We Are Approaching the Bond Yield Event Horizon
Tom Luongo | Sep 25, 2023 05:07AM ET
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.
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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.
h2 Resting Hawk Face/h2This 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 Brent 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!”
h2 Yellen Plans Yield Curve Control/h2Because 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.
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:
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.
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