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October
18
2023

Bonds Bust!
David Haggith

The Big Bond Bust brewed into a huge storm today with the US 10Yr making a face-ripping rise above 4.8% to its highest level in 17 years and fastest climb in years.

The bond storm is here, and it really proved itself today. The storm blew in with an off-the-charts show this morning when retail sales soared in today’s retail report for the month of September. The huge 0.7% month-on-month spike in retail sales was more than double what economists had expected. Excluding autos, retail sales were up triple what was expected. However, the reasons were not as good as reports made things sound. Most of the huge boost was due to gasoline sales, which were not up in gallons sold but up in price.

All sales reported are in dollars that are not adjusted for inflation. Some publications said the fact that sales rose more than the last monthly inflation report for September prove sales rose even more than inflation as if that is good news for the economy. In one sense it is, but the fact that two-thirds of the increase was due to inflation being back on the rise should be alarming (and was!), and the fact that sales rose more than inflation rose shows sales this month are likely to drive inflation next month as the economy measured in sales is not slowing the way the Fed wants.

A storm in bonds quickly blew up

That means more pressure on the Fed to tighten higher for longer, and that is why bond yields went off the charts today. 

Of course, my recession thesis is not that recession is coming due to economic damage we are already seeing but that the Fed will tighten even higher and longer than most people believe, likely including the Fed (which has revised all of its projections upward all year long), which will cause a severe bond crash with a corresponding collapse in banks that depend on bonds in their reserves. Hedge funds and other entities will be crushed by the plunge in the value of the bonds they hold as yields on new bond issuances continue to soar, making their old bonds kind of stinky by comparison.

Today’s actions added more weight to the big bond bust that has been building all year. The yield on the 10-year Treasury leaped 15 basis points to 4.86% at the high point intraday, and the 2-year soared 12 basis points! Both moves are huge leaps for one day in normally glacial bond terms.

Of course, the continued rise in bonds will continue to compete more and more heavily against stocks, causing the stock-market to fall, while the busting of banks and funds to come will cause the stock market to crash; and the combination of the bond bust and stock crash along with more bank failures will certainly plunge the US into a deep recession before the Fed stops tightening because inflation continues to hold its flames to the Fed’s backside, forcing it to keep on tightening into the storm.

Hence, Egon Von Greyerz, a permabear with gold to sell, says this bust will be one for the history books. Permabear that he is, he has a lot on his side of the argument that stacks up logically right now:

We have a coming collapse of stock markets and debt markets and a bankingsystem which probably will not survive in its present form…. As if all the above wasn’t bad enough, adding a Middle East war to this makes the crisis properly global and the step toward a Global or World War is very short even dangerously short…. On top of that, the US is also spending money like a drunken sailor who will never sober up but only spend or drink more to drown his ever increasing debts and sorrows…. We are now talking about the greatest uncertainties in my 78 year lifetime which started at the end of WWII 1945. 

To put today’s developments in retail sales and the bond market’s response in perspective, another article notes,

“Retail sales came in higher than expectations this morning which sent yields ripping back up to problematic levels for the market,” said by Alex McGrath, chief investment officer at NorthEnd Private Wealth. “This print continues to weigh on investors struggling to digest neutral fed speak….”

In fact, it says any neutral Fed speak was, itself a delusion held by the Fed, and that is why investors are suddenly struggling to continue to believe we are really nearing the neutral point, now that inflation is back to adding so much to sales, and sales are tearing still higher than that! With consumers pressuring sales to rise faster than rising inflation is rising, the day’s report certainly added pressure to the Fed’s tightening agenda.

“The U.S. consumer cannot stop spending,” said David Russell, global head of market strategy at TradeStation. “All three retail sales reports for Q3 were above estimates, which puts us on track for a strong GDP number later this month. It also gives the Fed zero reason to loosen policy, which keeps the 10-year Treasury yield pushing toward 5%.”

Again, what it does for current GDP doesn’t matter because it is what the extra tightening will do to bond funds, banks and stocks that will crush the economy down in a huge flush when all of that falls in a collapse for the history books — the likelihood of which builds the longer and deeper the Fed tightens. We have already seen one of the biggest bond busts in history developing all year, which already led to a banking crisis for the record books in terms of the scale of banks that went bust, but it keeps going deeper.

The Treasury market is serving up levels of volatility last seen during the pandemic-era turbulence of March 2020. 

The 30-year Treasury bond also rose 13 basis points today, which was its biggest move since the Covid lockdowns and everything that ensued. 

The large swings pose a challenge to investors reckoning with the highest yield levels in more than a decade. They also underscore the dangers for traders drawn in by expectations the Federal Reserve’s hiking cycle may spur a recession, even as a surge in US bond scales sparks concern about the risks of holding longer-dated debt. Hamas’s strike on Israel and an expected ground offensive into the Gaza Strip are also adding uncertainty.

The traders drawn to bonds by expectations that the Fed creates a recession were betting on the Fed swinging back to looser policy soon to stop that recession; but today’s sales report said that dream of a Fed flip is going to be as elusive as all prior Fed pivot talk, recession not withstanding, as inflation is cutting it no slack to make such a turn.

Soaring yields had eased down a bit a few days ago as the Israel-Hamas war drove people to safe havens for a couple of days (probably the biggest reason for the decline in yields), but that all spun on its head today, taking yields higher than they were before the war as it became clear the Fed has no path for backing off from its inflation fight.

The yield on the 30-year bond topped 5% this month for the first time since 2007, reflecting anxiety about a sustained tightness in Fed policy. A poor reception for a bond auction on Oct. 12 also highlighted skittishness about the increasing supply of Treasury debt. However, yields posted three steep declines last week as the threat of a broadening Middle East war fueled demand for haven assets.

Bond guru says we are sailing off the charts

The volatility in normally stable US Treasuries and the poor showing in recent Treasury auctions is why long-time-experienced, bond-trading chief Mohamed El-Erian says the Treasury market is now headed for an “unknown destination,” as in off the known navigational charts for bond traders, as its moves go beyond any plotting the Fed has laid out:

The Treasury bond market is headed for the unknown as it sheds key anchors, economist Mohamed El-Erian wrote in the Financial Times.

The recent volatility that rocked bond yields into sudden extremes goes beyond the latest reports on inflation or policy stances from Federal Reserve officials, the chief economic adviser to Allianz added.

"The US bond market is losing its strategic footing, whether in economics, policy, or technical aspects," he said.

Currently, long-term Treasury yields are hovering near 5% amid a massive US bond sell-off, due in part to a strong US economy that will require extended tightening to further rein in inflation….

This also comes as the US ran a $1.7 trillion deficit in fiscal year 2023, with the Treasury Department issuing a massive supply of bonds. And the Isreal-Hamas war has added to geopolitical worries that have contributed to the rollercoaster ride Treasurys are on.

"But my primary concern lies elsewhere: the most influential segment of the world's financial markets is losing its longer-term strategic anchors and is at risk of losing its short-term stabilizer ones as well," El-Erian said, raising doubt about who will absorb the additional supply of US debt. 

In other words, the most important bond market on the plant is seriously losing allstability for the reasons I’ve been laying out here all year as the certain path for bonds to take.

How bad is the situation stacking up behind the Big Bond Bust?

He noted that the Fed is no longer purchasing Treasurys and is instead shrinking its balance sheet, foreign buyers have turned more hesitant, and US institutional investors already have big paper losses on bond holdings, while banks may have to sell bonds to replenish declining deposits….

"No matter how you look at it, the world's most crucial benchmark market is on an unpredictable journey with an uncertain destination," he said.

In other words, it’s an anchor-dragging mess of a storm, pulling Treasuries out to sea and off the charts.

Seeing the Great Recession Before it Hit

My path to writing this blog began as a personal journey. Prior to the start of this so-called “Great Recession,” my ex-wife had a family home that was an inheritance from her mother. I worked as a property manger at the time, and near the end of 2007, I could tell from rumblings in the industry that the U.S. housing market was on the verge of catastrophic collapse. I urged her to press her brothers to sell the family home before prices dropped. The house went on the market and sold right away — and just three months before Bear-Stearns and others crashed, taking the U.S. housing market down for the tumble. Her family sold at the peak of the market.

 

 

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