, administered from China’s dumping US Treasuries and thus pushing up US long-term yields, would solve that problem. And the Fed can go about its path of raising short-term yields, confident that the Chinese authorities will do their part to push up long-term yields faster than the Fed is pushing up short-term yields. This would steepen the yield curve.

For people who dread and want to avoid a flat or an inverted yield curve, China’s dumping of US Treasuries would be a God send. So China’s threats of this type of retaliation make good media soundbites but are ultimately vacuous.

Source: By Wolf Richter | Wolf Street

Bond Carnage hits Mortgage Rates. But This Time, it’s Real

The “risk free” bonds have bloodied investors.

The carnage in bonds has consequences. The average interest rate of the a conforming 30-year fixed mortgage as of Friday was quoted at 4.125% for top credit scores. That’s up about 0.5 percentage point from just before the election, according to Mortgage News Daily. It put the month “on a short list of 4 worst months in more than a decade.”

One of the other three months on that short list occurred at the end of 2010 and two “back to back amid the 2013 Taper Tantrum,” when the Fed let it slip that it might taper QE Infinity out of existence.

Investors were not amused. From the day after the election through November 16, they yanked $8.2 billion out of bond funds, the largest weekly outflow since Taper-Tantrum June.

The 10-year Treasury yield jumped to 2.36% in late trading on Friday, the highest since December 2015, up 66 basis point since the election, and up one full percentage point since July!

The 10-year yield is at a critical juncture. In terms of reality, the first thing that might happen is a rate increase by the Fed in December, after a year of flip-flopping. A slew of post-election pronouncements by Fed heads – including Yellen’s “relatively soon” – have pushed the odds of a rate hike to 98%.

Then in January, the new administration will move into the White House. It will take them a while to get their feet on the ground. Legislation isn’t an instant thing. Lobbyists will swarm all over it and ask for more time to shoehorn their special goodies into it. In other words, that massive deficit-funded stimulus package, if it happens at all, won’t turn into circulating money for a while.

So eventually the bond market is going to figure this out and sit back and lick its wounds. A week ago, I pontificated that “it wouldn’t surprise me if yields fall some back next week – on the theory that nothing goes to heck in a straight line.”

And with impeccable timing, that’s what we got: mid-week, one teeny-weeny little squiggle in the 10-year yield, which I circled in the chart below. The only “pullback” in the yield spike since the election. (via StockCharts.com):

https://i2.wp.com/wolfstreet.com/wp-content/uploads/2016/11/US-treasury-10-yr-yield-2016-11-18.png

Note how the 10-year yield has jumped 100 basis points (1 percentage point) since July. I still think that pullback in yields is going to happen any day now. As I said, nothing goes to heck in a straight line.

In terms of dollars and cents, this move has wiped out a lot of wealth. Bond prices fall when yields rise. This chart (via StockCharts.com) shows the CBOT Price Index for the 10-year note. It’s down 5.6% since July:

https://i2.wp.com/wolfstreet.com/wp-content/uploads/2016/11/US-treasury-10-yr-price-2016-11-18.png

The 30-year Treasury bond went through a similar drubbing. The yield spiked to 3.01%. The mid-week pullback was a little more pronounced. Since the election, the yield has spiked by 44 basis points and since early July by 91 basis points (via StockCharts.com):

https://i1.wp.com/wolfstreet.com/wp-content/uploads/2016/11/US-treasury-30-yr-yield-2016-11-18.png

Folks who have this “risk free” bond in their portfolios: note that in terms of dollars and cents, the CBOT Price Index for the 30-year bond has plunged 13.8% since early July!

https://i1.wp.com/wolfstreet.com/wp-content/uploads/2016/11/US-treasury-30-yr-price-2016-11-18.png

However, the election razzmatazz hasn’t had much impact on junk bonds. They’d had a phenomenal run from mid-February through mid-October, when NIRP refugees from Europe and Japan plowed into them, along with those who believed that crushed energy junk bonds were a huge buying opportunity and that the banks after all wouldn’t cut these drillers’ lifelines to push them into bankruptcy, and so these junk bonds surged until mid-October. Since then, they have declined some. But they slept through the election and haven’t budged much since.

It seems worried folks fleeing junk bonds, or those cashing out at the top, were replaced by bloodied sellers of Treasuries.

Overall in bond-land, the Bloomberg Barclays Global Aggregate bond Index fell 4% from Friday November 4, just before the election, through Thursday. It was, as Bloomberg put it, “the biggest two-week rout in the data, which go back to 1990.”

And the hated dollar – which by all accounts should have died long ago – has jumped since the election, as the world now expects rate hikes from the Fed while other central banks are still jabbering about QE. In fact, it has been the place to go since mid-2014, which is when Fed heads began sprinkling their oracles with references to rate hikes (weekly chart of the dollar index DXY back to January 2014):

https://i2.wp.com/wolfstreet.com/wp-content/uploads/2016/11/US-dollar-DXY-2016-11-18.png

The markets now have a new interpretation: Every time a talking head affiliated with the future Trump administration says anything about policies — deficit-funded stimulus spending for infrastructure and defense, trade restrictions, new tariffs, walls and fences, keeping manufacturing in the US, tax cuts, and what not — the markets hear “inflation.”

So in the futures markets, inflation expectations have jumped. This chart via OtterWood Capital doesn’t capture the last couple of days of the bond carnage, but it does show how inflation expectations in the futures markets (black line) have spiked along with the 10-year yield (red line), whereas during the Taper Tantrum in 2013, inflation expectations continued to head lower:

https://i0.wp.com/wolfstreet.com/wp-content/uploads/2016/11/US-treasury-10-yr-yield-v-inflation-expectations-2016-11-16.png

Inflation expectations and Treasury yields normally move in sync. And they do now. The futures markets are saying that the spike in yields and mortgage rates during the Taper Tantrum was just a tantrum by a bunch of spooked traders, but that this time, it’s real, inflation is coming and rates are going up; that’s what they’re saying.

The spike in mortgage rates has already hit demand for mortgages, and mortgage applications during the week plunged. Read…  What’ll Happen to Housing Bubble 2 as Mortgage Rates Jump? Oops, they’re already jumping.

By Wolf Richter | Wolf Street