I mean, after all, Big Bird is a canary. Right?
As I migrate back from solemn tribute to the more routine madness of this forum, it is my honor, this week, to deliver to you, for your consideration, what I think is a juicy mash-up.
The first component (the “Mash”, if you will), and at the risk of stating the obvious, is the reality that entire market is now keying almost exclusively on the fortunes of the long end of the Treasury Curve. Its steepness and associated trajectory are, from a risk management perspective, of paramount, pertinent importance.
This dynamic has risen to the dignity of an obsession for me, so much so that I’ve found myself, in recent conversations, describing yields on the Ten-Year Note (Madam X) in particular as being the canaries in the proverbial market coalmine.
I think it works pretty well, save one minor detail. It’s not like Madam X is some little yellow bird in a cage, whom no one chooses to notice until she turns, tits up on her perch and flat out expired, from carbon monoxide poisoning. Nay, my friends, it’s the largest liquid market under heaven.
So, if it’s a canary, it is an enormous one.
Like Big Bird. The Biggest Canary of all. Or at any rate, the biggest canary in my field of awareness.
And who doesn’t love Big Bird? Not me, that’s for sure. I don’t not love Big Bird, and no one can accuse me otherwise. More than that, I need Big Bird and am deeply invested in his longevity.
Moving, now, from “Mash” to “Up”, I’m pleased to report that Big Bird – the artiste, received a major shot (covid dose?) in the arm last week, with the ramming through, along party lines (and featuring the now-holy ritual of reconciliation), that $1.9 Tril stimulus package — out of which the Corporation for Public Broadcasting (CPB which is still the major underwriter of Sesame Street production) is due to receive a juicy $175M.
Please know that I love the oxymoronic (is it a Corporation or is it Public?) CPB as much as the next guy; almost (but not quite) as much as I love Big Bird his-self. We should just remain aware that while $175 large will buy a great deal of bird seed, this and other elements of the package come at a significant cost – to the Big Bird in the Market Coalmine, and to other elements of the capital economy.
The latter is in unambiguous recovery mode, lockdowns are winding down, vaccines appear to be working, and, certainly, we can all be grateful for these manifold blessings. But there’s so much cash floating around – Fed Funny Money, CARES Act Stimulus that has yet to be allocated, CARES Act stimulus that has been allocated but not spent – that there’s every likelihood of economic explosion over the next few months. The economic kettle is simmering to a boil and the lid may very well blow off.
And that is before the $2T handout to state governments, public sector unions, individuals already incentivized to remain out of the work force (so long as they follow the voting instructions of their paymasters) and other favored constituencies – all of which projects out to a 2021 budget deficit of at least $4T – its highest level since just after WWII.
The Federales have not issued a major tax call – yet. So, the only way to finance all of this love is through the issuance of more debt. Which should lower its price and increase the vig that the country, as borrowers, will need to shell out for securing these funds.
We can call this a Washington problem, and maybe it is, especially when you consider (in contrast to its political leaders) that the American citizenry has saved more of its income in 2020 than at any point since they started tracking these statistics in 1960:
United States Savings Rates:
Nobody should take a victory lap on this. Savings are piling mostly due to the government handing out oodles of cash to individuals, who, because they have been locked down, have had nowhere (heretofore) to spend it.
But as I suggested a couple of weeks ago (Sloppy Seconds) it looks like there’s a major party about to commence, with festival favors taking such forms as renewed freedom of movement, historic liquidity, burgeoning savings, and fiscal policy that wishes to reward us for, well, just for being us (as well as for our assistance in dispatching Big Orange).
When you put it all together, you’re looking at an economy with enormous pent-up demand, wallowing un unspent Benjaminz, and looking to bust out of shackles it has been compelled to wear for a year. The ruling class, worried that this wasn’t enough, just topped us off to the tune of $2T.
But they gotta borrow the money to do so, and this means that the Treasury Market will be flooded with supply. And the $30T question is as follows: who will be the takers? If any shred of economic theory remains intact in this current monkey circus, the usual buyers would be there, albeit, presumably, at lower prices and higher yields.
And, if the monkey circus had not built permanent structures rather than pitching tents, this wouldn’t be such a problem. Interest rates (or so they taught me in Grad School) should drift upwards in an economic environment of accelerating growth.
However, here’s where it gets a little bit tricky around Sesame Street. Higher rates imply lower valuations for debt securities; really, they’re one and the same. But that means that anyone holding this paper as an asset will take a P/L haircut, and many cannot afford to do so. And the entities set to take the biggest bath are our people, folks, good old American institutions. China? A pitiful $1T of U.S. Treasuries in their vaults. Saudi Arabia? A microscopic $180B.
Nay, Secretary Yell and her cronies at Treasury are mostly in hock to U.S. Insurance Companies, (underfunded) Pension Plans and other domestic fiduciary pools of capital, which are not in a position to roll over and get stiffed when the value of their Bonds and Notes drop. And this is to say nothing of the pounding that is in line for the holders of Corporate/Municipal Debt and Structured Securities, which: a) are owned by the same types of investors, who b) might be less inclined to lend or purchase debt in the wake of these losses.
All of this comes at an inopportune time, what, with millions of businesses either zombified or toe-tagged entirely, and a massive effort needed to repair the carnage wrought by both the virus and its associated mitigants.
So, while Secretary Yell is serenely teeing up all of those new IOUs, her successor at the Fed – Chair Pow – has a real problem on his hands. All of his policy manuals tell him to allow interest rates to drift upwards in an environment like this, but then again, his policy manuals don’t have to deal with $30T in outstanding obligations, and a debt to GDP ratio that is certain to hit the historic and improbable level of 150% sometime this year.
No wonder he looks like he’s aged about a decade over the last few months. I’d give you the Before/After images to prove this, but I’m already in enough trouble with the Copyright Police as it is.
And nothing for nothing, but Powell has shown his sinister interest rate raising predispositions before, and when he did, the markets imposed swift justice on his perfidious ass. Most memorably, at the end of 2018, his bare hint at yield curve normalization catalyzed a > 20% drop in equity valuations in the weeks leading up to the Christmas Holiday. At which point, he backed off, begged our forgiveness, and the benevolent markets rewarded him with an approximate 70% Gallant 500 gain over the next two years.
He knows this much: if he pulls that sh!t again, the market will initiate another whuppin’.
Thus, even as all signs point to upward pressure on interest rates, it is my view that the capital economy can’t sustain them, and that investors won’t abide them. At the end of the day, if supply exceeds demand for our paper (as is highly likely), Powell will be forced to step in and buy out the whole inventory.
But meanwhile, the psychodrama of upward rate pressure, on an economy that is drunk and addicted to free financing, will be a wonder to observe in its unfolding. So, I’m asking you to keep your eye on the action at the long end of the Treasury Curve: the ginormous, anthropomorphic canary, singing in the coal mine.
It will be a white knuckler, but I encourage everyone to retain some equanimity here. Big Bird, like Keith Richards himself, is by and large indestructible.
He takes his lumps but keeps rolling. However, and this is my main point: when the Big Treasury Bird sneezes, we all catch a cold. So, if you see his eyes a’puffing and his beak a’twitching, you might be best served to impose an extra measure of social distance from him, and this means cutting your risk.
Not gonna lie: all of it wears me down. But some of these days, and soon, I’m gonna take you far away from all of these monkey muffins. We’ll go somewhere private, and just talk all night long. Where nobody can hear us, about subjects that are nobody’s business but our own.
In the meanwhile, let’s keep our eyes open, our feet moving, and say a prayer that our angular, feathered ornithologically anthropomorphic friend remains upright and in his locked position.
TIMSHEL