Clowns to the left, Jokers to the right – Oct 6th 2023

Ladies and gentlemen, can we just take a moment to appreciate the sheer spectacle of the last three weeks? It’s been like front-row seats to the financial circus, “clowns to the left of me, jokers to the right, here I am…” and the past six trading days? Well, they’ve been like a wild ride in a theme park of pain and emotional distress. But guess what, brave souls? When I finally dared to stick my head above the trench this morning, amidst the smoke and the wreckage, I saw it—a ray of sunshine! It’s like a beacon of hope, reminding us that, perhaps, the worst is behind us.

Let’s talk big numbers first. Brace yourselves for this one: a whopping 336k jobs added in September, while the so-called experts, those PhDs who are clearly overpaid to preserve their own jobs, had predicted a measly 170k. It’s almost comical, isn’t it? Reality instantly hit the long bond which held a perfect swan dive through the 5% mark, only to correct once the law of round numbers took over the market. [30yr yields closed at 4.958%].

But here’s the kicker: this move allowed the yield curve todo something it hasn’t done in a while—show some signs of rationality! Yep, you heard me right, it’s actually steepening! Sure, it’s more like a flat line drawn with chalk on a bumpy sidewalk, but hey, at least it’s no longer doing that awkward inversion dance. Now, I’m about to make a call that’s so early, it’s practically in a different time zone. The front end of things isn’t quite on board yet, with 2-year rates stubbornly pinned around 5 1/8. Of course, the overall rates picture is still a bit of a puzzle and levels will hang in the balance of consumer strength and the looming specter of an economic blow-up. But here’s the interesting part—the term structure is normalizing. And history tells us that’s usually a sign of transitioning from a downturn to recovery, or even expansion down the road. The bounce in risk assets today? Well, that might just be the first hint of it.

Now, let’s not forget to exercise some caution. The mind-boggling amount of new and maturing debt lurking in the shadows poses quite a risk. Especially for those brave souls with balance sheets loaded up with US debt, many of which are marked down nearly 50%. And let’s not kid ourselves, leverage is still on the rise, ready to snowball and take a few more folks down with it the longer we stay here.

How long is longer you ask? How about, as transitory as transitory can be? Don’t waste your time there, here is what we know: we have a government with an insatiable appetite for spending. Rising debt interest, foreign aid and subsidies — all served up against a backdrop of lower tax receipts. We’re running on a near 10% deficit at the moment, and it’s time for the treasury to scout for more buyers, many more buyers. Oh, did I mention the recent strength of the US dollar? Brace yourselves for major stakeholders of US bonds liquidating positions to support their local currencies. In comes the Bank of Japan and other Asian economies.

Price discovery will be the name of the game in the bond market for the next few weeks, maybe months, particularly in the long end, and fear? Well, it’s going to be the theme, it helps sell paper, especially during those heavy auction dates. And should all else fail to attract interest before another liquidity crisis arrives, rest assured that our government officials will be brewing up some creative solutions on the backs of the taxpayer. Yellen and Powell are likely already rehearsing their pitch to major banks… if you’re not happy with the first 5%, the Fed will find a way to send you the extra 2%… FREE! In homage to the famous 7-minute abs scene in “There’s Something About Mary.” Jamie Dimon nervously hinted at the 7% ‘“holy moly” level a few weeks ago.

To ease some of the concern, let’s not forget about the natural buyers of debt—they’ll emerge, there are ALOT of them, and will be drawn to these historically exciting yields. No joke here, 5yr yields at 480bps as CPI trends lower to 3.6% next week? Mine all day. And dont forget your bond math, high rates shorten duration, naturally drawing more bids as extensions trickle through from insurers and other LDI’s. And if that’s not enough, those bond salesmen might even remind us of the positive convexity profiles in these debt instruments to sweeten your portfolios. The reality is that there is a plethora of capital on the sidelines which will be getting deployed. Enough to take down all of the supply at current rates? We’ll soon find out.

The crew worthy of a mention here are the Retiring Baby Boomers. They will be the talk of the town and will be living the good life, enjoying their retirement with high-yielding, riskless assets. That’s 10k retirees (turning 65) every day this year, and 12k everyday in 2024. Has the BLS adjusted the size of our workforce yet? As for the rest of us, well, these higher yields should serve as a reality check. It’s time to scrutinize every investment, to ensure we’re not getting complacent when assessing risk. Let’s be thorough, and make sure our assets are parked in the right places. Because you see, the next few innings are all about selection—whether it’s in a country, currency, sector, company, or a sweet spot on the yield curve. Options are aplenty once again, my friends. So, stay sharp, and dare I say it, a tad greedy!