Ever since the Federal Reserve kicked off its massive asset purchase programmes, with all those letter-soup facilities on March of this year - so as to support all kinds of financial markets, from money markets to muni bonds, and from corporate bonds to main street bank loans -, the financial media (here, here and even in the mainstream media), with the help of some financial gurus (here, here and here), has been emphatically proclaiming the Fed's actions are set to open the Pandora's box of inflation. Therefore, the bond rout and inflation are finally, without a shadow of a doubt, coming to a pension plan and shopping centre near you (just do not forget to wear a mask, btw). Once again, the bond market is being rather stubborn. As you can see below, every time Treasuries' yields go up a little bit, these fools come out of their caves to spout confidently about the imminent inflation and soaring UST yields. Soon after, yields plunge until they make a new low. The 2018 global synchronised gowth delusion exemplified this perfectly, with this article coming out right when Treasuries' yields topped and set off its decline, bringing the stock market, along with other markets, down with them. Unsurprisingly, the bond rout bandwagon is packed like a can of sardines - though I am sure they are masking themselves. From the October 2018 top that I mentioned above onwards, speculators have been shorting the long-end bond, with a brief pause throughout the recession scare of last summer - which ostensibly appears they were right to be so -, having since then increased their bets the 30-year is set to drop (resulting in a higher yield). Note that even though the yield has come off its August low, the net short position swelled again this week, meaning that investors are expecting yields to soar. Curiously, speculators have the opposite approach on the 10-year note. Since October 2018, the net position has gradually become less short, turning into a long position in June of this year. The benchmark yield is treated as a distinct beast. Unlike the 30-year, speculators have thrown the towel and are now positioned for rising prices. This tells me that they are not expecting rising inflation/dollar debacle in the following decade. Obviously, this is a tremendous change of sentiment. From asserting that the unquestionable global synchronised growth premonition would "finally declare an end to a three-decade-long bull run" to believing meaningful growth will only come in the 2030's, in just two years, is nothing short of astonishing. Apparently, this belief is shared by central bankers and even the mainstream media is starting to catch up, as this Washington Post article demonstrates. Furthermore, looking at the level of bank credit, one would be led to think inflation is a no-brainer, causing the anticipated bond rout. As the H.8 document depicts, bank credit peaked on the week of September 2 at $14.944 trillion and has been subsiding since then, with the October 14 figure being $14.899 trn. As you ought to know, banks are the real money creators, not the Fed nor any other central bank, at least in the developed world. If they believe economic opportunities are proliferating, more credit is going to be originated by providing loans and other types of debt to consumers and businesses. However, is this really the case? Of course not. In spite of ballooning rapidly from March to its May 13 top at $10.857 trn, loans and leases have been dwindling from thereafter, reaching the amount of $10.434 trn on October 14. That surge at the beginning of the pandemic is explained by the rolling out of lines of credit directed to businesses in order to keep up with current expenses, such as salaries, rent, etc., by making up for the diminishing revenues. In fact, comercial and industrial loans shot up by 10.3% on Q1 compared with the same period last year, being reinforced in Q2 by 89.8% in relation to 2019. Yet, this kind of loans plus real estate loans have joined the downward trend set by consumer loans, which has been decreasing since the kung-flu hysteria invaded the New World, especially credit cards and other revolving plans. Thus, this demystifies the whole idea of right-around-the-corner inflation and upcoming bond rout that a lot more people, both officials and market participants, are starting to reject. On the flip side, what made bank credit not fall as sharply, the Treasury and agency securities have been multiplying relentlessly. Taking into account just the Treasuries (graph below), which is what matters for the topic of today's post, the banks have been binging those sweet, liquid assets, coming up with the highest amount of $1.192 trn, on the latest figures. If you just think the banks are acquiring UST just so they can flip them to the Fed, then why, for example, did the total amount (by primary dealers and direct and indirect bidders) tendered in the latest 30-year Treasury auction surpassed the available $22,996,151,800 by $29,618,909,000? The truth is banks have a very gloomy outlook for the economy in the short- and medium-terms, forecasting continously flagging business activity and possibly global trade. Finally, another common argument the inflationists and dollar bears usually make is that the contracting holdings of Treasuries by foreigners during periods of financial distress is proof the dollar is on the brink of losing its world reserve status. Once again, the same thing has happened. Throughout the March panic, foreigners liquidated some of their Treasuries to satiate their need for dollars, which were extraordinarily scarce at the time. As financial conditions began to improve (because of the economy reopening), their holdings rose, though only up to July. However, at the end of August, the amount went down again, indicating that the dollar shortage is very much present. In conclusion, traders, analysts, technocrats and the public in general is waking up to the fact inflation is not on the horizon, despite all the "money printing". Unfortunately, market participants, having been taught lousy economics, take the view that inflation is going to come in the ultra long-term, hitting the 30-year Treasury.
This belief comes from the concept that, in this case, the 30-year yield is simply a multiplication of the current 1-year rate and next 29 1-year forward rates. As you know, what matters is the liquidity risk. Hence, seeing that UST have the least liquidity risk - yes! Even the 30-year, though it increases a little bit with maturity -, this security is in extremely high demand. Owing to the historic level of speculative short positioning in the 30-year UST, in addition to the high demand mostly by banks, once its price begins to climb and, consequently, the yield wanes, those speculators are going to be forced to cover their positions, short-squeezing the bond price, pushing the yield into negative territory. As soon as we stop listening to the central bankers and economists (of all schools of thought) on monetary matters, considering we keep on operating in a debt-based setup, and, instead, start being more inquisitive about the monetary and financial system, as well as what drives economic activity most efficiently - FYI, laissez-faire capitalism -, then we may expect inflation to appear and, more importantly, accelerate. Nevertheless, there is no sign that day is about to dawn in the near future. Despite that, I am convinced it is coming, resulting in the bond rout at last. Perhaps, the 333rd time is the charm.
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AuthorDaniel Gomes Luís Archives
July 2023
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