We Are Approaching the Bond Yield Event Horizon
2023.09.25 08:08
I get asked for my opinions on what’s happening by members of the press pretty regularly. They don’t always make it into print, nor do I respond to them all. It’s a tough business so I don’t ascribe any malice to it. Some stories simply get stale. I was asked about two topics the other day — the potential government shutdown’s effect on Ukraine aid and the FOMC meeting. I wrote up my comments and sent them off.
While they didn’t make it into print these two issues are inextricably linked in ways beyond the obvious, money. So, I’m not leaving them on the cutting room floor.
The budget wrangling and monetary policy are not just about the money. How the money flows is the essence of the political process.
The reason I led off with the backstory here is that I felt it necessary to place these comments into the time frame of when they were written, early Thursday afternoon. These comments echo things I talked about in the regular Market Report I publish every Wednesday and Sunday for my patrons.
So, with the prologue done, on to the show.
On the potential government shutdown, I wrote:
While I have a very dim view of most Democrats and the Biden Administration in particular, I have almost no faith in the Republicans either. The push for a government shutdown is coming from the so-called Liberty Caucus wing of the GOP led by Rep. Matt Gaetz (R-FL). The question isn’t whether a government shutdown will slow aid to Ukraine it is whether the talk about shutting the government down is all just pre-primary positioning for fundraising purposes.
I hope it’s not but given the track record of the “good” Republicans and their ability to strategically outmaneuver the GOP establishment, I think that hope is fleeting. Speaker Kevin McCarthy gave the Democrats what they wanted to vote for him to get the office and then in June to end the standoff over raising the Debt Ceiling.
So, if there is a deal to be made where McCarthy can neutralize Gaetz et.al. he will make it, all the while playing games to make it look like he’s taking spending cuts seriously.
For argument’s sake, if Gaetz is successful in challenging McCarthy and actually forcing change, it will mean US support for Ukraine will dry up temporarily. Biden will have to work around that through existing budgets and appropriations. It will also imply that the ground is shifting under McCarthy’s feet and he’s losing control over the Davos agenda on Capitol Hill.
This is why the GOP and the media are relentlessly amplifying arch-Neocons like Nikki Haley and Mike Pence as challengers to Donald Trump. They are setting up another false election. But, if Wall St. and the MIC no longer want a war with Russia, but would rather protect the ‘sanctity’ of their toys and the gravy trains they support, then Ukraine will turn into an albatross for the Democrats very early in 2024.
This dim view of McCarthy and his willingness to court Democrats *Cough* Davosians *Cough* to keep the policy status quo in place was vindicated by this article from Zerohedge on Friday morning.
Here’s the money shot:
Politico has reported secret, urgent cross-aisle talks as follows: “Small groups of centrist Democrats are holding secret talks with several of McCarthy’s close GOP allies about a last-ditch deal to fund the government, according to more than a half-dozen people familiar with the discussions.”
The House voted 212-216 against moving the funding bill to a final vote: Axios
By Friday afternoon Ukrainian Con Man Volodymyr Zelenskyy left D.C. mostly empty-handed, with just $384 million versus the $24 billion he was seeking. At this point, given the state of affairs on the ground in Ukraine, that kind of dosh being thrown into that money pit isn’t intended to really prolong the war.
It has to serve a different purpose. Of course, when speaking about Davos, it’s all about keeping the US spending well beyond its means to hasten the demise of the country. Another $24 billion is a drain on the private economy we can’t afford, especially with real savings rates negative, as explained in this excellent talk between Danielle Dimartino Booth and Lacey Hunt on Hedgeye.
But that kind of money also has to be raised in the bond markets as well as through the tax system. We’re already fundamentally running on fumes economically here in the US. There’s no hope from anyone else, so the doctrinaire Keynesians have reached the limit of their toolbox.
There is no room to do anything other than cut spending, but that is the last thing anyone who is anyone on Capitol Hill wants to do. Everyone you saw take a picture with “the slob” Zelenskyy is someone intimately connected to the gravy train of tax money flowing into that hellscape and into their pockets and the pockets of their benefactors in the MIC, private equity space, etc.
It is only the gadflies like Gaetz that are really willing to call this out, but again, if they have no real power then the whole thing is just some pre-primary fundraising LARP.
The $384 million is symbolic money. It won’t do a thing to stem the bleeding in Ukraine. The signs are piling up everywhere that Project Ukraine is ending and all that’s really left now is to squeeze the final drops of blood from the US taxpayer stone.
Resting Hawk Face
This brings me to my post-FOMC comments about Jerome Powell and the markets’ reaction to him.
I wrote a lot here so I’ll break it into chunks and fill in some details as I go.
Powell did exactly what I expected him to do. He didn’t raise rates and he cut a very hawkish jib at the podium. The FOMC didn’t raise rates because they didn’t need to. The announced oil production cuts by Russia and Saudi Arabia created a big rally in oil prices which ensure there will be another round of inflation in the West beyond the Fed’s control.
So, OPEC+ did Powell’s job for him. Inflation will come back supporting his “higher for longer” stance. The Dot Plot of FOMC Members was forced to square with this reality, shocking bond traders out of their complacency. Only a select group of commentators and myself believed Powell could make it into and possibly through 2024 with rates north of 5%.
Now the bond markets believe it. And that means further normalization of the yield curve, putting tremendous pressure on the ECB and other foreign central banks hoping for a reprieve because of falling headline inflation.
Powell spent his entire time at the podium sticking to his Dual Mandate Mantra, using it to hide behind what he’s really doing, restoring control over US monetary policy to the Federal Reserve. The questions from most of the Davos-aligned media outlets — The NY Times, the WaPo, the Financial Times — were asked by wet-behind-the-ears Millennials who stuck to the dying Keynesian model of hiking rates into a recession trying to play “Gotcha” with Powell who kept coming back to his line that the FOMC will watch the data, which they know is lagging, and try not to over tighten.
The inverted US Yield Curve is the thing that is sticking out right now, but it’s normalizing, albeit slowly. It’s being fought every basis point of the way by Janet Yellen at Treasury, Christine Lagarde at the ECB, Bailey at the BoE, and Joachim Nagel at the Bundesbank.
Because Powell had been alone the Bond Vigilantes hadn’t been fully convinced of Powell’s fortitude. I believe they are now. The movement in yields in the six-month to two-year band confirms this.
The recessionary response to Powell’s resting hawk face on Thursday saw Crude correct below $93 per barrel. And yet, it, along with gold rallied into the close this week.
If that’s a profit-taking bar in Brent, “Brussels we have a problem!”
Because of the moves in oil, Christine Lagarde’s panicked rate hike from last week, and Thursday’s employment data, Powell knew he could spend the entire press conference sticking to his mantra about serving the Fed’s dual mandate of “full employment and stable prices.” In Fedspeak, ‘stable prices’ equals a 2% inflation target.
Powell knows he can’t really affect oil prices with demand-side tools. He said as much directly in the press conference. So, because of this and the fact that the US economy is in better shape than even he expected at this point, he remains open to further rate hikes to curb credit demand and force a reorganization of capital internally from the financial class back to the industrial class.
In effect he kept telling the “2 and 20 carried interest” guys in private equity that there are no cheap dollars for them. You want them? Go find projects worth the 6% vig.
Otherwise, the money is going back to Main St. through reinvestment in savings at higher rates to raise their purchasing power.
Yellen Plans Yield Curve Control
Because Powell is encouraging savings and demand for short-term Treasuries he’s supporting his “Higher for Longer” rate policy. Since the June Debt Ceiling resolution, the US yield curve has been normalizing. The long end has stayed suppressed but the inversions are tightening.
What it’s doing is forcing his opponents into even more panicky moves. And right on schedule, Bloomberg let the cat out of the bag Friday morning:
This is Yellen announcing that she’s ramping up a new round of Yield Curve Control. And she won’t be buying them back at par, it’ll be to provide liquidity to prevent the market from going bidless.
From the Bloomberg article:
The department intends to be more “price sensitive” as it chooses the buyback offers to accept — and therefore may end up purchasing “materially” less then the maximum, he said.
“Buybacks can help improve the liquidity of the Treasury market by providing a regular opportunity for market participants to sell back to Treasury off-the-run securities across the yield curve,” he said. “This should improve the willingness of investors and intermediaries to trade and provide liquidity in these securities, all else equal, knowing there is a potential outlet to sell some of their off-the-run holdings.”
All of this begs the question, with what money is Yellen going to intervene in the bond market? Well, of course, with the money she’s raising this fall to cover the massive budget shortfall, but only if there are some concessions to Gaetz on spending.
She will buy back underwater US Treasuries at 40-50% haircuts to issue new bonds at higher yields than the ones she’s buying.
But what is Yellen actually doing?
Well, it’s called Yield Curve Control, folks.
Here let my friend Vince Lanci explain it:
These people all they know is punting problems down the road and hoping the market, the free market, or what is left of the free market can sort out their errors.
Eventually they run out of road on which to punt. And when that happens, they manipulate even further and their… pic.twitter.com/AWSu7yFcix
— VBL’s Ghost (@Sorenthek) September 19, 2023
She’s buying back low, which makes sense, but she’s doing so to sell bonds the market expects to go off at even lower prices (higher yields). If the market wasn’t expecting this they wouldn’t be offloading their crap at 2-3 points lower (presumably Yellen’s overpriced bid) than they would be when they buy them off-the-run new treasuries at higher coupons.
They’ll go from getting a 1-2% coupon payment to a 4-5% coupon for 10 years.
All she’s really doing is announcing that she’s managing the rise in the long end of the yield curve. She’s not going to be buying short-dated bonds. They’ve already been rolled over at the higher rates.
No, as always, this is about those , , , and that are deeply underwater, where the yield curve inversions are the worst.
And that’s why Wednesday’s Dot Plot spooked the markets so much. Powell convinced even the Obama/Davos doves put on the board to drag him down that he’s going higher into 2024 than the markets were expecting.
So, how effective (or more importantly expensive) do you see Yellen’s attempt at YCC being this fall?
This brings me back to the beginning and the Gaetz v. McCarthy Battle overspending.
His [Powell’s] main obstacle to this [normalizing monetary policy] is government deficit spending. Nothing has changed on this front. Biden and the rest of the vandals in D.C. who have their own interests and/or the interests of Davos to break the US through fiscal and legal shenanigans, are committed to running up the bill as far as they can.
They have much of the GOP complicit in this scheme and that’s what the guys like Matt Gaetz are trying to stop.
I know it feels like a pipe dream that they’ll stop spending in D.C. I also know it feels pointless to talk about these things because nothing ever seems to change. But they are, slowly. This is an inertia problem more than it is an intention problem.
Why do you think the Bank of England held rates and let the pound get crushed this week? Why do you think the Swiss did the same thing? Why do you think McCarthy is letting things go to the last minute again over the dreaded “government shutdown?”
This is to spook capital markets and continue the illusion that somehow China is collapsing alongside the US but somehow Europe isn’t with $94/bbl oil? McCarthy and the Democrats want to come to an arrangement to neutralize Gaetz, leave his ass out to hang, and get the deal done before Q4 starts. This is MOPE – Management of Perspective Economics – on steroids.
But that would also feed into that perception that DC is broken and force rates higher. On the other hand, they could throw Gaetz a bone, throw Davos under the bus, force a political revolt, and begin cleaning the house.
In both cases, the long-bond rises in yield. In the worst case, the government sucks all the money out of the economy, capital tries to flee, Powell holds the line, and risk of default goes sky-high.
In the latter case, more money flows through the private economy, stabilizing both the labor and credit markets, raising the outlook of a soft landing and investors stop being scared of a pivot by the Fed.
If I’m the GOP establishment, I think option #2 looks good coming into the election season.
Powell won’t get much if any, help from the Fed’s staff economists or most members of the FOMC or Board of Governors. They are all doctrinaire Keynesians or traitors. That help is going to have to come from the markets.
It’s going to have to come from the Bond Vigilantes. who need to return now and call everyone’s bluff — McCarthy’s, Yellen’s, Lagarde’s and Udea’s (BoJ). And if they finally do arrive in Q4 because there are no more EMs to punish worth punishing, then who should they look at?
Hello Chrissy!
[Powell] did the hard work this summer. By raising interest rates in July, he left himself optionality in September. He was clear that he expects one more hike this year and is still open to another one in Q1 2024.
Slowing rate hikes here gives banks a little more time to repair their balance sheets and force them to jettison underwater commercial real estate loans. Powell continues to throw private equity under the bus.
He is also forcing Congress to face the music on their egregious spending. The dirtiest secret in Washington is that we could cut the budget between 25% and 40%, reducing the waste, fraud and, frankly, welfare for useless bureaucrats and no one would see a drop in functionality of efficiency.
Everyone knows it. Powell can’t say any of this but that’s exactly what he’s targeting.
Rising energy prices, now a 3-month-old phenomenon, should produce an uptick in inflation this fall, giving Powell the cover he needs to tighten the screws on the offshore dollar markets and give depositors even more incentive to pay down debt, save at higher rates, and force Congress to face their lack of reflection in the mirror.
We’re staring at the black hole and are about to cross the event horizon into a period of, at best, stagflation and, at worst, outright deflation. No matter what happens, it won’t be hyperinflation. The USDX is very clear on this folks.
Do you know who wins when prices fall? You do. Do you know who loses? The ones who stole your futures with free money.
Yes, the Fed created this problem during COVID-19, on this point I wholly agree with both Hunt and Booth (see linked interview above). But at the same time if Powell’s thinking is let’s take everyone to the edge of the abyss and see who jumps, then that wouldn’t be so bad either.
Original Post
