“The pen is in our hands. A happy ending is ours to write.”
Hilary Mantel
This one goes out to Hilary, Not Hillary but Hilary, who left us unexpectedly this past week. Not many of you know her, but she was the perhaps greatest writer of historical fiction of our time. She wrote of vast conspiracies that were real, not artifacts of political device. Rest well, Hilary. And thank you.
Meantime, something’s been bugging me: the obsessive market focus on short-term interest rates. We were treated to an example of this on Wednesday, when, Chair Pow, as expected, jacked up the overnight Federal Reserve borrowing rate by 75 bp, and (as less anticipated) indicated that he weren’t nowhere near done yet. Got another >1% of hikes in store for us, and that only takes us until year end.
But (laying aside that only a few hundred privileged financial institutions are even eligible to borrow from the Fed), the following question emerges:
Who borrows overnight? Goldman Sachs, yes. Citigroup, yes. Occidental Petroleum, maybe.
But not you. Or me. Our mortgages, if we’re smart, extend out more than a decade. Personal loans gotta run for at least a year. My best research suggests that corporations typically borrow for minimum periods of at least 5 years.
So, why all this bruhaha about the overnight rate?
To me, it’s not an idle question, preferring as I do to fixate on longer term borrowing costs. This may make me a bad person, but I firmly believe that the real action in the debt markets has less to do with overnight rates, repos, reverse repos and such, and is much more impacted by the vig imposed over much larger numbers of clock ticks.
All this is arguably timely, because a review of rates across maturities is not especially\ recommended for the faint of heart:
In the pointy-headed parlance of the markets, this configuration is called inversion. It is not the preferred construct; normally one expects that the farther out on the maturity curve one traverses, the higher the rate should be. There are several reasons for this – some even risk-related.
But I won’t get into them right now.
Suffice to say that the government is currently paying a higher rate to borrow for two years than it is for thirty. And something about that seems, at minimum, rather unholy to me.
But there are identifiable root causes. The Fed wants high rates — to cool the fires of demand, and, by doing so, taming the inflation beast. It explicitly sets its short-term levels, but much like us regular schmucks, must yield to the caprices of the market at the longer end of the curve.
The Fed has indeed begun the long trek towards reducing its subsidizing ownership of Treasury and Agency paper. But even this is oriented towards the short end. No, they’re not selling into the market; rather they are simply allowing securities they hold to mature without replacing them. And the shortest end of the short part of the curve is a maturing debt security.
The current pace is $100B/month of passive unwind, a rate which would place their holdings at previrus levels by early 2026. Reverting to longstanding, pre-financial crash thresholds (~$ 1 Trillion) will take a good bit longer, but, with diligence, they could reach this reverse milestone by the end of the decade (by whence all California engines will be forced to run on sun, wind and daisy droppings):
The Fed may indeed wish to see higher rates out beyond two years (again, where nearly All God’s Children borrow), but does not appear to have the stones to engage in some bona fide selling at the long end of the curve.
It can perhaps take some perverse comfort in the reality that others are doing the selling for them. This past (withering) week featured not only an equity market rout, but a fire sale of Govies by entities other than our own Central Bank. This placed Madame X’s (Ten Year Rates) yield skirts at levels last witnessed in 2010. One can have nothing but sympathy for this sexy but aging siren, who, with 3/4ths of Terrible ’22 in the books, is having the worst year of her long, stormy existence:
Similar sorrow has worked its way across the globe last week, as, in the immediate aftermath of the laying to rest of Liz II, not only did her own, stolid, Bank of England jack up terms, the Central Banks of colonial Canada, New Zealand, Australia, as well as Sweden, Norway and even Switzerland (Switzerland?) followed suit.
The lone global exception is Japan, which is stubbornly clinging to its subsidized interest rate policy. In response, and you can’t make this up, the JGB recorded zero trading volumes on multiple days this week.
Probably the other matter to which we must attend is the continued quagmire in Eastern Europe. As you are no doubt aware, having suffered some reversals in the field (Ras)Putin is making menacing threats about cranking up the nukes. Which is not a particularly promising prospect for global commerce. But, beyond this, we can perhaps take comfort that his contemplated plans only involve the use of shorties – missiles that have ranges of a mere few hundred kilometers.
If, by contrast, he was contemplating use of the long boys – Inter-Continental-Ballistic Missiles – we might really have something to worry about.
If all the above gives you a long face and renders you short-tempered, please know that you come by these conditions honestly. But it begs the following question:
Long or short?
Wish I had a better answer, but I find both market orientations depressing. There may be some bargains here and I’d venture so far to state that there probably are, but and one must seek them out carefully and at one’s own risk. Could be, the time has come to load in on the short side and gloriously capture an all-out market crash.
Which I don’t think will happen. And if you play for this, be prepared for the possibility of being squeezed into oblivion.
So, the answer to the long/short question is both. And neither. There’s nothing really for us to do but pick ‘em as we see ‘em. I think this will be an exercise of significant frustration, and I don’t anticipate that it will bear much fruit – at least in the short term.
Longer term, well, there is hope. Which springs eternal.
Over time, the pen may indeed be in our hands. However, with due respect to the brilliant Ms. Mantel, I’m not sure if this renders us fully empowered to compose a happy ending. All the protagonists in her magnificent Cromwell trilogy, as well as in her masterwork on the French Revolution, end with heads severed from necks, by rope or blade.
I fear we also need some help – from Above, from Providence, or maybe just a simple fortunate turn of the random die. But we can, in fact, we must, manage our risks along the way, lest we deny ourselves even the possibility of benefitting from positive happenstance.
And that, my friends, is the long and short of it.
TIMSHEL