While the rest of the world is still jumping up and down and celebrating the Dow Jones’ scaling of the 19,000-point mark, bond markets are in a more reflective mood.
The US 2-year note yesterday traded to an intraday high yield of 1.103%, its highest since early 2010. 1.103% might excite some folks but in a broader context it’s the same as being impressed with getting a C+ on a statistics paper that you had expected to fail – good from far but far from good.
It might be pretty much spot on the average yield for the past 10 years, which is 1.129%, but it’s a long way from the return investors were getting going into the global financial crisis in the summer of 2007 when 2s yielded over 5%. In the previous decade from 1996 to 2006 the self-same 2-year note averaged around 4.20%.
The exercise on the 10-year is not quite so straight forward. Despite having backed up from the low yield of 1.359% on July 8 to close at 2.356% last Friday, the year’s high, over a longer term these rates still look as though they might have a long way to go were they to reflect the sort of surge in the economy that stock markets seem to be expecting. For the 10s, we have to bear in mind the decade-long average yield of 2.83% and a high of 5.29%, also in the summer of 2007. For the sake of completeness, the average 10-year yield in the decade from 1996 to 2006 was 5.035%.
Now, I’m not in the game of questioning the new normal but I’m once again pointing at the issues that the US will face if rates to refinance its debt pile of close to US$20trn at are anything more than it is paying at the moment. Markets are still relatively sanguine as they have so far only priced in two increases in Fed Funds for 2017 as they continue to focus on only one half of the Federal Reserve System’s remit, namely economic growth. The other half of the brief, the control of inflation, is not in clear focus; let’s face it, who can remember when inflation rather than deflation was the spooky phenomenon?
A dollar at ¥110.00 or above is not going to put the fear life into inflation watchers but the prospect of large swathes of protectionist Trumponomics might. That said, if there were an Olympic gold medal awarded for back-pedalling, the president-elect would be a shoo-in. Hasn’t he just said that he is not going to “lock her up”? Not that that comes as much of a surprise; the strict division of powers into executive, legislature and judiciary is utterly axiomatic to the US – other than of course the highly contentious process of the presidential appointment of Supreme Court judges – and the Donald, like it or not, has no role in deciding whether or not Hillary is charged and tried for a felony, any felony.
Vanity vs sanity
The case is simple: the US cannot afford, any more than Greece can, to pay anything more than peppercorn interest on its debt. Federal debt is approximately six times current tax take. As a property man, Trump should know that the value of the assets is vanity; cash flow and debt service costs as a percentage of total revenues is sanity. In a squeeze, a property guy can sell a property to raise cash. As a nation, the US has nothing other than Treasuries to sell and if Zero Hedge’s report is correct, it will be competing with China and Saudi Arabia to do just that. Zero Hedge does occasionally have the habit of hearing the grass grow even before it has been seeded but it certainly has a point when it offers up the question why anybody, reserve banks included, would necessarily want to be long of Treasuries in a bear market, not least of all when they are in need of cash. There is surely nothing malevolent in the decline of foreign holdings of Treasuries – it’s pure cash-flow management – but the US Treasury would surely not want to be in competition for selling its own paper.
Of course the US is not Greece but econometricians, both for the government and for the investing public, would do well to cast a few charts integrating a number of scenarios for a putatively increased base cost of government borrowing.
In New York and beyond nobody will care for that today; just get to lunch time, switch off the screens, hope the limo that has been booked actually gets to the office, rush though the traffic to the airport and then home for the holidays. Travel safely one and all, and Happy Thanksgiving!
Meanwhile, here in the UK, Chancellor of the Exchequer Philip Hammond will rise in the House and offer his Autumn Statement – or should that be read back to us all the leaks we’ve been treated to over the past few weeks, along with a few guarded, headline grabbing surprises – which will be his first major act since the personnel changes brought about by David Cameron throwing all his toys out of the pram.
The key message will be simple: up-date Britain’s infrastructure and help the lower middle-classes. New bottles of old wine? How often have they told us that Britain wants to be a leader in this and a leader in that but by the time the cash has been spent on this public enquiry and defending against that challenge on behalf of rare snails or nesting widget-bills, there’s nothing left to do what had originally been intended. Anybody who has spent three years waiting for the completion of the Coventry Tollbar End “improvement” to the A46/A45 intersection will be praying the roads are left alone. In China one can land at an airport, watch the beginning of a highway being built and drive back to the airport on that road in about the time it takes us Brits to decide what brand of tea we’re going to serve in the engineering office. HS2? Heathrow’s third runway? Yikes!
Hammond has a big job – he has to work with economic forecasts that are pitched against an unknown future and are supplied by statisticians who have done nothing but get it wrong this year. The intentions will surely be good, not least of all as the government has a new acronym to play with – the “JAMs” – the struggling mass of low-paid workers who are “just about managing”. The government’s intentions are surely good and as the daughter of a vicar, Theresa “Kitten Heel” May surely has her heart in the right place but the administration is playing in a game of pre-post-Brexit for which the rules are unknown and unwritten. While the Yanks are busily giving thanks, the Westminster grandees will still be praying for a decent outcome and that they don’t end up looking like turkeys.