This morning the heat is on and it comes from a source that you might nor expect as investor’s minds turn towards when the central banks will start easing policy. Actually in a way it is a reversal of the response to the credit crunch. Back then we saw interest-rate cuts which were followed by QE bond buying to lower yields. Now we have seen interest-rate rises and maybe the balance sheet reductions ( for example the Bank of England sold another £650 million yesterday) have led us to this.
10-Year Treasury Yield moved up to 4.55% today, highest since Oct 2007. ( @charliebilello )
Others put it in more clickbait fashion.
BREAKING: Bond tracking ETF, $TLT, falls below $90 for the first time since April 2011. The 10-year note yield is now trading above 4.50% for the first time since 2007. The 2-year note yield is now up a massive 500 basis points since September 2021. Treasury yields are hitting 15+ year highs daily now as Fed pause expectations go well the second half of 2024. ( The Kobeissi Letter )
There is quite a bit going on as this applies pressure in a lot of areas. We can start with the US itself where borrowing for the US government is getting more expensive and it is not the only one.
For the average lender, a top tier 30yr fixed rate is now over 7.5% for the first time in at least 22 years. The average borrower (not “top tier”) is seeing rates that are even higher. ( Mortgage Daily News)
With yesterday’s push higher in bond yields maybe more is to come. Although care is needed as we have two different situations here. New buyers and those refinancing are being hit but due to the existence of 15 and 30 year mortgages the effective rate for the overall market is between 3.5% and 4% due to some many (wisely) being taken out at cheaper yields.
King Dollar
It could not be much clearer here.
LONDON/SINGAPORE, Sept 26 (Reuters) – The dollar rose to a new 10-month peak on Tuesday as U.S. bond yields surged to their highest level since October 2007, while the Japanese yen resumed its slide, putting traders on alert for signs of government intervention.
The Japanese Yen has gone through 149 and the Euro has gone to a 6 month low.
The euro was last roughly flat against the dollar at $1.0588, after hitting its lowest since March at $1.057.
So the international consequence is another phase of US Dollar strength which makes everyone else’s inflation problem worse. Another issue is that the interest-rate rise from the ECB a week or so ago has not helped here.
What is causing this?
One potential factor is the Higher for Longer theme of the US Federal Reserve.
Sept 25 (Reuters) – Minneapolis Federal Reserve Bank President Neel Kashkari said on Monday that given the surprising resilience of the U.S. economy, the Fed probably needs to raise borrowing rates further and keep them high for some time to bring inflation back down to 2%.
Although if you listened to the words of central bankers you would be long US bonds at the top and now selling at the bottom!
Next up is the borrowing of the US government but that has not really changed although there are again shutdown fears.
“A shutdown would be credit negative” for the U.S. debt, while “A shutdown “would underscore the weakness of U.S. institutional and governance strength relative to other Aaa-rated sovereigns that we have highlighted in recent years,” Moody’s analysts wrote.
The credit rating firm added, “In particular, it would demonstrate the significant constraints that intensifying political polarization put on fiscal policymaking at a time of declining fiscal strength, driven by widening fiscal deficits and deteriorating debt affordability.” ( CBS News)
This is one of those spiraling issues as higher yields cause wider deficits and weaker debt affordability.
Hedge Funds
There seems to be another factor in this scenario as the Financial Times explains.
Over the past month, the Bank for International Settlements, a convening body for the world’s central banks, and the US Federal Reserve have both pointed to a rapid build-up in hedge fund bets in the Treasury market.
The so-called basis trade involves playing two very similar debt prices against each other — selling futures and buying bonds — and extracting gains from the small gap between the two using borrowed money.
On a tactical level there is no risk here because your futures position should be the mirror image of your cash bond position. It is also nothing new as I recall watching traders do such trades in BTPs on the LIFFE floor in the 1990s. That was very old era technology as they were on landlines connected mostly to Milan to trade cash Italian bonds against the futures in London. It is always Italy isn’t it? Actually it is the higher interest-rates which bring this into play again in the US which was true of Italy back then with the addition that the frenetic nature of the Italian bond market added to the risk but also potential profits.
The problem is not this per se as someone getting the wrong way on a particular deal may not be significant. But if we switch from tactical to strategic we see that the size of the trades might be an issue.
By taking advantage of the ability to borrow on both sides of the trade, hedge funds can deploy huge leverage. The head of one fund that has engaged in this trade says traders have in the past been able to lever up to 500 times.
Ah leverage of 500 times! What could go wrong?
For them now we have another bit of central banking influence they think very little as thy have a backstop.
In such a situation, it would be highly unlikely for the US central bank to simply stand back and watch. The executive at the large US bank says: “The assumption is that the Fed will step in to save the repo market, which they have in the past, so my view is that they will step in again if anything happens.” ( FT)
Actually what you are creating is the possibility of an enormous whipsaw as this happens first.
Regulators say this all adds up to a situation where just a few large firms getting out of their bets could potentially encourage or force others to do the same, quickly leading to a doom loop of distressed selling in the world’s most important asset market. ( FT)
Comment
In a way a lot of this comes from the consequences of the largest financial punt in history. That was when the central banks surged like headless chickens into the world’s bond markets and not only pushed them to all-time highs but bought at the top. That helped create the inflation that forced them to raise interest-rates and reduce their balance sheets and so effectively sell bonds at the bottom.
In that scenario we see how bond yields have risen. But there is another factor at play which further raises the risk of the basis game. QE has reduced bond market liquidity as so many players were punished. Think of what the ZIRP equivalent for bond yields did to pension funds and insurance companies?! All the 2020 and 2021 purchases now look awful. In a sense we are back to this again.
Does anyone know the way?
Did we hear someone say
“We just haven’t got a clue what to do!”
Does anyone know the way?
There’s got to be a way
To Block Buster! ( Sweet)
Now as we are seeing a bit of a panic let me give you the other side. Buyers of US Treasuries are getting 4.5% which is 4% or so better than 2020. Next up is those wondering that the central banks have little alternative but to buy it all again, however much they might deny it.
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