• 288 days Will The ECB Continue To Hike Rates?
  • 288 days Forbes: Aramco Remains Largest Company In The Middle East
  • 290 days Caltech Scientists Succesfully Beam Back Solar Power From Space
  • 690 days Could Crypto Overtake Traditional Investment?
  • 695 days Americans Still Quitting Jobs At Record Pace
  • 697 days FinTech Startups Tapping VC Money for ‘Immigrant Banking’
  • 700 days Is The Dollar Too Strong?
  • 700 days Big Tech Disappoints Investors on Earnings Calls
  • 701 days Fear And Celebration On Twitter as Musk Takes The Reins
  • 703 days China Is Quietly Trying To Distance Itself From Russia
  • 703 days Tech and Internet Giants’ Earnings In Focus After Netflix’s Stinker
  • 707 days Crypto Investors Won Big In 2021
  • 707 days The ‘Metaverse’ Economy Could be Worth $13 Trillion By 2030
  • 708 days Food Prices Are Skyrocketing As Putin’s War Persists
  • 710 days Pentagon Resignations Illustrate Our ‘Commercial’ Defense Dilemma
  • 711 days US Banks Shrug off Nearly $15 Billion In Russian Write-Offs
  • 714 days Cannabis Stocks in Holding Pattern Despite Positive Momentum
  • 715 days Is Musk A Bastion Of Free Speech Or Will His Absolutist Stance Backfire?
  • 715 days Two ETFs That Could Hedge Against Extreme Market Volatility
  • 717 days Are NFTs About To Take Over Gaming?
What's Behind The Global EV Sales Slowdown?

What's Behind The Global EV Sales Slowdown?

An economic slowdown in many…

Market Sentiment At Its Lowest In 10 Months

Market Sentiment At Its Lowest In 10 Months

Stocks sold off last week…

How Millennials Are Reshaping Real Estate

How Millennials Are Reshaping Real Estate

The real estate market is…

  1. Home
  2. Markets
  3. Other

Bond Beatings Continue

The beatings are continuing, and apparently morale really does improve with such treatment. Consumer Confidence for June vaulted to the highest level since early 2008, at 81.4 handily beating the 75.1 consensus. Both "present situation" and "expectations" advanced markedly, although the "Jobs Hard to Get" subindex barely budged. It is unclear what caused the sharp increase, since gasoline prices (one of the key drivers, along with employment) also didn't move much and equity prices had been steadily gaining for some time. It may be that the rise in home prices is finally lifting the spirits of consumers, or it may be that credit is finally trickling down to the average consumer.

Whatever the cause, it is not likely to prevent the rise in money velocity that is likely under way, driven by the rise in interest rates. Between the rise in home prices - the Case-Shiller home price index rose a bubble-like 12.05% over the year ended April, and Existing Home Sales median prices have advanced a remarkable 14.1% faster than core inflation (a near record, as the chart below shows) over the year ended in May. (Lagged 18 months, such a performance suggests about a 3.9% rise in Owners' Equivalent Rent for 2014).

Existing Home sales Median Prices

But of course, we must fear deflation more than ever!

The nonsense about deflation is incredible to me. Euro M2 growth hasn't been this high (4.73% for year ended April) since August of 2009. Japanese M2 growth hasn't been this rapid (3.4% for year ended May) since May 2002. US money supply is "only" growing at 6.5% or so, down from its highs but still far too fast for a sluggishly-growing economy to avoid inflation unless velocity continues to decline. But you don't have to be a monetarist to be concerned about these things. You only need to be able to see home prices.

Core inflation in the US is being held down by core goods, as I have recently noted. In particular, CPI for Medical Care just recorded its lowest year-on-year rise since 1972, and Prescription Drugs (1.32% of CPI and an important part of core goods) declined on a y/y basis for the first time since 1973. The chart below (source: Bloomberg) illustrates that as recently as last August, that category was rising at a 4.0% pace.

US CPI Prescription Drugs

Now, I suspect that this has something to do with Obamacare, but no one seems to know the full impact of the law. Keep in mind that Medical Care in CPI excludes government spending on medical care. So, one possible narrative is that the really sick people are leaving for Obamacare while the healthy people are continuing to consume non-governmental health care services. This would be a composition effect and would imply that we should start looking at CPI ex-medical for a cleaner view of general price trends. I have no idea if this is what is happening, but I am skeptical that prescription meds are about to decline in price for an extended period of time!

But that's the bet: either core inflation is going to go up, driven by things like housing, or it's going to go down, driven by things like prescription medication. Place your bets.

Equity prices recovered today, but bond prices continued to slide into the long, dark night. For a really incredible picture, look at the chart below (source: Bloomberg), which shows the multi-decade decline in 10-year yields on a log scale, culminating in the celebrated breakout below that channel. Incredibly, the recent selloff has yields back to the midpoint of the channel and not outrageously far from a breakout on the other side!

US Treasury Chart

Incidentally, students of bond market history may be interested to know that the selloff has now reached the status of the worst ever bond market selloff (of 90 days or less) in percentage terms. Since May 2nd, 10-year yields have risen from 1.626% to 2.609%, a 98.3bp selloff which means that yields have risen 60.5% in less than two months.

And we are probably not done yet. I wrote about a month ago about the "convexity trade," and I made the seemingly absurd remark that "This means the bond market is very vulnerable to a convexity trade to higher yields, especially once the ball gets rolling. The recent move to new high yields for the last 12 months could trigger such a phenomenon. If it does, then we will see 10-year note rates above 3% in fairly short order."[emphasis in original] Incredibly, here we are with 10-year yields at 2.61%, up 60bps over the last month, and that statement doesn't seem quite so crazy. As I said: I have seen it before! And indeed, the convexity trade is partly to blame for what we are seeing. I asked one old colleague today about convexity selling, and here was his response:

"massive - the REITs are forced deleveraging and there are other forced hands as well. The real money guys are too large and haven't even sold yet - no liquidity for them. The muni market has basically crashed and at 5% yields in muni there is huge extension risk on a large amount of bonds: something like $750bln in bonds go from 10-year to 30-year maturities as you cross 5%." (name withheld)

Now, I am not a muni expert so I have no idea what index it is I am waiting to see cross 5%...but what is interesting about the response is that (according to this one source, anyway) the mortgage community (what he refers to as the "real money guys") haven't even been selling in large amounts yet.

Lots of bad things have happened to the market, but they really aren't big bad things. In fact, I move that we stop using the term "perfect storm" to mean "modestly bad luck, but I had a lot of leverage." The Fed was never going to be aggressively easy forever, and as various speakers have pointed out recently they didn't exactly promise to be aggressively tightening any time soon. There is bad news on the inflation front, but the market is clearly not reacting to that. Some ETFs have had some liquidity issues, and emerging markets have tumbled, and there was a liquidity squeeze in China. But these are hardly end-of-the-world developments. What makes this a really bad month is the excess leverage, combined with the diminished risk appetite among primary dealers who have been warned against taking too much "proprietary risk."

And markets are mispriced. Three-year inflation swaps imply that core inflation will be only 1.9% compounded for the next three years (the 1-year swap implied 1.6%; the 2y implies 1.75%). That is more than a little bit silly. While I have not been amazed that the convexity trade drove yields very high, and probably will drive them higher, it has surprised me that inflation swaps and inflation breakevens have continued to decline. Still, investors who paid heed to our admonition to be long breakevens rather than TIPS have done quite a bit better, as the chart below (source Bloomberg), normalized to February 25th (the date of one of our quarterly outlook pieces) illustrates.

breaksvstips

As the bond selloff extends, I don't think TIPS will continue to underperform nominal bonds. I believe breakevens, already at low levels (the 10-year breakeven, at 1.97%, is lower than any actual 10-year inflation experience since 1958-1968), will be hard to push much lower, especially in a rising-yield environment.

 

Back to homepage

Leave a comment

Leave a comment