THE HEADWINDS OF THE LAST THREE DAYS DISAPPEARED

Markets had a broad base rally with technology outpacing other sectors.  The headwinds of the last three days appeared to have just disappeared…Omicron, interest rates and fiscal policy.

Some believe yesterday’s gains were the result of the lack of liquidity, a view that I partially share.   Nominal buying or selling can considerably impact prices.

Treasuries however continued to decline in price albeit prices did come off their lows following a “successful” 20-year Treasury auction.  The yield curve continued to steepen.

As noted many times, most are perplexed about the advance in Treasury prices given current and future inflationary expectations.  The 2-year Treasury or the instrument most sensitive to monetary policy has already discounted three rate hikes over the next 13 months, a discounting that took place before last week’s FOMC meeting.

This “discounting” was the basis for the flattening of the curve as the “market” believes the central bank is ahead of the proverbial curve, a belief that is not rooted in fact given current and future inflationary pressures and expectations are between a 20 and 40 year high depending upon the data utilized.

Tapering has been discussed at length.  As widely noted between 50% and 80% of net Treasury issuances during the last 10 years was purchased by the Federal Reserve.  This buyer will no longer be present by mid March.  How will prices respond?

It is often said the most obvious conclusions are those that are ignored.

A steady decline in interest rates during the past four decades has challenged fiscal hawks and shown that the government has a greater capacity for borrowing than it did in the past.

Federal debt surged to more than the size of the economy last year, with the ratio of publicly held debt to GDP climbing from 79% in 2019 to reach the highest since WWII according to Bloomberg.

The cost to service this debt declined to 1.6% of GDP from 1.8% in 2019, the result of sliding borrowing costs; the ratio was more than 2% back in the late 1990s and 3% or above in the later 1980s according to Wrightson Icap.

A separate metric shows the outstanding stock of marketable Treasuries as of the end of last month was sold at a yield of 1.44% from 2.32% at the eve of the pandemic and 6.36% at the start of the century, also according to Wrightson Icap.

As noted above, inflation and inflationary expectations are between 20- and 40-year highs and interest rates are still around all-time lows [resulting in the lowest real yields on record].

It could be a very large problem if rates returned and maintained at levels that were experienced at the start of the century.  The current federal budget could almost be consumed via interest coverage on the debt if this were to occur.

What will happen today?  Revised GDP is released.  Little change is expected in the data.

Last night the foreign markets were up.  London was up 0.10%, Paris up 0.22% and Frankfurt up 0.21%.  China was down 0.07%, Japan up 0.16% and Hang Seng up 0.57%.

The Dow should open flat as volume begins to wane ahead of the holidays, with attention focused on the clarity of the economic impact of Omicron and the outlook for fiscal US stimulus.  The 10-year is off 5/32 to yield 1.49%.

 

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