It looks good- on paper
July 2, 2023 – Weekly Comment
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…as the Crisis mood congeals, people will come to the jarring realization that they have grown helplessly dependent on a teetering edifice of anonymous transactions and paper guarantees. Many Americans won’t know where their savings are, who their employer is, what their pension is, or how their government works. …Debtors won’t know who holds their notes, homeowners who owns their mortgages, and shareholders who runs their equities – and vice versa.
-The Fourth Turning (pg 274)
“Bears make you smart – but bulls make you money,” said BMO Cap Mkts Brian Belski, who recently raised his end-year target to 4550 from 4300. (Tweet by Gunjan Banerji)
[that’s the guy who runs your equities. SPX ended week at 4450]
In Sunday’s FT, Pimco’s Dan Ivascyn said the company is preparing for a “harder landing”.
“The more tightening that people [CBs] feel motivated to do, the more uncertainty around these lags and the greater risk to more extreme economic outlooks,” Ivascyn told the FT, noting that when rates have risen in the past, a lag of five or six quarters for the impact to be felt has been ‘the norm’. The market is “too confident in the quality of central bank decisions.”
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The Supreme Court’s decision that Biden doesn’t unilaterally have to power to forgive student debt was a hot topic last week. Freely extended loans which contributed to runaway tuition at Universities will supposedly now have to be serviced. There’s a lot of whining about unfairness. Many debtors feel that higher education should be free so they shouldn’t have to pay their contractual loans. (And besides, Biden promised!) On the other side many taxpayers ask why THEY should have to shoulder the burden of paying for gender studies classes (valuable though they may be). I think that debt forgiveness on a random and mass scale is damaging in that many families and individuals have scrimped and saved to pay for higher education and now find incentives have been toppled and those that did sacrifice have come to the jarring realization that meeting obligations is a suckers game. But would taxpayers really be harmed if the debt vanished? I personally have little connection or understanding of where my own taxes go. Except for the guys that collect the trash. That one I get. I don’t think my tax bill will immediately increase because some kid’s debt goes away. On the other hand, the US Fed’l government is running massive deficits financed by bond issuance. This debt is easily placed, in part because buyers, domestic and foreign, are confident in US institutional law. If you feel as if we’re in the Fourth Turning, you might have a nagging concern that we’ve reached the “teetering edifice of anonymous transactions and [questionable] paper guarantees.”
This week the US 5y rose 13.3 bps to 4.128% and the 10y 7.3 bps to 3.815%. PCE prices yoy reportedly rose 3.8% with Core 4.6%. So the 5y is above headline but below core, and the ten year is equal to headline.
Are we at restrictive levels? Apparently PIMCO thinks so. It seems a rather stark repudiation when Powell, just this week, repeated that markets have become much faster adjusting to policy, while Ivascyn cites a rule-of-thumb five to six quarters for the economy. Of course, both can be right; markets don’t necessarily reflect the economy at a given point. Let’s say that lags have shortened. Just under a year ago, at the July 27, 2022 FOMC, the Fed raised the FF target to 2.25 to 2.5%. On July 28 PCE prices were +6.8% yoy. Have we felt the full impact of this rate having more than doubled in less than four quarters? In September, when the Fed hiked to 3.0-3.25%, PCE prices were +6.2%. Now FF are 5.0-5.25% and PCE prices are 3.8%. Winning.
In my estimation, the risk is rising that creditors will not be as liberal in extending credit to the US as they’ve recently been. Currently, the US 10y inflation-indexed note yield is around 1.6%, and the ten-year breakeven is about 2.2%. This year the 10y breakeven, which reflects long term inflation expectations, has been between 2.12 and 2.52%. In the past three months the range is just 2.17 to 2.32%. Quite tame. According to the St Louis Fed the peak was 2.98% in April 2022. In 2018 the range from January to mid-Nov was 2.00 to 2.17%, ending the year at 1.71%. Real yields may yet increase.
On the SOFR curve, the weakest contracts this week were SFRM4, down 26.0 to 9524, and SFRU4 down 27.5 to 9563. The May highs in these contracts were 9696 and 9722, so from the May 4 high to Friday M4 is down 172 bps and U4 is down 159. The Fed (helped by data) has been incredibly successful at convincing the market that bank failures were a mere blip on the radar (perhaps analogous to a UFO, but that’s another story) and that the Fed will maintain restraint until inflation hits 2%. Ever since I have been in this business there are intermittent cries that the Fed is risking its credibility. Clearly the Fed has made many mistakes, but in terms of credibility, I know that if the Fed hikes, funding costs increase. Forward rates may go up or down, but if you’re a short term borrower, you feel actual credible pain.
Consider SFRH4, which settled 9488.5 or 5.115%. This contract is 3 to 4 quarters past the last Fed hike which occurred May 3, so you might say it captures the lag. Pre-SVB the low settle was 9480.5 on March 8. The subsequent high print was 9684 on March 24 (~200 higher than now) and the high settle 9653.5 on May 4 (165 higher than Friday’s settle). At 5.115% this contract is above every inflation measure except Core CPI (5.3% last). Headline CPI is 4.0%, Avg Hourly Earnings 4.3%, NY Fed’s Underlying Inflation 3.5%, Atlanta Fed Sticky Prices 4.1%, Friday’s PCE 3.8% and Core 4.6%.
FFQ3 settled 9472 or 5.28%. The Fed Effective had been 5.08% through the first half of June, but 5.07% since June 20. Call it 5.075 or 9492.5. A hike of 25 at the July 26 FOMC would mean 5.325% or 9467.5. Therefore the market is now about 80% sure of a hike. This week brings the employment report with an expected UE rate of 3.7%, NFP 225k and Avg Hourly Earnings 4.2% yoy.
Just a couple of cherry-picked quotes to wind up:
From June 25 FT (credit bubble bulletin)
‘In New York, buildings are selling for less than the value of the land they sit on,’ said Will Silverman, managing director at Eastdil Secured… ‘We are seeing prices lower than they have been in 20 years in absolute dollar terms.’
From June 25 WSJ. [Remember ‘covenant-lite’? Good times… ]
So far this year, companies such as American Airlines and Six Flags have issued $91 billion of speculative-grade bonds, according to PitchBook LCD, up 35% from the year-earlier period… But those bonds look different than during the borrowing boom of recent years. A full 62% of them have been secured—backed by collateral—offering investors greater protections if the company defaults. That is easily the highest percentage in records going back to 2005. The average maturity of the junk debt has also shrunk to 6.1 years, down from an average of 7.4 years over the previous decade…”
The market is too confident in the quality of central bank decisions.
| 6/23/2023 | 6/30/2023 | chg | ||
| UST 2Y | 474.8 | 487.2 | 12.4 | |
| UST 5Y | 399.5 | 412.8 | 13.3 | |
| UST 10Y | 374.2 | 381.5 | 7.3 | |
| UST 30Y | 382.1 | 385.2 | 3.1 | |
| GERM 2Y | 310.6 | 319.6 | 9.0 | |
| GERM 10Y | 235.3 | 239.2 | 3.9 | |
| JPN 30Y | 121.4 | 123.5 | 2.1 | |
| CHINA 10Y | 267.4 | 264.0 | -3.4 | |
| SOFR U3/U4 | -124.0 | -103.0 | 21.0 | |
| SOFR U4/U5 | -73.5 | -83.0 | -9.5 | |
| SOFR U5/U6 | -14.5 | -21.0 | -6.5 | |
| EUR | 108.95 | 109.13 | 0.18 | |
| CRUDE (CLQ3) | 69.16 | 70.64 | 1.48 | |
| SPX | 4348.33 | 4450.38 | 102.05 | 2.3% |
| VIX | 13.44 | 13.59 | 0.15 | |
Finally, an Alan Arkin scene from Little Miss Sunshine
