Login

Speculative Bond Short Hits New High: Others Claim "Rates Headed to Zero"

Iflationistas think a major inflationary move is at hand and they bet that with futures. I suggest the opposite.

A commitment of traders (COT) report for 10-year treasuries shows record bets that treasury yields are headed higher.

Large Spec Contracts

  • Long: 606,022
  • Short: 1,058,155
  • Net Short: 452,133
  • Bullish: 36%

Small Spec Contracts

  • Long: 371,438
  • Short: 575,158
  • Net Short: 203,720
  • Bullish: 39%

10-Year Yield

Inquiring minds may be wondering what speculators were doing mid-2016. The feature chart is easy to read but it does not go back far enough. Here is a second treasury chart that completes the picture.

Summary

  • Speculators were on the wrong side of a major, 123 point basis point, surge in yield starting mid-2016.
  • In early 2017, right as yields were ready to temporarily dive, speculators piled on with shorts. Yields rallied about 55 basis points.
  • Since December 2017, speculators amassed a new record short position. Those in early (December 2017), pick up 55 basis points.

Lisa Abramowicz Offered This Tweet

Now what?

I expect those record shorts will get blown out of the water. Only a small minority see things the same way.

As part of Weekend Reading, Lance Roberts suggests Rates Still Headed To Zero.

According to Roberts, "Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals combined with the demand for safety and liquidity will be the ultimate arbiter."

Rear View Mirror

Overdue credit card debts are piling up. More Americans are falling behind on mortgages. Car sales are dismal. Consumer spending is drying up. The global economy is slowing. These numbers are huge deflationary. Here are my definitions.

Inflation and Deflation Definitions

  • Inflation: An increase in money supply and credit, with credit marked to market.
  • Deflation: A decrease in money supply and credit, with credit marked to market.

You may not like or agree with my definitions, but in a fiat credit-based global setup, this is how the real world works.

Deflationary Debt Trap Setup

  • Credit card delinquencies are priced as if they will be paid back. They won't.
  • As soon as recession hits, defaults and charge-offs will mount. In turn, this will reduce the amounts banks will be willing to lend.
  • Subprime corporations who had been borrowing money quarter after quarter will find they are priced out of the market, unable to roll over their debt.

Rear-View Mirror Thinking

Those looking for a huge, sustained, inflation boost fail to understand credit dynamics.

I do not rule out a further spike in oil or any other commodities. Temporarily, Trump's dismally poor tariff policy may also give a boost to prices.

About a year ago, Lacy Hunt at Hoisington Management stated “Secular Low in Bond Yields Remains in the Future”

Fatter Crayons Needed

In January of 2018, Hedge fund heavyweight David Tepper appeared on CNBC and, when asked whether he was short bonds, said, "You bet your heinie." The same day, Bill Gross, citing technical analysis, proclaimed the "treasury bull market is over".

Exploding Debt

In April, Lacy Hunt at Hoisington Management offered this opinion:

"Important to the long-term investor is the pernicious impact of exploding debt levels. This condition will slow economic growth, and the resulting poor economic conditions will lead to lower inflation and thereby lower long-term interest rates. This suggests that high quality yields may be difficult to obtain within the next decade. In the shorter run, in accordance with Friedman’s established theory, the current monetary deceleration, or restrictive monetary policy, will bring about lower long-term interest rates."

Law of Diminishing Returns

Ponder the strong possibility that growth is getting weaker, the Fed is nearly at the end of this rate hike cycle, and numerous firms on interest rate life support are poised to go under.

There is nothing remotely inflationary about that setup.

The Name is Bond

For further discussion of Lacy Hun'ts law of diminishing returns and expected bond yields, please see The Name is Bond, Long Bond.

Mike "Mish" Shedlock

Full faith and credit (of the printing press)
600billion deficit in the 2nd QTR,700billion 3rd qtr,and wait for it .....800billion 4th qtr will undoubtedly trigger (overt) QE.

As usual, I think Mish is overstating the economic doom and gloom. I expect that economic growth will slow slightly during the next year, probably dropping below 2% annually by Q1 2019, while the fed raises interest rates modestly over the same period. Inflation will see a modest uptick towards 3% until slowing growth causes a reversal. At which point I believe, the Fed will reverse course as well, to provide some stimulus. I have no idea if rates will approach zero as some suggest will happen during the next phase of Fed stimulus. I do not agree that we are on the verge of a recession, as Mish has been implying on this site for years. Of course, that assumes no black swan event, like Trump starting a trade war.

Realist, a major trade war would not be a "black swan" it is approaching a given. I hope it does not happen

Realist - I am trying to understand. How do your expectations treat the debt that is outstanding? "Overdue credit card debts are piling up. More Americans are falling behind on mortgages. Car sales are dismal. Consumer spending is drying up. The global economy is slowing." Is Mish wrong about these? Or are you saying the amount of debt has no effect on future economic conditions? I don't know enough to do other than guess.

Hi Mish. As usual, I agree with you on the importance of trade. I also hope it does not happen. However, I do not believe it is “approaching a given”. I believe that cooler heads will prevail to prevent it. — Hi Curious. I don’t think that Mish is wrong about the problems that the US economy faces. I just disagree with his conclusion. He believes that a recession (or worse) is a given. He has also been saying this now for several years. I believe that all these problems are merely slowing the economy down to a slow but steady 2% growth rate. I have also been saying this for several years. I do agree that we are nearing the end of this decade long period of slow growth. But rather than a major recession or depression on the horizon, I foresee a minor recession followed by more slow growth. And I don’t expect the minor recession till perhaps 2020. My predictions are actually pretty boring. Talk of “the coming total collapse” is way more interesting and attracts viewers and helps some people sell books. Sensationalism sells, but it doesn’t mean that it’s right.

I don't know if this is deflationary, but I just bought a brand new Chevy (with a lifetime engine warranty), which stickered for $15K, and delivered out of state to my driiveway for $6K, with no trade-in (if I had owned a foreign car and not traded it in, it would have been only $3K to buy). My wife did not get quite as good a deal, but she got a $33K -stickered loaded GMC Terrain for $20K (could have saved $3k more if we had that foreign car), also delivered to our driveway from out of state.

The only time we've had deflation (in terms of the U.S. dollar) was in late 2008 and early 2009. That's it. The Fed printed and it made its way into the economy. Inflation resulted. Oh, it was only 2 per cent for most years since 2008 but in the last few years it's been 3-5 per cent inflation in terms of the purchasing power of the dollar. Deflation will never be allowed to happen. The central banks will always print. That's ultimately how the money will be "paid back". It is absolutely ludicrous to try to argue that a fiat currency will increase in value which is exactly what delfationistas are really saying. I've been an inflaitonista since the 1970s. Inflation is usually the rule. Deflation, rarely. Oh and I think rates are going back to zero and even negative. That's not deflation, that's insanity. They have no choice but to print.

@Realist - Looking at how the Canadian housing market has performed and how the 2008 mortgage crises in the US barely slowed the Canadian market, I can see how you would be perennially optimistic. It also seems the Federal Reserve shares your view that asset price appreciation will be slowed and inflation contained without triggering another big credit contraction.

No doubt the Fed had a similar goal in 2000 and 2008. Since they triggered substantial credit contractions the last two times they did this, I suspect that will happen again. The hypothesis there exists a Goldilocks policy between serious credit contraction and runaway inflation after massive credit expansion has resuscitated asset price growth may not be true. At a minimum, any enterprise that relies on ever cheaper financing to survive will implode soon after rates start climbing. The size of the economic implosion depends on how much malinvestment occurred. Of course, the Fed will respond to any substantial implosion by creating new credit and asset prices will nominally increase in the long term.

If you cite some macro evidence for the position that today’s asset prices and cash flows are sustainable with slowly increasing rates, I would find it easier to accept the argument that there will not be another big contraction this cycle.

I'm looking through the FRED delinquency charts and I'm not see

seeing consumers falling behind on credit cards or mortgages.

Sometimes it is best to just do nothing! We never know what the future will bring but if it is a financial crisis liquidity is generally one of the first things to dry up and when it does cash is king. In my line of work I do a great deal of negotiating and I have found one word people wanting to reach an agreement don't want to hear is "IF"! This is why I will never call the holder of cash stupid unless it is during a long period of massive inflation. More on this subject in the article below.

Hi Cautious. I tend to think of myself, not as an optimist, nor a pessimist; but as a realist. The reality is that for the last 100+ years, the economy and markets move up roughly 90% of the time. Big contractions (depressions or major recessions) happen rarely, yet people are always predicting that the next “big one” is right around the corner. As I say; “sensationalism sells”. As to rising interest rates, that will be the main reason for slowing growth over the next year or so. However, I do not believe it will trigger a massive recession and major market contraction. Once the economy slows enough, the Fed will reverse course and begin lowering rates to stimulate once more. On that point, I agree with Mish. Where we disagree is the level of volatility in the economy and market. He sees dramatic volatility. I see “Ho-hum”.

Uh, uh, @Realist. The insane corp. valuations of today are predicated on robust earnings growth catching up with said valuations. That can’t happen in a 2% growth regime. The result will eventually be a major price readjustment of financial assets (read “crash”). Remember that the Fed could not prevent crashes in either 2001 or 2008. We are currently at the top of the economic cycle and as such a recession is coming in 1 to 1.5 years.

The added complication on top of all of this is that at the glacial pace of interest rate rises and balance sheet reductions ongoing the Fed won’t be able to build enough “runway” for the steps you mention that the Fed will take to be nearly as effective as the last time they were tried.

(edited)

Mish, I find myself agreeing with much of what you have to say but find myself scratching my head on the direction of rates longer term. Short term, while the world still treats the dollar as the reserve currency I get why rates can go lower on a contracting economy and credit imploding...but, we are broke, just like Greece. When the world wakes up to that, gold explodes as do other hard assets and rates skyrocket, no?

Hi QTPie. I also believe the market is overvalued at these

levels. However, with tax cuts, buybacks, increased dividends, and a little bit of investment, I don’t think the overvaluation is “insane”. I think markets will shuffle up and down over the next year or so so. I don’t see a big crash coming.

@Realist - it’s all going to come down to actual earnings growth. Over the past decade it’s averaged about 2.5% per year. At this point companies are forecasting almost 30% growth per year for this year and next. Personally, I am quite skeptical of that.

the alternative to raising rates is to allow the bonds to go at auction at a discount to par, effectively rebating the buyer cash, which is better for domestic buyers than foreign because it implies more weakness in the dollar. They plan to increase the offering size, so where's the money coming from? The other problem if stocks roll over owning bonds as collateral for buybacks is no longer a good deal. Imagine if people only bought bonds for the interest?
I think the rebate is their best answer

the alternative to raising rates is to allow the bonds to go at auction at a discount to par, effectively rebating the buyer cash, which is better for domestic buyers than foreign because it implies more weakness in the dollar. They plan to increase the offering size, so where's the money coming from? The other problem if stocks roll over owning bonds as collateral for buybacks is no longer a good deal. Imagine if people only bought bonds for the interest?

I think the rebate is their best answer

Stories