October saw the US Treasury bond market fall sharply, something we haven’t seen in two years with yields rising to multi-decade highs due to inflation, an aggressive Federal Reserve, a strong internal, and a mountain of new market offers. However, it is too early to call it a bubble according to The Street’s Martin Baccardax.
Call it collapse. Call it the end of “free money.” Call it the result of a recession exit that would make Houdini envious.
Woody Allen makes a beautiful analogy about love at the end of ‘Annie Hall,’ an old comedy about two women complaining about their Catskills resort.
“The food here is terrible,” one told another. “Yes, I know. And such small portions,” agreed his friend.
Understanding that paradox provides a better view of what is happening (and, perhaps more importantly, what is not happening) in the world’s largest financial market.
Treasuries may seem unattractive at best and extremely weak, but that does not change the nature of their demand, which remains relatively constant regardless of the yields on offer.
They may not taste good, but everyone likes big portions.
Data released on Wednesday showed that foreign investors increased their holdings of US Treasuries to the highest level in 18 months in August, raising $7.707 trillion of Uncle Sam’s bonds to a month in which the 10-year yield did not move more than 3 basis points. within 30 calendar days.
Even a more “weak” auction of $35 billion in 10-year Treasuries earlier this month, as interest rates rose, attracted $87.5 billion in total bids, with foreign investors They took almost 60% of the total.
function over form
The $25 trillion Treasury bond market plays an incredibly important role in financial arithmetic by providing a proxy for “risk-free” interest rates that can be applied to any type of asset.
On top of that, foreign buyers, usually central banks, simply exchange dollars earned in trade with the United States (without interest) for Treasury bonds backed by the same dollars (which now offer no risk yield for health).
Japan, the biggest foreign buyer, increased its purchases in August at an annual rate of 3.4%, to $1.116 trillion, even as its central bank plans to raise government bond yields to Japan.
It’s also worth noting that Japan’s exports to the United States rose 5.1% in August, boosting its trade surplus by 38.2% to 650.60 billion yen ($4.33 billion).
Those numbers, while unreliable, go a long way toward debunking the idea that Treasury markets are some kind of “bubble” that is likely to burst if yields continue to rise.
While stocks, currencies, cryptocurrencies, and indeed corporate debt, may offer the promise of returns that are never guaranteed, the two key promises that bonds carry remain: that the government will pay you interest on the money. that you borrowed from him and you. it is completed when the bonds mature, and never deviate.
Value maturity, not the market
The loss of market value, as shown in Bank of America’s third-quarter earnings report, may cause some alarm, but CEO Brian Moynihan rightly noted that the bank’s bond holdings are the result of putting depositors’ money (such as trade balances) and most assets are in a held-to-maturity account with little or no risk. “These are government-guaranteed securities,” Moynihan told CNBC.
All that said, no one knows where we go from here, as seen in Thursday’s speech by Federal Reserve Chairman Jerome Powell at the Economic Club of New York.
“We are looking at recent data that shows the strength of economic growth and labor demand,” Powell said, after the weekly jobless claims data showed another surprise. decrease in the number of Americans filing for unemployment benefits. . Department of Labor figures released earlier this month also noted that 336,000 new jobs were added to the economy in September.
That economy is now growing at a rate of 5.4%, according to the Atlanta Federal Reserve’s GDPNow forecasting tool, contradicting the conventional belief on Wall Street that the United States is already in recession.
All progress, of course, comes at a price, and inflationary pressures have risen again, as evidenced by the larger-than-expected jump in September retail sales and the hawkish rhetoric from Federal Reserve officials heading into next month’s monetary policy meeting.
CME Group’s FedWatch suggests a 48.5% chance of a rate hike in January, while the odds of an early move in December stand at 37%. However, traders expect the Federal Reserve to hold steady between 5.25% and 5.5% next month in Washington.
Bonds will also come under pressure from several other factors, including concerns about the fate of US fiscal policy, ongoing debates over the debt ceiling, the ongoing debate over spending cuts in Washington, and the inability of Republican lawmakers to elect a speaker of the House. , all of which combine to make Treasuries less attractive in the short term.
Pile of supplies
The Federal Reserve also sold about $75 billion a month in Treasury, agency, and mortgage-backed bonds back to the market as part of its “quantitative tightening” program.
This allowed the Federal Reserve to reduce the size of its $7 trillion balance sheet while raising market interest rates, which in turn supported a higher level of its policy rate.
“Financial conditions have tightened significantly in recent months, and long-term bond yields have been a major factor in this tightening,” Powell added in a nod to the recent rise in interest rates. proceeds of the Treasury. “Further evidence of continued above-trend growth, or that labor market tightness is not easing, could put further inflation gains at risk and justify a further tightening of monetary policy.”
But here’s what won’t happen: a collapse in Treasury bond prices.
As long as countries do business with the United States and hedge funds need assets to offset their risks, or pension funds need to match their long-term liabilities with an asset that doesn’t exist risk, there is always – always – strong demand for government-backed funds and trade in the world reserve currency.
