(New York)
Every advisor is likely already aware of the huge ruction that occurred in money markets this week. A number of short-term stresses sent over-night borrowing rates up to 10% this week before the Fed had to intervene to inject tens of billions of Dollars of liquidity to calm things down. Most media outlets have explained this as a number of cyclical short-term factors, without really giving any specifics. The whole episode has been curiously vague. This has led to an unusually fertile environment for rumors and speculation.
FINSUM: So our readers will know that we have been reporting for years, and we must say that this has been one of the oddest, mostly poorly reported, and vague events we have ever covered. None of the cited reasons of this money market flare up make much sense relative to the scale of money the Fed has pumped in. One of the best rumors we have heard is that there may be a bank failure coming. Just before this market flare up, oil jumped almost 20% in a day, its single largest one-day move ever. That kind of black swan event could easily destabilize a large financial institution if it was positioned the wrong way, and ultimately led to the kind of short-term funding desperation we saw before the last Crisis. This analysis is probably all wrong, but the situation must be taken seriously.
(New York)
Treasury bonds and their associated funds just had one of the worst periods on record. Specifically, they had their worst week since Trump was elected. The iShares 20+ Year Treasury Bond ETF fell 6.2% in a week, the sharpest drop since bond markets panicked on Trump’s surprise election. What is odd about the big drop is that the stock market remained relatively muted throughout. Usually, big losses in Treasuries come when there is a big risk-on rally in stock markets.
FINSUM: There has been a huge rally in bonds, and in the last week, a lot of the pessimism has faded from markets as economic data is relatively stable and trade war fears are ebbing. Accordingly, this could be the start of a real rout.
(Washington)
If higher inflation could be a headwind to rate cuts by the Fed, then there is new data today that could prove a tailwind. New figures show that retail spending was significantly weaker in August than in past months. The data showed that core retail spending stagnated after several months of strong expansion. The data is crucial because consumer spending, and American consumer health generally, has been a bedrock of the economy.
FINSUM: The American consumer has been keeping the economy afloat despite a lot of negative signs around the margins. This could either be a blip or the start of a worrying trend.
(Washington)
Everything you think about the direction of rates could be wrong. That is the general fear after this week’s inflation report. US core consumer prices hit a one-year high in August at 2.4% year-on-year growth, ahead of the Fed’s target. Importantly, it was also a bit higher than expectations. The Fed’s new cutting agenda is partly predicated on the fact that inflation has been so subdued, so any change to that assumption could prove disruptive to a cutting cycle.
FINSUM: We don’t think one month’s report will change the Fed’s path, but it is certainly something to keep an eye on. It is going to make September’s inflation report a lot more important.
(New York)
If you look at some of the areas hardest hit by fears over the economy and the trade war, there is cautious optimism starting to show up. One of the best examples of this is the corporate bond market. Investors have been pulling money from the stock market and sticking it in bonds. They appear to be unworried about high debt levels or the possibility of default. In this move, there is an underlying faith that the US economy will stay solid, otherwise credit-worthiness would be seriously in question. Spreads to Treasuries are very low too, further reflecting the optimism.
FINSUM: It seems like the market is worried that stock valuations are tapped out, but that there may not be a significant downturn. In such a case, corporate bonds look like a good bet.
(New York)
New data just released shows the US economy is a bit weaker than everyone expected. Second quarter GDP data has been revised downward, showing that the US expanded at only 2.0% in the quarter instead of the first-reported 2.1%. Government spending, weaker exports, and private inventories weighed on the numbers. However, the very good news in the data is that consumer spending increase was the strongest in 4.5 years.
FINSUM: Consumer spending is at its highest levels since 2014 at the same time as bond yields are at extraordinary lows and everyone is worried about a recession. Either a recession will arrive or there will be some big losses in bond markets.
(Los Angeles)
Pimco is probably the most respected name in fixed income, and the firm just went on the record warning about the economy and encouraging the Fed to act. The asset manager argues that the US economy is in worse shape than many think and is admonishing the Fed to cut rates more aggressively than expectations. Pimco says that momentum in the labor market is slowing, the trade war is showing little sign of abating, and the risk of financial excess caused by lower rates appears minimal. According to Pimco, “We can’t emphasise enough that labour market momentum has decelerated more markedly than most forecasters were previously expecting”.
FINSUM: We actually are on the opposite side of the fence as Pimco. We think the market is blowing things out of proportion about the economy and is overly worried. We surely hope we are right.
(New York)
The bond market is doing something that it usually doesn’t—it is scaring stocks. Generally speaking, big sell offs in stocks drive moves in bonds, but rarely do moves in bonds spook stocks. Except for right now, that is. The ten-year yield dropped to 1.48% recently, below the two-year’s 1.51%, signaling another 2y-10y inversion which is a classic recession indicator. But the 3m-10y is even scarier as it touched a fresh new low of negative 51 basis points.
FINSUM: The bond market thinks a recession is coming and that Fed policy is too tight. The velocity with which that sentiment is driving yields is spooking stocks, and rightly so.
(New York)
There are a lot of worries in the market that a recession may be headed the way of both the world generally, and the US more specifically. However, two analysts from well-respected Ned Davis Research have a different opinion. Of their 10 recession indicators which they watch, only one is signaling a recession. In particular, they dismiss five of the market’s biggest worries: the inversion, market breadth, deteriorating economic signals, earnings deceleration, and the trade war.
FINSUM: These guys seem overly optimistic. One of our big questions is whether some weakening signs in the economic actually point to a recession, or are they just part of a temporary ebb.
(New York)
Negative bond yields dominate the globe, and US yields are headed inexorably lower. The bond rally that has unfolded year is hard to over-state, with the 30-year Treasury at an all-time low. However, all those gains look likely to reverse sharply, as signs are on the horizon that US inflation is about to jump. The trend in CPI looks likely to show a bump after a series of lower annual highs. The movement is exactly the same as the one that preceded gold’s big jump this year. According to the data, CPI looks likely to rise to 2.5%, which would virtually eliminate the possibility for negative yields on the 30-year bond.
FINSUM: While calling higher inflation is a dangerous game in the post-Crisis world, the general analysis here is reflective of the fact that yields are way too low for how healthy the economy looks in data.
More...
(New York)
This is a tough market. Stocks are right near all-time highs and bond yields are near all-time lows. So how can an investor find steady current income and keep the door open to capital appreciation? Enter an underappreciated asset class—convertible bonds. Often referred to as “equities with training wheels”, convertible bonds have a lot of the upside of stocks due to their conversion feature, but also the downside protection of bonds because of their income feature. According to a convertible fund manager at Franklin, “You don’t get all the equity upside, but you can only fall so far because you have the downside protection of the bond”. Look to find converts with 7% of the equity upside of stocks, but only 50% of the downside risk.
FINSUM: Converts have actually outperformed a 60/40 balanced portfolio historically (by almost 2% per year with a similar level of volatility!). Some funds to look at include FISCX, PACIX, and AVK.
(New York)
The muni market has traditionally been a safe haven for investors seeking steady returns. However, things are beginning to change. The huge drop in yields is fueling some very risky behavior in certain corners of the muni bond market. With yields on even the riskiest munis down to about 4%, highly speculative borrowers, such as those building risky mall developments or far-away housing projects are raising muni money through governmental agencies.
FINSUM: Investors need to look out for these kind of deals. However, what could be more troublesome is how they will inevitably end up in many popular funds without investors even having awareness of them.
(Copenhagen)
The inverted yield curve may be odd, and negative yields in Europe may be strange, but the weirdest current perversion of markets (or is it the “new normal”?) is in Denmark specifically. That oddity is the negative rate mortgage. Yes, homebuyers are getting paid to take out mortgages to buy a home. Jyske Bank, Denmark’s third largest lender, is offering a mortgage rate of -.50% before fees.
FINSUM: So this is already happening in Europe, but it may have limited effects given the continent’s demographic struggles. It is hard to imagine this happening in the US, but if it did, we bet it would cause a housing boom.
(New York)
Bloomberg has published a very insightful article about the current state of the market. In particular, it offers a view of how the big run up in bonds is likely to end. The fears that are driving the bond market—mostly that de-globalization will cause a recession—can only end two ways. Either the recession and de-globalization never materialize, in which case yields shoot back up, causing big losses in bonds. Or, the breakdown of global trade does happen, In this scenario, goods likely become significantly more expensive (especially in west) because there is no more labor and cost arbitrage. In this scenario, inflation then jumps, again sending yields much higher and sparking losses. In other words, the current bond market can only end in tears.
FINSUM: This was a very insightful argument in Bloomberg today. While there are some nuances that might cause some different outcomes, the basic contention is quite astute. Stocks seems a much better bet.