POLL: Fed and interest rates

[Spekulatius]

If I had to condense what's  happening with respect to interest rates I would say that the world is long central bank confidence and short common sense.

 

I have no idea what is going to happen and how it ends, but I think it could be a trip to financial market hell like in 2008 and possibly worse.

 

Going long real assets like real estate, gold, land etc. seems to be one way to escape. Even buying bitcoin seems to me a better bet than buying a 100 year bond yielding nothing. At least with bitcoin, you have a chance to make money (vs fiat currency ), while with a 10” year bond, you are almost guaranteed to be a loser.

[RuleNumberOne]

Viking, negative rates will never come to the US, because they harm the economy rather than help. Bernanke, Greenspan have spoken against it. They don't make any sense anywhere. I think the Fed is making the 25bp cut to expand the NIM for banks.

 

The ECB force-fed negative yields to their savers/pension funds/banks/insurance companies just so that they could keep Italy and Greece in the European Project and French banks solvent. The upside of driving Italy/Greece borrowing costs so low, has come at a great cost. They have created a huge bond bubble that they are too afraid to prick.

 

I think the Eurocrats started by ramming the negative yields down the throats of their savers. But then it took on a life of its own as evidenced by the 100-year bond where you take the risk of huge downside for the upside of a 1% yield. At least with the S&P 500 the upside is unlimited.

 

In the current bond bubble, unscrupulous politicians could probably issue a 0.01% rate 200-year Tulip bond - the bond buyer can choose to get redeemed in either Tulips or Euros (since Tulips are guaranteed to be around in 200 years, and be worth something at least, unlike the Euro.) With the proceeds of the Tulip bonds, the politicians can provide everyone a new car every 2 years, a new boat every 3 years, and a new plane every 5 years.

 

RuleNumberOne, i just shake my head at where yields are at today. What i wonder, however, is what if yields fall lower. Instead of a 1% or so move higher, what if we see a significant move lower? I am now wondering not if but when 10 year US treasuries go to a negative yield.

 

The Fed appears to be giving financial markets whatever they want. We are going to get a rate cut shortly, even with the economy doing ok. Should the economic data get worse, the Market will clamor for more and the Fed will oblige. As the US cuts, the $US will go down. Other central banks will then also cut (or engage in more QE). And we will have a race to the bottom. Lots of things going on that i clearly do not understand :-)

[RuleNumberOne]

Spekulatius, I completely agree. It is hard to believe grown-up, purportedly literate adults could create such an environment.

 

I was trying to work out maturity by maturity, using zero-coupon bonds. It probably went something like this:

 

1. One-year bonds.

Eurocrats: "We have engineered the one-year yields to be negative. Why aren't you pension funds buying?"

Pension fund says: "We are not suicidal. We have pensions to pay."

Eurocrats: "Hey, fu. Who do you think you are? You little pension fund, you! The law says you have to buy, just buy it!"

 

The one-year zero-coupon bond bought at $102 turns into $100 at the end of the year. Soon, companies reduce pension fund contributions and pay the money directly to employees instead, since money in the mattresses/bank vaults is a better investment.

 

2. Five-year bonds.

Eurocrats: "Here are 5-year bonds. We have negative rates guidance for the next few years. Spread the word and trade this with your friends."

 

The one-year zero-coupon bond bought at $102 turns into $103 at the end of the first year, and $105 at the end of the second year. Then they head south because they turn into $100 at the end of the fifth year.

 

By now the banks are busily building more vaults for clients, insurance companies are going broke. The ECB has even started regulating the number and size of bank vaults.

 

3. Ten-year bonds.

Eurocrats: "Hey, this time we have increased our negative rates guidance and you can trade the 10-year with your friends."

 

The bonds go up for the first few years and then head south. Since bank employees still need bread to eat and clothes to wear, they have to punish depositors even more to create a spread. By now, all wealthy Europeans have moved all their assets abroad in the dark of night. Housing bubbles and rent controls pop up everywhere.

 

4. 100-year bonds

Eurocrats: "At last we have found the solution. We created a 100-year Tulip bond, as in, we take real Euros and return Tulips a 100 years from now. You can trade this to the skies. Tell your friends. Spread the word. It is just like a stock without a P/E, your imagination is the limit!"

 

Bond fund managers: "If we don't buy these 100-year Tulip bonds right now, we will miss our benchmarks and be out of a job. Look at my former classmate over there, he made 55% on those Austrian Tulip bonds bought 2 years ago. I need to take some of that imagination medication he uses."

 

Politicians: "Everybody lives in a marble palace from now on. You don't need to go to college, even if you do, you don't need to graduate. We will give everyone a big free house and a new car every 2 years. Everybody makes the same income as a brain surgeon. But, to get all this, you will have to vote for me first!"

 

 

If I had to condense what's  happening with respect to interest rates I would say that the world is long central bank confidence and short common sense.

 

I have no idea what is going to happen and how it ends, but I think it could be a trip to financial market hell like in 2008 and possibly worse.

 

Going long real assets like real estate, gold, land etc. seems to be one way to escape. Even buying bitcoin seems to me a better bet than buying a 100 year bond yielding nothing. At least with bitcoin, you have a chance to make money (vs fiat currency ), while with a 10” year bond, you are almost guaranteed to be a loser.

[TwoCitiesCapital]

Negative rates in Europe have inverted the US yield curve.

 

Dan Fuss:

https://www.barrons.com/articles/why-bond-legend-dan-fuss-is-buying-at-t-stock-51563363000

 

"The flows of capital from abroad means the gulf between ultralow or negative yields elsewhere and the high U.S. yields will have to narrow, he continues. "

 

Fed chief Powell said 2 days ago:

 

https://www.cnbc.com/2019/07/16/feds-powell-says-uncertainties-have-increased-chances-of-a-rate-cut.html

 

“We have seen how monetary policy in one country can influence economic and financial conditions in others through financial markets, trade, and confidence channels. Pursuing our domestic mandates in this new world requires that we understand the anticipated effects of these interconnections and incorporate them into our policy decisionmaking,” he said.

 

While I don't disagree with the statement overall, I'd like to see flows information confirm it.

 

It was my understanding that this was, in part, what drove the 10-year to 1.60% back in 2016, but since then I thought it had been a net negative return for most foreign buyers to buy treasuries and hedge the currency risk which has eliminated a lot of the foreign demand over the past 2 years.

 

Is there any flow data supporting foreign buyers?

If the references I looked at are correct, US government debt held by foreign entities has increased ++ after the last recession but has relatively plateaued.

https://fred.stlouisfed.org/series/FDHBFIN

However, the US government has issued debt at a rate much higher than GDP growth and somebody/somewhere has been piling up. In percentage terms, US government debt held by foreign entities over total US government debt (as per the Treasury Department) has risen from about 25% entering the Great Recession peaked at around 34% in 2013-6 and is now on its way down to 29% even if absolute numbers keep going up. Remember also that the Fed has recently been a net seller of government debt. Against all odds, rates have gone down despite the increased supply and demand from US individuals and institutions (including banks) seems to be the driving force.

Here is official data showing what happened recently (over a year-period when public debt increased by 960B).

https://ticdata.treasury.gov/Publish/mfh.txt

From a bird's eye view it seems that the fear and greed spectrum looks more and more like the bimodal distribution that is becoming obvious in other segments which cannot be discussed in investment threads. The US continues to have the cleanest dirty shirt but it's getting dirtier in our beg-thy-neighbor world.

 

I think this supports that we cannot believe that it's foreign buyers. Foreign held treasuries have increased slightly since 2016, but at a far lesser rate than the supply which results in them owning a significant % of the total supply less than their peak in 2016 (as you pointed out).

 

If foreign buyers went from 34% ownership of the Treasury market to 29%, they certainly can't be the cause of the recent drop in rates - someone else had to absorb their 5% reduction along with the increase in new supply.

 

I would tend to believe the BofA CEO because he has the whole of Merrill Lynch at his disposal to find out what's going on (does anyone here know why the Treasuries held by "private investors" has more than doubled from $6 trillion to $14 trillion in the graph from the same website linked below?). But whether or not it is foreign buyers, let us look at the duration risk.

 

https://fredblog.stlouisfed.org/2018/04/whos-buying-treasuries/?utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=fredblog

 

home.treasury.gov/news/press-releases/sm679

 

Press release from May 2019. Pietrangeli is the Director of the Office of Debt Management and a member of the Treausry Borrowing Advisory Committee. I'd take what he says, and the data, over what BofA says any day.

 

Pietrangeli next reviewed recent tends in foreign holdings of Treasury securities. He noted that foreign participation in auctions remains in line with historical levels and the amount of foreign holdings had remained steady or had increased gradually since 2014, even as borrowing needs have grown substantially . He concluded that domestic buyers have increasingly absorbed the larger debt issuance since 2014.

 

Once again, it's not foreign buyers driving U.S. rates

[RuleNumberOne]

Talk, talk, and more talk but no action from the ECB. They are out of bullets. They have been threatening monetary easing for several months and will continue to wave their empty gun. The easing is always going to happen at the next meeting, it has been that way for a long time now.

 

German industry in "free fall". Ifo survey lowest in 9 years

https://www.ft.com/content/08010baa-aeb6-11e9-8030-530adfa879c2

 

Eurozone manufacturing activity lowest in 7 years

https://www.ft.com/content/7b7c5140-ade2-11e9-8030-530adfa879c2

 

 

Italy debt to GDP higher than before the crisis, youth unemployment in Italy 33%.

[JimBowerman]

The easing is always going to happen at the next meeting, it has been that way for a long time now.

 

Agree with you on that one.  Despite their words, ECB unlikely to ease (but no, they aren't out of bullets, they just refuse to use those bullets.)

 

I (half) jokingly say: You really want the market to believe ECB will ease?...then have Draghi come out on stage with a lie detector showing his heart rate on a big screen behind him.  Then have him read the following statement:

 

"we are doing unlimited open market operations (QE) until inflation is above 2%"

 

Inflation would go up in 5 minutes before any bonds need to be bought.  ECB balance sheet would likely SHRINK if he did that...with inflation rising

 

I'm only half kidding about the lie detector :-\

 

Market is sniffing out ECBs weak actions not their strong words

 

 

[RuleNumberOne]

Someone from Blackrock suggested the ECB should  buy stocks. Why not just buy entire companies Buffett-style?

 

That way we can complete the journey to Soviet collectivism. It would lead to even greater prosperity.

 

Companies do not need to generate a return on capital anymore since debt is free. Free-markets have a much diminished role in setting prices.

 

If we go even further and have the central bank buy everything, we would all be rich. 

 

[JimBowerman]

Someone from Blackrock suggested the ECB should  buy stocks. Why not just buy entire companies Buffett-style?

 

That way we can complete the journey to Soviet collectivism. It would lead to even greater prosperity.

 

Companies do not need to generate a return on capital anymore since debt is free. Free-markets have a much diminished role in setting prices.

 

If we go even further and have the central bank buy everything, we would all be rich.

 

Would inflation go up in such a scenario?

[TwoCitiesCapital]

Someone from Blackrock suggested the ECB should  buy stocks. Why not just buy entire companies Buffett-style?

 

That way we can complete the journey to Soviet collectivism. It would lead to even greater prosperity.

 

Companies do not need to generate a return on capital anymore since debt is free. Free-markets have a much diminished role in setting prices.

 

If we go even further and have the central bank buy everything, we would all be rich.

 

Would inflation go up in such a scenario?

 

Asset inflation. Which could lead to limited, but ultimately unsustainable, amounts of inflation elsewhere.

[RuleNumberOne]

I prefer free-markets with 1.5% inflation rather than a nationalized economy with 2% inflation.

 

Whether the ECB can buy all equity and get 2% inflation can probably be answered by the Soviet Union's records.

 

This FT journalist writes better than me, my thoughts are the same:

https://www.ft.com/content/9a6295f6-aefa-11e9-8030-530adfa879c2

 

"Our senses have been dulled by increasingly extreme monetary policy over the past decade, so we must try and look at it afresh. What is being suggested here is that the ECB, a publicly owned institution, prints money and uses it to buy equity stakes in private companies. In other words, the only way to save capitalism is to begin to nationalise it.

 

Global elites have a full-on meltdown every time the UK opposition leader Jeremy Corbyn suggests some kind of “people’s QE” or nationalising a couple of utility companies. Yet when BlackRock says this no one blinks.

 

It isn’t quite the same — utility nationalisation isn’t good for big asset managers for starters. But it isn’t all that different either. Public equity purchases distort pricing signals; they are anti-free markets; they will be almost impossible to unwind; and think of the governance issues. BlackRock likes to promote the idea that big shareholders should be active when it comes to corporate governance. What if one of those big shareholders is a central bank? Should they be active too?"

 

Finally, the ongoing shift towards increasingly bonkers monetary bazookas is surely more evidence that the whole thing just isn’t working. If the big financial firms could see beyond their own business models they wouldn’t be asking for more measures to stabilise the status quo."

 

[JimBowerman]

Asset inflation. Which could lead to limited, but ultimately unsustainable, amounts of inflation elsewhere.

 

So...so far we've seen asset price inflation which will eventually spill over into CPI but we haven't seen that spill over yet?  But its coming? Any eta on when you think it's coming?

 

What do you mean exactly by "elsewhere"? Billions prices project? CPI?

 

Are we all having skin in the game and holding massive short treasury positions for this "second coming" of inflation that is always just around the corner? 10 years and counting.....

 

(if its only stocks and other assets that ever go up, and the price of milk and bread don't ever go up....then haven't we found nirvana and a perpetual motion machine?)

 

In a society where a central bank does unlimited printing w/ only stocks going up and the price of milk and bread remaining flat - everyone would pay a 0% tax rate and see their net worth go sky high

 

Its either that or we need to all start admitting (after 10 years) that "asset price inflation"/"shadow stats inflation" /"pushing on a string", etc. etc. theories are exactly wrong

[RuleNumberOne]

According to Wikipedia, Russia had hyperinflation in the first 6 years after the Bolshevik Revolution until the gold standard was put in.

 

We could repeat the Bolshevik experience by making the ECB buy equities. They have already made debt free (i.e. nationalized it and removed free-market pricing.) The Bolshevik experience is promising. We could have the central bank own the equity of all companies and thereby generate prosperity.

 

 

[TwoCitiesCapital]

Asset inflation. Which could lead to limited, but ultimately unsustainable, amounts of inflation elsewhere.

 

So...so far we've seen asset price inflation which will eventually spill over into CPI but we haven't seen that spill over yet?  But its coming? Any eta on when you think it's coming?

 

What do you mean exactly by "elsewhere"? Billions prices project? CPI?

 

Are we all having skin in the game and holding massive short treasury positions for this "second coming" of inflation that is always just around the corner? 10 years and counting.....

 

(if its only stocks and other assets that ever go up, and the price of milk and bread don't ever go up....then haven't we found nirvana and a perpetual motion machine?)

 

In a society where a central bank does unlimited printing w/ only stocks going up and the price of milk and bread remaining flat - everyone would pay a 0% tax rate and see their net worth go sky high

 

Its either that or we need to all start admitting (after 10 years) that "asset price inflation"/"shadow stats inflation" /"pushing on a string", etc. etc. theories are exactly wrong

 

I think it's quite possible we've already seen it. It could be the only reason inflation has been 1-2% instead of -1 or 0%.

 

But again, I'm not supporting the idea. Just not hard for me to believe blowing a bubble that makes everyone temporary millionaires could lead to unsustainable inflation in areas outside of stocks as people liquidate and spend their newfound riches.

[John Hjorth]

... According to Wikipedia, Russia had hyperinflation in the first 6 years after the Bolshevik Revolution until the gold standard was put in. ...

 

Yeah, tell me about it - have you ever studied something more recent, - something like the doings of Elvira Nabiullina.

 

To me, naturally, you haven't, and thereby you don't have a clue about what you're talking about. Please prove me wrong here.

[RuleNumberOne]

The obstacle to studying more recent stuff is the news in Europe is not in the English language.

 

Unlike these hedge funds, I can't go to Europe to investigate when and why things are going to crash. I will open a relevant thread to attract more discussion. I have some urgent questions, I will also read up on Nabiullina.

[Spekulatius]

For the macro folks out there, anybody noticed that the inflation numbers are pointing up and pretty fast apparently. YoY change is ~2.7% now and the monthly annualized change ~3.6% and high 3 month in a row. Of course there is a signal and the noise issue, but this seems worrisome. The inflation target is 2% and we are way above that. I wonder what the Fed officials are thinking about this.

https://www.frbatlanta.org/research/inflationproject/stickyprice/

[TwoCitiesCapital]

For the macro folks out there, anybody noticed that the inflation numbers are pointing up and pretty fast apparently. YoY change is ~2?7% now and the monthly annualized change ~3.6% and high 3 month in a row. Of course there is a signal and the noise issue, but this seems worrisome. The inflation target is 2% and we are way above that. I wonder what the Fed officials are thinking about this.

https://www.frbatlanta.org/research/inflationproject/stickyprice/

 

More concerning for bond longs, but not so much for the Fed yet I don't think.

 

I imagine that much like employment, inflation is a trailing indicator that always appears at it's "best" prior to a downturn - we'd need to see a sustained rise before it becomes an issue. Not just a few months worth.

 

Also, I have to believe the tarriffs are a portion of that meaning it's transitory and potentially reversible and not emblematic of an elevated trend in inflation.

[TwoCitiesCapital]

For the macro folks out there, anybody noticed that the inflation numbers are pointing up and pretty fast apparently. YoY change is ~2?7% now and the monthly annualized change ~3.6% and high 3 month in a row. Of course there is a signal and the noise issue, but this seems worrisome. The inflation target is 2% and we are way above that. I wonder what the Fed officials are thinking about this.

https://www.frbatlanta.org/research/inflationproject/stickyprice/

 

More concerning for bond longs, but not so much for the Fed yet I don't think.

 

I imagine that much like employment, inflation is a trailing indicator that always appears at it's "best" prior to a downturn - we'd need to see a sustained rise before it becomes an issue. Not just a few months worth.

 

Also, I have to believe the tarriffs are a portion of that meaning it's transitory and potentially reversible and not emblematic of an elevated trend in inflation.

 

Obviously didn't foresee covid happening - but think this is important to note in an environment where everyone is expecting sustained inflation again. Inflation is a trailing indicator.

 

Rates can continue higher in the intermediate term, but ultimately they're capped by the debt burden on society and will likely peak below their prior peak in the last cycle.

 

Also attached is a piece from Doubleline's presentation today. Foreigners have been fleeing treasuries since mid-2016 and I don't quite see a reason for that to stop - even our higher nominal rates are still negative in real terms. More likely people continue to buy inflation hedges now that negative real rates are becoming a global phenomenon, but we don't need foreigners for rates to come back down like we didn't need them in 2019.

[Cigarbutt]

...

Also attached is a piece from Doubleline's presentation today. Foreigners have been fleeing treasuries since mid-2016 and I don't quite see a reason for that to stop - even our higher nominal rates are still negative in real terms. More likely people continue to buy inflation hedges now that negative real rates are becoming a global phenomenon, but we don't need foreigners for rates to come back down like we didn't need them in 2019.

i just want to mention that fleeing is too strong a word.

For a while now, US government debt held by foreigners has grown (at a rate slightly less than GDP).

https://fred.stlouisfed.org/series/FDHBFIN

https://ticdata.treasury.gov/Publish/mfh.txt

After the GFC, this ratio (US gvmnt debt over GDP) has grown and sort of peaked in early 2014 at 34.8%. At yr-end 2020, it's at 32.9%.

The most liquid market in the world has become very crowded(!?). For a contrarian, crowded trades are interesting because of potential reversals. In this case however, my bet, at least for a while, is with the momentum crowd who can control the yield curve. Don't fight the Fed, they say.