TMC #9! The private sector is over-leveraged and structural GDP growth is poor: we can't afford higher rates. The bond market knows it, and it's trying to talk to you: would you listen?
Hi. Today i re-read this article and have a comment:
I do not completely agree with the argument that debt repayment only narrows the money supply and does not promote inflation. Yes, by the time debt is paid, the money supply has shrunk.
During crisis, Creditors found themselves own a lot of bad, or unperformed loan.
However, when those loan on asset side of Creditor balance sheet are paid backwith stimulus money from Debtors (essentially the Government - Public sector - uses its own debt to absorb the risk from the private sector - essentially a wealth redistribution process) then Creditors will change their view about risk - Because now their balance sheet is healthier than before and they can lower lending standards, thus the money supply could increase again.
Isn't US deficit spending just a redistribution of already existing dollars? One group gives their dollars to the Treasury for T-paper and then the Treasury doles it out to other groups. Then the dollars flow back to the first group and the cycle repeats. I don't see the creation of anything except higher debt service costs. The pool of dollars stays the same, but just goes from one set of hands to another until the debt service costs in the system becomes too great for the pool of dollars to support. It's a big pool, but it must have a limit to how much debt it can stand before there are not enough dollars to go around. China is certainly coming up short at the moment.
I just watched a video from Daniel Lacalle (https://youtu.be/pcygEd24Vig) where he questions the validity of any insight provided by the bond markets, considering they are so intervened by Central Banks. As such, he argues that organic price discovery is shattered.
Would you terribly mind taking a look at that video (it is only 3 minutes long) and comment? I believe Mr. Lacalle's points are fair.
Hi Hector. The bond market is still very alive and telling in both EUR and USD. You might have noticed I often use inflation swaps rather than nominal yield as my reference, as Central Banks can't receive/pay inflation swaps.
If you observe the price of Treasury securities (or its yield) vs the size of Fed balance sheet and their asset purchase speed for each term maturity, it doesn't fit the "Manipulation" narrative.
I think yes, somehow the Fed could affects but can't "Manipulate"
Always representing myself and not my employer, so we're talking my private accounts.
In my structural asset allocation and being a EUR investor, if I think we sit in Quadrant 1 (the secular quadrant, where we sit most of the times) I own 20% of medium to long-term US Treasuries denominated in USD.
Tactically, I am in 5s30s US flatteners - not advertised here because I entered it before launching the PA section of the newsletter and it would not be fair and transparent to claim that trade. But if you follow me on Twitter, you'll see it there.
Nicely in the money and not planning to exit it anytime soon.
Al, great interview on RV. I do have a question regarding Gov't deficit spending which you metaphorically called money printing/credit creation. Do the banks create new credit when they purchase Gov't securities similar to when they create new credit when they purchase a loan from the private sector? Thanks for all the great content , huge value for little guys like me.
I've read articles how when the Gov't spends, it is crowding out the private sector leading to less investment. But that implies they are borrowing existing credit. How is the new credit created from a balance sheet perspective when they have a bond auction. Are the primary dealer banks creating that new credit?
The only similar thing between now and the 40s is that governments will try to keep real yields below real GDP growth (financial repression).
But no runaway inflation or any other similarities.
Birth rate are completely different, wage bargaining power is zero today, tech now vs Industrial Age in the 40s, appetite for credit back then versus private sector wish to de-leverage today. Really two different beasts.
101% agree governments are all in on financial repression.
I do think you can dismiss hyper-inflation, but you should not dismiss inflation spikes like the one we are living through now. As you point out inflation swaps price the next year at 3.6%…. In a world of zero or negative bank deposits that’s quite a lot of inflation.
For the next couple of decades it’s not birth rates that matter, it’s the fact that millennials who now outnumber baby boomers, at an ever increasing rate, have only just started to spend. US housing is a good example of their coming demand.
Agree that non unionised labour has reduced wage pressure but the increase in minimum wages and the recent signing bonuses is evidence that wages are rising.
And heck the way ESG and OPEC are going maybe oil does hit 200 and we’re back to something like the 70s.
The Bond Market is sending a strong message. Alfonso do you think U6 will not decline below 7% this cycle? Or that the part rate will not exceed 63%? Or is the bond market counseling patience?
Based on your observations on those bond market facts, how does the FED who are monetising the debt and the government, who continues to print it, deflate it away over time? We assume they need to... of course the notion that there is zero need to do so has been given some air time recently, as long as real gdp remains higher than debt repayments. Tricky game!
How do you see the magnitude of the FED purchases in the bond market having an impact on true price discovery and therefore a true reflection of what the bond market is really saying? If they are the dominate buyer of bonds vs foreign entities, etc., which have peeled off in the past 4-5 years, then doesn't that suggest the structure of the market has fundamentally changed from the past 40 years? Notwithstanding the other data points (loans, employment, debt) you have used to support your deflationary perspective.
Incidentally, have you seen Russell Napier's perspective on secular inflation. He's been a massive deflationist for 20+ years and has now pivoted to an inflationist. His central thesis (from memory) revolves around CBs taking more control and "influencing... read force" commerical banks to lend (backed by CB guarantees). Doesnt' appear to be a sound principle, but as they say... desparate times.... The motivation to take such drastic action hinges on debt levels and the need to reduce them significantly, so there's a fair rationale.
The above said, lending money to zombie companies who cant' generate growth and therefore profit above repayments can only be very bad med/long term. Outside the FAANG stocks, which have created a misconstrued view of the S&P, the significant majority of other companies aren't generating anything above average. If there's a market shock, then the fact the rally is not broad based in nature can only mean a sudden reversal. The chatter about interest rates rising would constitute one of these "shocks", so its unlikely to be self inflicted by the FED. They have a massive problem generating enough inflation already, as a way of deflating debt.
So, fiscal policy appears to be the only way for them to generate growth, but that naturally will be acommpanied by additional debt. If the 'investments' aren't prudent, we will simply have more debt and little growth. So many ways this can potentially go wrong and a policy mistake(s) is made.
1. You can inflate real debt burdens away with real yields < real GDP growth. That's what authorities are trying to achieve.
2. The price discovery in fixed income is very poor. That's why I look at inflation swaps and other metrics to have a better grasp of what the market is really pricing in.
3. Napier's main point was that lending operations would be overtaken by the government running around commercial banks and basically guaranteeing their loans and ''force'' them via regulations to lend..that ain't happening.
Thanks for the response and clarity on the point 2.
With respect to p3, you're right and they've been doing that for years. Risk/Reward is to low to drive momentum. But that is exactly the environment that provides the ambient condition to create a structral change in the banking system.
Why? If the FED can't generate sufficient GDP growth and inflation delta to real yields using traditional means, then they and the governement are going to resort to non traditional means. Which is exactly Napier's underlying thesis.
DEBT/GDP is 130% and forecast to be higher, so desparate times drive desparate measures. Time will tell.
Hi Alf,
Was trying to check the 2 year breakeven rate as of today. Cannot find it. Any idea where to look?
Since TIPS are issued starting from 5 years, FRED only has break even rates for 5, 7, 10 and 30 y.
Hi. Today i re-read this article and have a comment:
I do not completely agree with the argument that debt repayment only narrows the money supply and does not promote inflation. Yes, by the time debt is paid, the money supply has shrunk.
During crisis, Creditors found themselves own a lot of bad, or unperformed loan.
However, when those loan on asset side of Creditor balance sheet are paid backwith stimulus money from Debtors (essentially the Government - Public sector - uses its own debt to absorb the risk from the private sector - essentially a wealth redistribution process) then Creditors will change their view about risk - Because now their balance sheet is healthier than before and they can lower lending standards, thus the money supply could increase again.
This is a very smart comment. I discussed this in my The Market Huddle podcast episode.
Isn't US deficit spending just a redistribution of already existing dollars? One group gives their dollars to the Treasury for T-paper and then the Treasury doles it out to other groups. Then the dollars flow back to the first group and the cycle repeats. I don't see the creation of anything except higher debt service costs. The pool of dollars stays the same, but just goes from one set of hands to another until the debt service costs in the system becomes too great for the pool of dollars to support. It's a big pool, but it must have a limit to how much debt it can stand before there are not enough dollars to go around. China is certainly coming up short at the moment.
Hello Alfonso,
I just watched a video from Daniel Lacalle (https://youtu.be/pcygEd24Vig) where he questions the validity of any insight provided by the bond markets, considering they are so intervened by Central Banks. As such, he argues that organic price discovery is shattered.
Would you terribly mind taking a look at that video (it is only 3 minutes long) and comment? I believe Mr. Lacalle's points are fair.
Thank you!
Hi Hector. The bond market is still very alive and telling in both EUR and USD. You might have noticed I often use inflation swaps rather than nominal yield as my reference, as Central Banks can't receive/pay inflation swaps.
If you observe the price of Treasury securities (or its yield) vs the size of Fed balance sheet and their asset purchase speed for each term maturity, it doesn't fit the "Manipulation" narrative.
I think yes, somehow the Fed could affects but can't "Manipulate"
Simple question: "Listen to what the bond market is saying", are you LONG on Bonds? and Fixed Income ?
Always representing myself and not my employer, so we're talking my private accounts.
In my structural asset allocation and being a EUR investor, if I think we sit in Quadrant 1 (the secular quadrant, where we sit most of the times) I own 20% of medium to long-term US Treasuries denominated in USD.
Tactically, I am in 5s30s US flatteners - not advertised here because I entered it before launching the PA section of the newsletter and it would not be fair and transparent to claim that trade. But if you follow me on Twitter, you'll see it there.
Nicely in the money and not planning to exit it anytime soon.
Expect to curve to flatten in.
Al, great interview on RV. I do have a question regarding Gov't deficit spending which you metaphorically called money printing/credit creation. Do the banks create new credit when they purchase Gov't securities similar to when they create new credit when they purchase a loan from the private sector? Thanks for all the great content , huge value for little guys like me.
Thanks for the nice words, Matt.
If the government spent more money than it plans to tax for, new credit was created.
I've read articles how when the Gov't spends, it is crowding out the private sector leading to less investment. But that implies they are borrowing existing credit. How is the new credit created from a balance sheet perspective when they have a bond auction. Are the primary dealer banks creating that new credit?
It's the 40's not the 70's.
https://www.lynalden.com/inflation/
The only similar thing between now and the 40s is that governments will try to keep real yields below real GDP growth (financial repression).
But no runaway inflation or any other similarities.
Birth rate are completely different, wage bargaining power is zero today, tech now vs Industrial Age in the 40s, appetite for credit back then versus private sector wish to de-leverage today. Really two different beasts.
101% agree governments are all in on financial repression.
I do think you can dismiss hyper-inflation, but you should not dismiss inflation spikes like the one we are living through now. As you point out inflation swaps price the next year at 3.6%…. In a world of zero or negative bank deposits that’s quite a lot of inflation.
For the next couple of decades it’s not birth rates that matter, it’s the fact that millennials who now outnumber baby boomers, at an ever increasing rate, have only just started to spend. US housing is a good example of their coming demand.
Agree that non unionised labour has reduced wage pressure but the increase in minimum wages and the recent signing bonuses is evidence that wages are rising.
And heck the way ESG and OPEC are going maybe oil does hit 200 and we’re back to something like the 70s.
Cheers,
Hi Karl, I agree with some points and disagree with others.
I should probably write a post on why I think the 2020s are different from both the 40s and 70s in more details.
The Bond Market is sending a strong message. Alfonso do you think U6 will not decline below 7% this cycle? Or that the part rate will not exceed 63%? Or is the bond market counseling patience?
Hard to say if participation rate and U6 will be back at pre-pandemic levels. I doubt they're going to look better than that, though.
Great outline Alfonso. Thanks!
Based on your observations on those bond market facts, how does the FED who are monetising the debt and the government, who continues to print it, deflate it away over time? We assume they need to... of course the notion that there is zero need to do so has been given some air time recently, as long as real gdp remains higher than debt repayments. Tricky game!
How do you see the magnitude of the FED purchases in the bond market having an impact on true price discovery and therefore a true reflection of what the bond market is really saying? If they are the dominate buyer of bonds vs foreign entities, etc., which have peeled off in the past 4-5 years, then doesn't that suggest the structure of the market has fundamentally changed from the past 40 years? Notwithstanding the other data points (loans, employment, debt) you have used to support your deflationary perspective.
Incidentally, have you seen Russell Napier's perspective on secular inflation. He's been a massive deflationist for 20+ years and has now pivoted to an inflationist. His central thesis (from memory) revolves around CBs taking more control and "influencing... read force" commerical banks to lend (backed by CB guarantees). Doesnt' appear to be a sound principle, but as they say... desparate times.... The motivation to take such drastic action hinges on debt levels and the need to reduce them significantly, so there's a fair rationale.
The above said, lending money to zombie companies who cant' generate growth and therefore profit above repayments can only be very bad med/long term. Outside the FAANG stocks, which have created a misconstrued view of the S&P, the significant majority of other companies aren't generating anything above average. If there's a market shock, then the fact the rally is not broad based in nature can only mean a sudden reversal. The chatter about interest rates rising would constitute one of these "shocks", so its unlikely to be self inflicted by the FED. They have a massive problem generating enough inflation already, as a way of deflating debt.
So, fiscal policy appears to be the only way for them to generate growth, but that naturally will be acommpanied by additional debt. If the 'investments' aren't prudent, we will simply have more debt and little growth. So many ways this can potentially go wrong and a policy mistake(s) is made.
1. You can inflate real debt burdens away with real yields < real GDP growth. That's what authorities are trying to achieve.
2. The price discovery in fixed income is very poor. That's why I look at inflation swaps and other metrics to have a better grasp of what the market is really pricing in.
3. Napier's main point was that lending operations would be overtaken by the government running around commercial banks and basically guaranteeing their loans and ''force'' them via regulations to lend..that ain't happening.
Thanks for the response and clarity on the point 2.
With respect to p3, you're right and they've been doing that for years. Risk/Reward is to low to drive momentum. But that is exactly the environment that provides the ambient condition to create a structral change in the banking system.
Why? If the FED can't generate sufficient GDP growth and inflation delta to real yields using traditional means, then they and the governement are going to resort to non traditional means. Which is exactly Napier's underlying thesis.
DEBT/GDP is 130% and forecast to be higher, so desparate times drive desparate measures. Time will tell.