Blain's Morning Porridge - April 24th 2018. 3% Treasury Yield Nailed On! Forget about and worry
(Sorry this post is delayed 1 day - system problems)
Blain’s Morning Porridge – 24th April 2018
“And the wheel’s kick and the wind’s song and the white sail’s shaking, and a grey mist on the sea’s face, and a grey dawn breaking...”
The Morning Porridge is unrestricted market commentary freely available to all investors on an unsolicited basis. It is not investment research.
From my eyrie in Mint Towers, I’ve just been watching a yacht sailing up the Thames.. its got me thinking..
Meanwhile, back on Planet Reality… Markets are bleating about the dangers of 3% 10-year US Treasury yields. (Not quite there yet, but very close at 2.9957% at one point y’day). “Danger, Danger, Will Robinson, Danger”, scream the headlines.
Do 3% yields spell the end of the stock market? Will 3% yields trigger the global market reset and the End of Times? Course not. If the Fed hikes 5 or 6 times, rates will still be below long-term trend. But, the market’s talking-heads have got it into their heads that 3% 10-year yields are a gathering storm, a looming crisis and moment to despair. Let them worry.. And recall that for the 10-years prior to the Global Financial Crisis beginning in 2007, the average 10-year yield was bang on 5%!
And, these pundits are looking at the wrong thing. The real issue might just be the dollar. The dollar’s relative weakness over the past 15 months – one major factor being the uncertainty engendered through Trump’s twitter rhetoric (a superbly effective instrument for manipulating the greenback lower) – looks highly likely to reverse, and that’s got massive implications…. The laws of unintended consequences are about to kick in.
What’s not to like about the dollar? When everyone else is still mired in extraordinary monetary experimental policy and their rates are unfeasibly low, US rates look high and should therefore be mega attractive! Trump doesn’t look half the muppet many thought he was as tax cuts, trade negotiations/punchups, and his “have a go” geopolitical stance garners grudging respect. (Let’s not dig too deep on Trump.. bear in mind one Roman emperor appointed a horse as his co-counsel and the empire still lasted another 350 years..)
Look at the US data – its strong. Housing is up. Order books are growing. The Fed is sending out a clear and consistent rationally higher message on rates (Mr Carney: take note.) The Euro has been range bound since New Year. As Japan devalues again (watch for Yen at 110 pretty soon), everyone and their mutts want to buy Treasuries as a liquid hedge against the vagaries of the World. There are plenty of bond analysts out there saying 3% is a buy signal on Treasuries.
Perhaps the question isn’t why are treasuries touching 3% and rising, but why aren’t they higher already? If it wasn’t the flood of cheap money wanting to buy treasuries, they’d probably be back above 5% - close to their long term average – a long time ago. While European real interest rates remain profoundly negative why buy them? I believe that is the ECB’s job… (let’s see if it still is on Thursday.) And stop worrying about the flatter yield curve – it’s a distraction (for the time being).
The fundamentals – global growth and rising inflation all play to a stronger dollar. Take a look at oil and aluminium – commodity driven inflation. They are eating away most of the recent tax cuts - a Bloomberg article highlights the fact the lowest 20% of US earners spend 8% of their income on petrol, the next 20% spend 5%. These are Trump’s core electorate. Any rise in gas prices will hurt. The same Bloomberg article quotes BMO: “every major economic slowdown has been preceeded by a jump in energy costs”.
More to the point, rising rates and rising inflation will damage corporate profits as they struggle to pass on input rises to customers. Tumbling results are negative for stock prices and are likely to be discounted sooner rather than later. Which explain’s the stock markets real discomfort.
Who will be the big losers of dollar strength? EM is the prime candidate. Borrow in dollars means paying back in dollars, or paying a cost to do so. Rising commodity prices are good for producers, but damaging for consumers. How much will China struggle? Not as much as markets may fear – but still enough to trigger doubts.
Meanwhile, I’m reminded this is the 25th anniversary of the IRA’s Bishopsgate Bomb of 1993. I remember that Saturday morning well – some chums and I were playing “combat squash” in the gym on nearby Appold Street, and the whole building shook coating us in fine dust. The truck bomb killed three people and annihilated the offices of the Japanese bank I was then working for. As part of our recovery plan, I was in one of the first teams escorted into the building to scavage key materials – picking up my business card files so I could keep calling clients. Out trading floor was absolutely wrecked – I have never seen such destruction. One thing that sticks out was a shard of glass that had gone straight through the screen of my computer. Scary. If it had happened in working hours….
Back to the day job, but still thinking of that boat sailing up the Thames..
* (For those of a certain age: I’ve only watched the first episode of the Netflix “Lost in Space” reboot, and not sure if I’ll bother with the second..)
Bill Blain