Bonds!

[gfp]

17 minutes ago, UK said:

 

'Nevertheless, the takeaway applies everywhere: The private sector may not be able to provide as much bond-market liquidity as officials’ fiscal plans imply.'

 

and 

 

'Eventually, central banks would buy bonds again. But backstops kick in only after severe market disruptions.'

 

25 minutes ago, gfp said:

 

I'm curious what people think the author is saying in this article.

 

I feel like he's trying to say something else that isn't such a mainstream take on it.  He makes the very rare (for journalists anyway) admission that "Yet the end-buyers of the debt are unlikely to disappear since government deficits automatically create the very savings that are then channeled into financial assets. The real issue is that the financial plumbing meant to make all this happen has become dangerously creaky."  He also acknowledges that the Citadel's of the world running massive leveraged Treasury basis trade books (long the actual bonds, short the futures, insane leverage on the bonds provided cheaply by the repo market) have taken on some of the role of primary dealers in creating a huge pool of demand for cash bonds.  (This is "bond warehouse managers" notion he closes with - picture Ken Griffin)

 

The government seems worried about these massive basis trade books because they seemed to have a hiccup for a short period of time when the COVID panic first broke (Treasury market was chaotic instead of what may have been predicted as an immediate flight to safe assets).  I thought maybe the author was trying to get at the real issue with the basis trade in a time of crisis like that, which is that it relies on a loose, liquid repo market for all that leverage and as soon as the repo market tightens up the giant basis trade hedge funds become sellers of treasuries and buyers of their short futures positions (to unwind leverage on their trade).  This is why the central bank is so focused on loosening up dollar funding shortages in crisis moments like that - to un-tighten the global market for stuff like repo.

 

It's not quite a LTCM situation but I think maybe that is what regulators are hinting that they are worried about.

 

Not sure he fully developed a point in the article though so was curious if anybody else got a point. 

[Munger_Disciple]

57 minutes ago, gfp said:

 

 

I feel like he's trying to say something else that isn't such a mainstream take on it.  He makes the very rare (for journalists anyway) admission that "Yet the end-buyers of the debt are unlikely to disappear since government deficits automatically create the very savings that are then channeled into financial assets. The real issue is that the financial plumbing meant to make all this happen has become dangerously creaky."  He also acknowledges that the Citadel's of the world running massive leveraged Treasury basis trade books (long the actual bonds, short the futures, insane leverage on the bonds provided cheaply by the repo market) have taken on some of the role of primary dealers in creating a huge pool of demand for cash bonds.  (This is "bond warehouse managers" notion he closes with - picture Ken Griffin)

 

The government seems worried about these massive basis trade books because they seemed to have a hiccup for a short period of time when the COVID panic first broke (Treasury market was chaotic instead of what may have been predicted as an immediate flight to safe assets).  I thought maybe the author was trying to get at the real issue with the basis trade in a time of crisis like that, which is that it relies on a loose, liquid repo market for all that leverage and as soon as the repo market tightens up the giant basis trade hedge funds become sellers of treasuries and buyers of their short futures positions (to unwind leverage on their trade).  This is why the central bank is so focused on loosening up dollar funding shortages in crisis moments like that - to un-tighten the global market for stuff like repo.

 

It's not quite a LTCM situation but I think maybe that is what regulators are hinting that they are worried about.

 

Not sure he fully developed a point in the article though so was curious if anybody else got a point. 

 

The underlined statement was the best point the author made. It is the first time I see a mainstream reporter make this point. 

 

I guess what he was saying (& the Fed worries about) is that if for whatever reason the hedge funds (acting like primary dealers) had to undo their basis trade, the treasury yields can go thru' the roof parabolically because they are big players in these markets and use ungodly amounts of leverage. In other words, something similar to the October 1987 Black Monday crash can happen.

 

Edit (added): Since the Fed cannot "theoretically" extend their credit facilities to hedge funds like they can for primary dealers it will make the problem that much worse. IIIRC, the Fed arranged a bailout of LTCM by banks, not directly rescued the hedge fund. But push comes to shove, IMO the Fed will "invent" some novel reason to rescue the hedge funds doing the carry trade.

Edited November 7, 2023 by Munger_Disciple

[Munger_Disciple]

https://www.cnbc.com/video/2023/11/07/the-surge-in-stock-prices-goes-hand-in-hand-with-dropping-yields-says-interactive-brokers-peterffy.html

According to Peterffy, the treasury basis traders use 100 to 1 leverage.  

[Gamecock-YT]

14 hours ago, Munger_Disciple said:

 

The underlined statement was the best point the author made. It is the first time I see a mainstream reporter make this point. 

 

I guess what he was saying (& the Fed worries about) is that if for whatever reason the hedge funds (acting like primary dealers) had to undo their basis trade, the treasury yields can go thru' the roof parabolically because they are big players in these markets and use ungodly amounts of leverage. In other words, something similar to the October 1987 Black Monday crash can happen.

 

Edit (added): Since the Fed cannot "theoretically" extend their credit facilities to hedge funds like they can for primary dealers it will make the problem that much worse. IIIRC, the Fed arranged a bailout of LTCM by banks, not directly rescued the hedge fund. But push comes to shove, IMO the Fed will "invent" some novel reason to rescue the hedge funds doing the carry trade.

yep, and with the bailout comes regulation to the industry

[gfp]

https://www.bis.org/publ/qtrpdf/r_qt2309w.htm

 

This is a recent BIS paper describing some of the above mentioned issues.  The worry is that the tightening of margin requirements on futures and/or the tightening of available leverage through the cash bond repo market can (and has) destabilized the treasury market in a hurry.  The US is very sensitive about the stability and liquidity of their government bond market.

[UK]

https://www.bloomberg.com/news/audio/2023-11-07/oaktree-co-chairman-howard-marks-talks-rates

[Cigarbutt]

^Here's a humble take from a noob.

Short version: Treasury yields have recently risen as a result of fundamental supply-demand factors and only a small part of this increase is from the technical issues mentioned in the WSJ article.

-----

During the 1907 liquidity crisis, people wondered if the size of the money (and moral authority) of JP Morgan et al was enough and if there were more efficient (and more widely mutualized) ways to deal with such liquidity crisis. Then the Federal Reserve was created. Now, the size of the potential commitments seems to be endless but there are developing technical issues that are liquidity related. The size of the US Treasury market is HUGE and it seems like the intermediation process through primary dealers is no longer adequate for liquidity purposes.

-----

As the supply of Treasury debt has soared in an inverted environment, primary dealers' balance sheet constraints have resulted in large and growing arbitrage opportunities which private market participants (hedge funds) have tried to exploit using very high leverage. When volatility hits, because of the value-at-risk framework, hedge funds tend to unwind their positions and, reflexively (and in counter-intuitive way?), this actually tends to increase volatility. This issue continues to be relevant and there is a macro-prudential discomfort for systemic risk. If and when volatility hits, the Fed has an almost limited set of "tools" to deal with this temporary noise but it's still an interesting issue (for private market participants).

 

The following 2 graphs are from a recent publication, data stops end 2022.

 

The following graph is from a report just released by government officials who can produce unusually euphemistic titles with more recent data, showing the same growing pains in primary dealers' balance sheet constraints.

 

The 'easy' way out, as mentioned in the WSJ article, would be to re-establish some kind of relaxation on the SLR rule in order to allow commercial banks (and consolidated primary dealers) to expand their balance sheet and absorb Treasuries but there are problems: 

1-This would mean continuing to allow private banks' balance sheet expansion ahead of underlying economic activity (just postponing the correction of imbalances)

2-This would mean to continue to allow banks to earn a significant (and growing) part of their return on assets from holding securities and not from making profitable loans to private market participants (the fundamental purpose of banks). Japan's banks have been on this trajectory for more than 20 years now and...

3-This would mean to re-ignite the fundamental factor behind the inflation with a lag that happened after Covid heroic monetary-fiscal measures

 

What's the point?

"I feel like he's trying to say something else that isn't such a mainstream take on it.  He makes the very rare (for journalists anyway) admission that "Yet the end-buyers of the debt are unlikely to disappear since government deficits automatically create the very savings that are then channeled into financial assets."

As a noob, i would submit that the above quoted statement only applies in selected circumstances, especially the automatic part.

 

[ValueArb]

Yet the end-buyers of the debt are unlikely to disappear since 
government deficits automatically create the very savings that 
are then channeled into financial assets.

 

This sounds like more Keynsiasm twaddle, like when Krugman said the economy would benefit if we paid people to dig holes and then fill them in again.

 

Deficits crowd out private investment and damages the economy. This is the truth but you'll never have a long career  as a government economist and reach the pinnacles if you say it. Instead to be a successful government economists you need to always justify increased government spending so your benefactors, the political class, can use that spending to reward their supporters who keep them in office. 

[gfp]

I'll go out on a limb and guess that ValueArb is not a big MMT guy

[UK]

https://www.barrons.com/articles/treasury-auction-bond-yields-stock-market-db08c04b

 

https://www.bloomberg.com/news/articles/2023-11-09/el-erian-says-2024-s-big-fear-is-credit-risk-as-fed-rate-peaks

 

 

[Ulti]

https://wealthtrack.com/financial-thought-leader-james-grant-on-the-investment-ramifications-of-the-new-era-of-higher-interest-rates/

[Cigarbutt]

On 11/9/2023 at 8:25 PM, UK said:

https://www.barrons.com/articles/treasury-auction-bond-yields-stock-market-db08c04b

The bid-to-cover ratio was 2.24.

In a context of a very high 'supply' of such securities. This requires to be interpreted into a wider context?

[TwoCitiesCapital]

So I was listening to a podcast of a value manager recently where he talks about one of the reasons of his having significantly high concentration in the portfolio is because historically most stocks have underperformed t-bills and he wants to concentrate on the handful of stocks that do so. 

 

I know I've had the debate here ad-nauseum of long stretches where bills/notes/bonds outperformed equities broadly, but I don't think I realized it was a big of a performance differential more broadly over time for most companies.

 

Most of the outperformance of broad equities can be attributed to fewer than 100 companies across history. You just don't see the underperformance in the indices because, by design, they're geared towards survivorship bias and the handful of companies that do outperform. 

 

Now that rates are nominally high relative to equities (and current inflation), seems it's pretty easy to beat t-bills going forward in fixed income. Take a little spread exposure in mortgages, corporates, high yield to increase yields 1-3% above bills and take a little govt duration exposure to lock some of that in for 2-4 years to hedge the spread exposure/falling rates components - and you have a high likelihood of outperforming t-bills over the next 3-5 years. Which apparently fewer than 1/2 of equities might be expected to do. 

 

I think I'm coming around to the idea of Blackrock flipping the 60/40 to 40/60 on a longer term basis. 

 

Focus heavily on bonds to get safe, reliable, high single digit returns, take index like exposure with ~1/2 of my equity exposure to lock in the bias of indices to those ~80-100 names, and then take individual positions in things like Exor/Fairfax/Altius to supplement and attempt to outperform those indices. 

[Red Lion]

21 hours ago, TwoCitiesCapital said:

So I was listening to a podcast of a value manager recently where he talks about one of the reasons of his having significantly high concentration in the portfolio is because historically most stocks have underperformed t-bills and he wants to concentrate on the handful of stocks that do so. 

 

I know I've had the debate here ad-nauseum of long stretches where bills/notes/bonds outperformed equities broadly, but I don't think I realized it was a big of a performance differential more broadly over time for most companies.

 

Most of the outperformance of broad equities can be attributed to fewer than 100 companies across history. You just don't see the underperformance in the indices because, by design, they're geared towards survivorship bias and the handful of companies that do outperform. 

 

Now that rates are nominally high relative to equities (and current inflation), seems it's pretty easy to beat t-bills going forward in fixed income. Take a little spread exposure in mortgages, corporates, high yield to increase yields 1-3% above bills and take a little govt duration exposure to lock some of that in for 2-4 years to hedge the spread exposure/falling rates components - and you have a high likelihood of outperforming t-bills over the next 3-5 years. Which apparently fewer than 1/2 of equities might be expected to do. 

 

I think I'm coming around to the idea of Blackrock flipping the 60/40 to 40/60 on a longer term basis. 

 

Focus heavily on bonds to get safe, reliable, high single digit returns, take index like exposure with ~1/2 of my equity exposure to lock in the bias of indices to those ~80-100 names, and then take individual positions in things like Exor/Fairfax/Altius to supplement and attempt to outperform those indices. 

I’m assuming this advice is using tax advantaged accounts? Fixed income seems attractive to me, but after tax not nearly as much other than trading a distressed debt or maybe gambling on a very long duration bond for the price swings. 
 

[TwoCitiesCapital]

6 hours ago, RedLion said:

I’m assuming this advice is using tax advantaged accounts? Fixed income seems attractive to me, but after tax not nearly as much other than trading a distressed debt or maybe gambling on a very long duration bond for the price swings. 
 

 

Yes - for tax deferred or tax free savings. 

 

That's the bulk of my savings outside of home equity and Bitcoin. 

[tede02]

One opportunity I've found for individuals in fixed income is with new-issue brokered CDs. As I understand it, a broker (like Fidelity or Schwab) will put an offering on their platform that doesn't settle for up to 30 days into the future for example. The opportunity exists when there is a big move in rates. For instance, the 5-year treasury was just under 5% at the beginning of November. Rates took a hard swing down and now the 5-year treasury is hanging around 4.5%. CDs are usually close to treasuries. But on Fidelity's platform, you can presently buy a Wells Fargo non-callable 5-year CD that yields 5.05%. It doesn't settle out until 11/21. I grabbed some this morning.

[CorpRaider]

10 hours ago, tede02 said:

One opportunity I've found for individuals in fixed income is with new-issue brokered CDs. As I understand it, a broker (like Fidelity or Schwab) will put an offering on their platform that doesn't settle for up to 30 days into the future for example. The opportunity exists when there is a big move in rates. For instance, the 5-year treasury was just under 5% at the beginning of November. Rates took a hard swing down and now the 5-year treasury is hanging around 4.5%. CDs are usually close to treasuries. But on Fidelity's platform, you can presently buy a Wells Fargo non-callable 5-year CD that yields 5.05%. It doesn't settle out until 11/21. I grabbed some this morning.

 Interesting.  Thanks.

[tede02]

I think I mentioned this previously, but DCMB still looks interesting. It's basically a portfolio of CMBS managed by one of the best firms in this space (Doubleline). The portfolio is virtually all AAA with an average YTM of nearly 7% and duration of 1. Probably will add to my holding as some T-bills mature. 

[lnofeisone]

One opportunity I'm tracking is municipals zeros. Huge caveat:  If you are in DC (as I am), tax exampt muni from any state is tax exempt. You may need to account for your state ore residence.

 

There are few zerost hat have 30 years to maturity and YTW is 5+% (here is one that I have CUSIP 54601TAA4) . If you are in high bracket, that's roughly 7% pre-tax. Given the duration on these things, any interest rate movement down will net you cap gain. So worst case, you hold to maturity and collect 5%. Best case, there will be interest rate move down, and you get capital gain. Because it's a tax exempt muni, you don't have to worry about taxes on accrued interest. 

 

This one is callable in 2029 and if that happens you get 13%/year return at today's prices.  

[TwoCitiesCapital]

3 hours ago, lnofeisone said:

One opportunity I'm tracking is municipals zeros. Huge caveat:  If you are in DC (as I am), tax exampt muni from any state is tax exempt. You may need to account for your state ore residence.

 

There are few zerost hat have 30 years to maturity and YTW is 5+% (here is one that I have CUSIP 54601TAA4) . If you are in high bracket, that's roughly 7% pre-tax. Given the duration on these things, any interest rate movement down will net you cap gain. So worst case, you hold to maturity and collect 5%. Best case, there will be interest rate move down, and you get capital gain. Because it's a tax exempt muni, you don't have to worry about taxes on accrued interest. 

 

This one is callable in 2029 and if that happens you get 13%/year return at today's prices.  

 

Aren't the capital gains on munis taxed at cap-gains rate though? So any gains outside of the amortized cost basis would be subject to tax in the event of falling rates? 

 

Not that this is different for any other type of investment, just trying to figure out what is, verse, isn't taxable in munis since I typically only play in tax-free/tax deferred accounts and don't really consider them. 

 

 

Edited November 16, 2023 by TwoCitiesCapital

[lnofeisone]

That's exactly right. If you (I) buy today, you get the 5% tax free + any appreciation will come at cap gains rate. 

[lnofeisone]

I should add - if you are going to do it in tax-free/deferred accounts, then you should go with taxable munis (I like Vogtle here). Tax-exempt and treasuries don't make sense in these accounts. 

[TwoCitiesCapital]

31 minutes ago, lnofeisone said:

I should add - if you are going to do it in tax-free/deferred accounts, then you should go with taxable munis (I like Vogtle here). Tax-exempt and treasuries don't make sense in these accounts. 

 

Sure - would probably just do ZROZ or a long-duration corporate fund in my tax deferred accounts - was just curious how the tax treatment for munis worked. 

 

Some day I'll have taxable savings to trade with, but at the moment most of that taxable savings goes to BTC and my mortgage. 

[tede02]

I bought a fair amount of TIPS when real yields surged over the last few months. But I'm starting to wonder if nominal treasuries (bought at the same time) will end up being better over 5-10 years. Inflation really appears to be coming down whether you're looking at the CPI or ongoing reports from retailers that are consistently seeing sales weakening (Walmart, Home Depot, Best Buy, etc.). Additionally, rents are flat and even contracting in some data which isn't yet reflected in the CPI. Also seeing weakness in commodity prices (oil in particular). Another two months of this will create a pretty convincing trend. 

[mattee2264]

I'm inclined to stay in short term bonds. While inflation will probably continue to come down I would expect the yield curve to steepen especially as concerns over US government debt begin to build.