The Federal Reserve has finally freed the bond markets to determine the time value of money (yield) after 20 years of financial repression. At the same time, the Fed is raising the short-term fed funds rate while the government continues to run large deficits.
ByEric Wallerstein, The Wall Street Journal, Updated Oct. 8, 2023
The autumn bond rout is challenging Wall Street’s longstanding belief that the U.S. government can’t sell too many Treasurys.
Ever since the Federal Reserve broke the inflation scare of the 1980s, Wall Street and Washington have shrugged off multitrillion-dollar deficits, counting on America’s global standing to provide perpetual demand for its debt that could finance the spending. Now, the steep declines in prices of Treasurys—meant to be the world’s safest and easiest-to-trade investment—are forcing markets to confront the possibility that the rates required to place all this debt will be higher than anyone expected…
This summer, the Treasury Department caught Wall Street off guard by announcing it would borrow roughly $1 trillion in the year’s third quarter, more than a quarter trillion dollars above previous expectations. Already more than $1.76 trillion of Treasurys has been issued on a net basis through September, higher than in any full year in the past decade, excluding 2020’s pandemic surge. Official estimates show that is unlikely to decrease…[end quote]
Yield spreads of junk bonds are widening even as the base Treasury yield is rising. The weakest of these are zombies, companies that earn just enough money to continue operating and service debt but are unable to pay off their debt. Many zombies borrowed at ultra-low interest rates in 2020 and 2021 but will be forced to roll over the debt at much higher rates. The Federal Reserve and IMF have been warning about this for many months.
By Sarah Chaney Cambon, The Wall Street Journal, Oct. 8, 2023
Business bankruptcies are rising briskly. What’s even more worrisome: Many of the troubled companies are large…More corporate filings are likely on the way as high interest rates push big companies over the edge.
While any type of bankruptcy signals distress, large-business bankruptcies carry particularly significant economic risks. They can send a chill through financial markets, involve tens of thousands of job losses or, in the case of Lehman Brothers in 2008, remove all doubt that an economic downturn is under way…
Big chapter 11 filings — which, by one estimate, tripled in the first half of this year compared with the same period last year — come alongside rising economic risks. Households are running down pandemic savings, banks are pulling back on lending and bond yields are surging, all of which could curtail growth…
“Mega bankruptcies,” or those filed by companies with more than $1 billion in assets, hit 16 in the first half of this year, surpassing the comparable half-year average of 11 from 2005 through 2022… [end quote]
So far, these bankruptcies haven’t weakened the economy. The Bureau of Labor Statistics reported that the American economy added 336,000 jobs in September 2023, while the unemployment rate remained steady at 3.8 percent, continuing the longest stretch under 4 percent unemployment since the 1960s. Wage growth has remained steady – up 4.3 percent over the past year.
Economic activity in the services sector (the largest part of the economy) expanded in September for the ninth consecutive month as the Services PMI® registered 53.6 percent. Economic activity in the manufacturing sector contracted in September for the 11th consecutive month.
The Atlanta Fed GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2023 was 4.9 percent on October 5. That would be extremely strong growth. It’s higher than the consensus of economists.
Such strong economic growth would be likely to encourage the Fed to raise the fed funds rate if inflation is still above their target. Strong growth would lead to higher interest rates as the demand for credit from individuals and companies would compete with the demand for credit from the government. (Yet another reason why the idiotic Modern Monetary Theory wouldn’t work.)
The Treasury yield curve has been rising for weeks. It has finally normalized (no longer inverted) between 5 and 20 years. The USD and Treasury yields are rising fast and haven’t stabilized yet. This is a surprise to the markets. There’s no way to know when the trend will change.
The Fear & Greed Index is in Fear. The risk is neutral.
The SPX reversed its 2023 rising trend in August. It’s been falling since then. The CAPE is still in bubble territory. With T-bill yields over 5%, there are plenty of alternatives to stocks. But there’s no sign of a panic or even capitulation.
The METAR for next week remains drizzly with some sun breaks. Stock and bond prices will probably decline mildly overall but plenty of noise.