45 and Counting
Doug Nolan
Forty-five basis points.
That’s the jump in 10-year yields since September 17th, the day before the FOMC meeting (and 50 bps rate slash).
Benchmark MBS yields are up 59 bps.
October 10 – Bloomberg (Catarina Saraiva and Amara Omeokwe):
“Three Federal Reserve policymakers on Thursday were unfazed by a higher-than-forecast September inflation report, suggesting the US central bank can continue lowering interest rates…
‘Month to month, there’s wiggles and bumps in the data, but we’ve seen this pretty steady process of inflation moving’ downward, New York Fed President John Williams said…
‘I expect that that will continue.’ Williams added he thought it would be appropriate to ‘continue the process of moving the stance of monetary policy to a more neutral setting over time.’”
Is the Fed feeling lucky?
The problematic scenario would have inflation reaccelerating, as it has often done historically following the initial venting of inflationary pressures.
And with the amount of debt outstanding coupled with unprecedented bond market speculative leverage, a Fed forced to reverse course and tighten conditions would risk the nightmare scenario.
Critical analysis can be disregarded or completely ignored.
But there will be consequences from the Fed aggressively cutting rates despite extraordinarily loose financial conditions and market Bubbles.
Investment-grade spreads (to Treasuries) ended the week at 81 bps, one basis point above the low from June 30, 2021.
More to the point, it is also within a basis point of the low all the way back to March 15, 2005, a period notable for being at the heart of mortgage finance Bubble excess.
Looking back to that period of excessively loose financial conditions, Total Mortgage Credit expanded a record $400 billion during Q1 2005 - on its way to 2005’s all-time record annual increase of $1.466 TN, or 13.8%.
For those wondering why I go on and on over the Fed slashing rates despite such loose conditions and Bubble excess, I’ve seen this movie before.
The Fed cut rates in late 2002, a year when Total Mortgage Credit expanded a record $909 billion, or 12.2%.
The Fed then cut rates down to 1.0% during 2003, the year mortgage debt growth exceeded $1 TN for the first time.
By March 2005, Total Mortgage Credit had expanded $3.321 TN, or 44%, in three years.
Home prices (Case Shiller) inflated 9.6% in 2002, 9.8% in 2003, and 13.6% in 2004.
Financial conditions seemingly couldn’t have been easier, with investment-grade corporate spreads in early 2005 the narrowest since the summer of 1998 exuberance (pre-Russia/LTCM collapses).
The S&P500 had rallied about 50% off 2002 lows.
And where, you might ask, was the policy rate set with such rampant Credit growth and asset Bubble inflation? 2.5%.
I titled the March 21, 2005, CBB: “Booming Broker Finance and Market Tops.”
That post delved into the week’s spectacular earnings reports from the major Wall Street firms:
“I would argue that there are today no better indicators of broad-based Liquidity Excess and Credit Availability than those provided by the operating success of Wall Street.”
History rhymes.
Q3 2024 earnings season for the big “money center banks” got started Friday with the nation’s behemoth.
It’s worth noting that JPMorgan’s $67 billion asset growth boosted its y-t-d expansion to $335 billion, or 11.5% annualized, to a record $4.210 TN.
The KBW Bank Index jumped 3% Friday to a 30-month high, increasing y-t-d returns to 27.5%.
The 1.9% gain of the Broker/Dealers (NYSE Arca) boosted 2024 returns to 31.0%, with the index closing Friday at an all-time high.
The financial boom is certainly not limited to banking.
October 10 – Financial Times (Brooke Masters):
“BlackRock’s assets under management topped $11tn for the first time… as the world’s largest money manager benefited from a rally in markets and attracted record new cash from investors.
The inflows helped push revenues up 15% to $5.2bn…
Improved margins lifted the group’s net income to $1.63bn…
BlackRock’s chief executive Larry Fink predicted his firm’s growth would continue.
‘We expect momentum to further build to year’s end and into 2025,’ he told analysts on an earnings call.
‘Investors will have to re-risk to meet their long-term return needs.’
‘Our strategy is ambitious and our strategy is working…
I have never felt more optimistic…
Capital markets are becoming a bigger and bigger part of the global economy.’”
More Blackrock details from Reuters (Arasu Kannagi Basil and Davide Barbuscia):
“Total net inflows hit a quarterly record of $221.18 billion, up from $2.57 billion a year ago.
A majority of the long-term inflows were captured by ETFs, at $97.41 billion.”
I’m still processing the news of a record $500 billion flowing into ETFs during Q3.
Signs of manic exuberance and financial excess are everywhere.
Money Market Fund Assets (MMFA) expanded another $11 billion last week to a record $6.474 TN.
MMFA surged $340 billion over the past 10 weeks, or 29% annualized, and $766 billion, or 13.4%, over the past year.
In one historic monetary inflation, MMFA inflated $1.916 TN, or 42%, since the Fed began its “tightening” cycle in March 2022 – and $2.840 TN, or 78%, since the onset of the pandemic (2/21/2020).
I believe the expansion of “repo” borrowings to fund leveraged speculation (i.e., the “basis trade”) is a primary factor underpinning this epic monetary inflation.
And similar to 2005, when rapid mortgage Credit growth fueled powerful real estate price inflation with limited effect on CPI, the massive inflation in “repo” Credit and MMFA is today having a greater impact on financial markets than consumer prices.
But there are important factors today supporting higher inflation, which were not issues during the mortgage finance Bubble period.
October 8 – New York Times (Alan Rappeport):
“America’s federal budget deficit rose to $1.8 trillion in the 2024 fiscal year, reaching the highest level in three years, according to new Congressional Budget Office estimates…
The increase from last year’s $1.7 trillion deficit came as tax revenue failed to keep pace with the rising costs of government programs and the mounting interest on the national debt…
The federal government spent $6.8 trillion in 2024, a 10% increase from the prior year.
A big driver of that was a $240 billion increase in interest costs, which surged 34% from last year because of high interest rates.
Spending on Social Security and Medicare benefits also increased substantially.”
It's wishful thinking by the Fed to expect consumer inflation to steady at the 2% target, while Wall Street is too optimistic that policy rates and bond yields are heading significantly lower.
There’s way too much complacency that deficits don’t matter.
It’s worth noting that they now matter in the UK, where spiking yields doomed a new Prime Minister and forced belt tightening.
UK gilt yields rose another eight bps this week – up 67 bps y-t-d - to a 13-week high of 4.21%.
And speaking of “deficits do matter.”
October 11 – Bloomberg (William Horobin):
“Fitch Ratings put France on negative outlook a day after the government presented its 2025 budget, delivering a rapid critique of Prime Minister Michel Barnier’s efforts to deal with a sharp deterioration in public finances.
The ratings firm’s reproach comes after it already downgraded France to AA- from AA in April last year, a credit assessment it shares with the the UK and Belgium.
‘Fiscal policy risks have increased since our last review,’ Fitch said…
‘This year’s projected fiscal slippage places France in a worse fiscal starting position, and we now expect wider fiscal deficits, leading to a steep rise in government debt towards 118.5% of GDP by 2028.’”
French yields rose five bps this week to a 10-week high 3.04%.
French yields have jumped 48 bps y-t-d, with the spread to German bunds closing the week at 78 bps, near the widest level since European bond crisis year 2012.
While on the subject of fiscal problems and bond yields, Japanese “JGB” yields jumped seven bps this week to 0.95% - the high since August 1st.
Few countries can these days outdo the U.S. when it comes to egregious deficit spending.
And no government has as many of its debt securities held by levered speculators.
This ensures latent fragility.
We can reasonably assume that “basis trade” leverage ramped up into what the market assumed would be the start of an aggressive Fed easing cycle.
After rates were slashed on September 18th, the rates market was pricing a 2.88% December 2025 Fed funds rate – implying 195 bps of additional cuts by the end of next year.
This rate rose another 15 bps this week to 3.34% – with rate cut expectations trimmed to 149 bps.
It appears the highly levered bond market is today especially vulnerable to upside inflation surprises.
With the Atlanta Fed GDPNow forecast up to 3.22%, it’s increasingly difficult to dismiss the risk of overheating.
“AccuWeather preliminarily estimates the total damage and economic loss from historic Hurricane Milton will be between $160 billion and $180 billion…
Hurricane Helene’s estimated total damage and economic loss of $225-250 billion.”
I believe climate change has created unappreciated inflation risks.
While these two ferocious hurricanes will create an initial hit on economic activity, spending for clean-up and rebuilding will be massive.
And this comes with tight labor markets.
Moreover, we can assume millions of households will up their spending on backup power and emergency preparations.
“Generac Runs Low on Portable Generators After Storms.”
Does a steamy Gulf of Mexico now create perpetual serious hurricane risk for an alarmingly large swath of the country and tens of millions of households?
But perhaps the greatest inflation risks lurk internationally.
China’s Shanghai Composite was down 3.6% this week, with the growth oriented ChiNext Index down 3.4%.
Wednesday headline: “Chinese Stocks Tumble Most Since 2020 on Stimulus Skepticism.”
Skepticism is understandable, as is sentiment that swings between “things are falling apart” and “major lifesaving stimulus on the way.”
Bubble deflation in China has gained significant momentum.
Only massive stimulus can hold crisis dynamics at bay.
After a couple years of relatively measured stimulus, frenzied markets crave evidence that Beijing is readying the bazookas.
Beijing is swamped with myriad conflicting Bubble problems, including wild stock market speculation.
Officials may initially hesitate to announce the momentous stimulus markets are demanding.
But until proven otherwise, I’ll assume Xi will do whatever it takes to reflate the Chinese economy.
I just don’t see tolerance in the current fraught geopolitical backdrop for risking the consequences of further Bubble deflation.
This could significantly reduce China’s role in fostering global disinflation, while raising the odds for inflationary surprises.
October 12 – Bloomberg:
“China promised new measures to support the property sector and hinted at greater government borrowing to shore up the economy, as authorities seek to put a floor under the country’s growth slowdown.
Local governments will be allowed to use special bonds to buy unsold homes, Finance Minister Lan Fo’an announced at a briefing Saturday…
He hinted at room for issuing more sovereign bonds and vowed to relieve the debt burden of local governments, signaling a possible rare revision to the budget that could come in the next few weeks.
‘The central government still has quite large room to borrow and increase the deficit,’ Lan said…
While Lan fell short of putting a price tag on any additional stimulus — potentially disappointing investors — the measures announced were largely in line with economists’ expectations of steps to ease the property sector crisis and debt woes that have forced local governments to tighten their belts.”
October 11 – NBC (Monica Alba, Andrea Mitchell, Mosheh Gains, Carol E. Lee and Courtney Kube):
“U.S. officials believe Israel has narrowed down what they will target in their response to Iran’s attack, which these officials describe as Iranian military and energy infrastructure.
There is no indication that Israel will target nuclear facilities or carry out assassinations, but U.S. officials stressed that the Israelis have not made a final decision about how and when to act.
The U.S. does not know when the response could come but officials said the Israeli military is poised and ready to go at any time once the order is given.”
Israel is seemingly poised for a major attack on Iran, while the U.S. election is only four weeks away.
I expect the geopolitical backdrop to be an ongoing source of inflation risk.
In the near-term, a strike on Iranian oil infrastructure would spark fears of crude supply shocks and a price spike.
Interestingly, the MOVE (bond market volatility) Index traded this week to the high (124) since the first week of January.
And rumblings of repo market instability have begun to emerge.
October 11 – Reuters (Gertrude Chavez-Dreyfuss):
“A sharp steady rise in overnight repurchase agreements is overwhelming banks that serve as middlemen for such short-term borrowings in U.S. government securities, threatening to fuel major funding pressure at the end of every quarter and year.
The market for so-called repos allows banks to borrow money quickly and cheaply when they need cash, and lend with little risk.
Hedge funds and Wall Street financial firms rely on the roughly $4 trillion repo market to finance daily trades, and any disruption could force them to cut holdings…
Repo rates jump when banks pull away from acting as middlemen at quarter- and year-ends due to higher balance sheet costs required at those times for reporting purposes.
That happened at the end of the third quarter on Sept. 30.
The secured overnight financing rate (SOFR), the cost of borrowing short-term cash, soared 13 bps over the effective federal funds rate of 4.83%.
It was 22 bps higher on Oct. 1.”
October 8 – Bloomberg (Alexandra Harris and Carter Johnson):
“The latest heightened liquidity pressures in the US funding market have some on Wall Street nervous about even greater challenges in the final month of the year.
Market participants say a spike in interest rates tied to repurchase agreements, which are overnight loans collateralized by US Treasuries, could intensify in December as both regulatory burdens and Treasury auction settlements collide for the second time in three months, siphoning cash out of the funding market.
It was those conditions that pushed rates to atypical levels at the end of the third quarter.
‘Year-end is now a bigger issue given the volatility’ at quarter-end, said Peter Nowicki, head of repo trading at Wedbush…”
Gold has gained 3.4% since September 17th, with Silver up 2.7%, Copper 6.6%, and Crude 8.0%.
The Bloomberg Commodities Index has risen 3.9% since the day before the Fed meeting.
Gold and Silver enjoy y-t-d gains of 28.8% and 32.5%.
If I were either a bond or a Fed official, I’d be getting a little jittery.
I won’t make too much of one occurrence.
But if bond yields continue to rise on Fed rate cuts, key bullish assumptions regarding monetary stimulus, the Fed’s liquidity backstop, and perpetual bull markets will be due for an overhaul.
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