Market news and our view on rising US bond yields.
Market News
US equity markets recovered early losses last night to end the session little changed – S&P 500 (-0.1%); Nasdaq (-0.5%). Ahead of the release of monthly payrolls report, the Fed’s Mary Daly argued the FOMC can refrain from hiking more if the labour market and inflation continue to cool. “Holding rates steady is an active policy action,” she said, adding the recent bond market tightening is equivalent to about one rate increase. The data is expected to show nonfarm payrolls of 170k and an unemployment rate of 3.7%.
This morning in Asia, markets were mixed: Nikkei 225 (-0.3%); Hang Seng (+1.5%); Shanghai Composite (holiday). The FTSE 100 is currently trading 0.4% higher at 7,482. The 10-year Treasury currently yields 4.73%, while gold is $1,820 an ounce.
The Labour Party gained a 20% swing from the SNP in big by-election win. According to mortgage provider Halifax, UK house prices fell for a sixth consecutive month in September. The average home now costs £278,601, down 4.7% year-on-year. However, they remain some £39,400 higher than in March 2020, such was the extraordinary growth seen during the pandemic. Sterling currently trades at $1.2175 and €1.1.553.
Brent Crude continued its recent slide and currently trades at $84 a barrel. China’s iron ore buying agency is in talks with Rio, BHP, Vale, and Fortescue about next year’s supply, people familiar said. China Mineral Resources, created in July 2022, is seeking preferential terms on transport, grades and delivery arrangements. Separately, Brevan Howard is planning a $750m push into commodities trading.
Source: Bloomberg
Macro View – Rising Yields
The big story in recent days and weeks has been the dramatic surge in longer dated US yields. For example, the yield on the 30-year long bond surged by 0.5% in September alone. Since the beginning of August, yields are up a full 1%. These are significant moves. This is in turn is feeding through into other long duration assets such as equities, particularly growth equities. Other developed markets such as the UK and Europe have seen similar directional pressure but have not moved as aggressively. Consequently, the dollar has been on a tear, rising 6% on an index level since its low in mid-July.
The aggressive Federal Reserve rate hiking cycle which jammed short rates higher over the last couple of years had, until recently, not been fully reflected further down the curve. Why the sudden change, especially as the Fed has signalled that it is at, or at least very close to, the end of its hiking cycle?
US 30-Year Yields
Source: Bloomberg
The answer can be found in the Quarterly Funding Announcement (QRA) made by the US Treasury on 2 August. In early June, the US Congress reached a deal to raise the debt ceiling which is part of US law. In the run up to the deal, the US had not been able to issue new debt and had been running down its Treasury General Account (TGA), which is essentially its cash balance. Once the deal was reached, the Treasury started to issue significant debt to replenish the TGA. However, virtually all of this was in short-term bills as opposed to longer-term bonds. The market was able to easily absorb this issuance because there was significant pent-up demand for these instruments from the Fed’s interest paying Reverse Repo Facility (essentially a place at the Fed where banks can place excess reserves accumulated via prior quantitative easings).
Although there are no specific legal limits, the Treasury tends to limit the amount of short-term bills outstanding to around 20% of the total debt. If they continued to issue bills at the same rate through the rest of this year, they would have breached that limit. The Q4 QRA told markets that the Treasury would issue a net $338bn in new longer maturity debt in the fourth quarter. The money to fund this issuance cannot come from the same sources as that which bought all the short-term bills. This issue of “duration” competes with other duration assets. The weakness in yields since that announcement is the market pricing in at what rate all that new issuance will get funded. Remember none of those bonds have yet to hit the market. Since that moment, all risk assets have been under pressure.
The price of long duration bonds is highly sensitive to changes in yield. The charts below show the price of a US Treasury maturing in 2050 has now fallen as much as the S&P 500 fell in the Global Financial Crisis. This demonstrates that just because an asset is risk free in terms of its cash flows, its price risk before maturity is significant.
US Long Bond Current Drawdown
Source: Bloomberg
S&P 500 Drawdown – Global Financial Crisis
Source: Bloomberg
Looking forward, it remains unclear whether the new issuance schedule has been priced in, although the move has been significant. Looking further out, with the US set to continue to issue huge quantities of debt to finance its projected deficits, the big question is at what rate the market will require to absorb it and whether that rate will be palatable for Uncle Sam. If it isn’t, the only actor with the balance sheet to buy all these bonds is the Federal Reserve itself. This in turn has its own consequences.