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Headwinds To Lower Bond Yields

We have been vocal that long-term Treasury bonds are an excellent investment at current yield levels. However, timing the purchase of bonds will prove…

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5 months ago

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We have been vocal that long-term Treasury bonds are an excellent investment at current yield levels. However, timing the purchase of bonds will prove difficult as numerous headwinds may temporarily impede their path lower in yield.

Discussing the potential headwinds to our trade idea is an important disclosure, given how often we voice our bullish bond opinion.

First, though, we remind you once again why we like bonds.

Key Takeaways

  • Economic and inflation trends will likely continue their pre-pandemic trends.
  • Bond yields and inflation are closely correlated.
  • As the Treasury’s x-date nears, more bond investors may sell.
  • Post-debt cap resolution will be met with significant Treasury debt issuance.
  • The Fed is not doing the Treasury any favors.

Our Bullish Case for Bonds

Economic and inflation trends of the last 30 years will continue. That is it! That is our simple and concise thesis for why bond yields will be markedly lower in the future.  

Pandemic-related fiscal and monetary stimulus generated above-trend economic growth and high inflation. Consequently, bond yields spiked to levels last seen 15 years ago, as shown below. They also broke the downward trend persisting for thirty-plus years.

Our thesis rests on the premise that the current yields, reflecting the past few years’ events, are an anomaly, not a new trend.

Bondholders invest to increase their future purchasing power. They can only achieve such a goal by earning a yield greater than inflation. Therefore, bond yields are a function of expected inflation, primarily a function of economic activity.

As economic activity gravitates downward toward its natural rate of 1.5% to 2.0%, inflation and bond yields will surely follow.

The graph below shows the strong correlation between economic growth and inflation.

gdp and cpi trends

The following graph shows that bond yields and inflation have trended lower for the last thirty years.

10 year yield vs cpi trends

The current Ten-year U.S. Treasury yield, less the CPI and GDP trend lines, is significantly elevated from the prior trend, as shown below. If pre-pandemic inflation levels resume, the ability to earn a long-term yield of 1.50-2.00% greater than the likely ten-year future inflation rate will be a steal. The circle within the graph shows that achieving a positive real yield (yield less inflation), even if small, has been an anomaly, not the rule over the last fifteen years.

yields vs cpi and gdp

Headwind 1- Debt Cap Drama

As political tensions heat up and the date of potential default (x-date) nears, the media and politicians will amp up their scare tactics. To wit:

  • The debt ceiling must be raised to avoid economic calamity- Janet Yellen
  • The fight over the debt ceiling could sink the economy – NPR
  • US debt ceiling impasse pushes government credit default swaps to record high – Reuters
  • How a U.S. default crisis could devastate your finances – Forbes

Such harrowing statements cause consternation among bondholders. Some domestic investors may sell bonds and move to cash until the situation is resolved. Foreign bondholders, less familiar with the ritual debt cap shenanigans, may also seek shelter. While most of the volatility will occur in the shortest of maturities, longer bonds will also gyrate with the headlines.

The graph below, courtesy of Bianco Research, shows the tremendous volatility in one-month bond yields. Short-term investors flocked to one-month Treasury bills when the x-date was longer than a month. At the time, the one-month yield fell to as low as 3.25%, while similar two- and three-month bills were around 4.75%.

With the x-date now occurring before the one-month bill matures, the yield is 5.60%, .50% above the 5.10% it should reside at.

bonds one month yield

Headwind 2- Post Debt Cap Issuance

Per Yahoo Finance:

For the first seven months of the fiscal year, the budget deficit hit $924.5 billion, more than double the same period of 2022, according to budget figures released Wednesday by the Treasury Department. Weaker revenues — including diminished transfers from the Federal Reserve — and bigger outlays for interest on the public debt, education and Social Security are among factors that propelled the widening.

federal deficits

The graph and comments highlight the sizeable fiscal deficit. As the chart shows, the deficit for fiscal 2023, thus far, is running on par with 2020 and 2021. Both years saw massive covid-related stimuli. The nation is running an emergency-like deficit despite a strong economy and the end of the pandemic.

Since January, when the Treasury debt outstanding hit $31.4 trillion, the Treasury ceased adding additional debt. Instead, they have used their “checking account” held at the Fed to fund the nation. The formal name for the account is the Treasury General Account (TGA). The graph below shows the steady decline in the TGA. It is expected to hit zero by June 8, 2023.

tga treasury general account

Once Washington agrees to increase the debt cap, the Treasury will ramp up issuance to restock its “checking account” and fund the widening deficit. Such a bump in the supply of bonds may require higher yields to help the bonds find a home. That said, the market knows heavy supply is coming and is likely pricing in much of the issuance before the Treasury issues new debt. Given the seemingly insatiable demand for Treasury Bills, the issuance bump may affect longer-term debt more than shorter-term debt.

Headwind 3 – Higher for Longer, QT, and Fed Remittances

The Fed, via monetary policy, drives up the deficit through higher interest expenses and remits less money to the Treasury. Further, the Fed is reducing its holdings of bonds.

The graph below shows that the Treasury’s interest expense has risen over $300 billion or 50% in a little more than a year. It now rivals defense spending. Higher inflation and the Fed’s monetary policy are to blame.

federal interest expense vs defense spending

The Fed typically remits its interest on its bond holdings to the Treasury. Per the Fed:

The Federal Reserve Act requires the Reserve Banks to remit excess earnings to the U.S. Treasury after providing for operating costs, payments of dividends, and any amount necessary to maintain a surplus.

In 2021 and 2022, the Fed sent $109 and $76 billion to the Treasury, respectively, which ultimately reduced the Treasury’s borrowing needs. This year, the Treasury should expect very little help from the Fed.

Lastly, the Fed is reducing its balance sheet via quantitative tightening (QT). Doing so will essentially put an additional $95 billion of Treasury and mortgage bonds into the market every month. The extra supply will sap demand for new issue U.S. Treasury bonds.

The graph below shows how much new issuance the Fed absorbed via QE and is now returning those bonds to the market via QT.

fed absorption of treasury supply

Summary

The headwinds to lower bond yields are significant but surmountable as demand for bonds is high, especially at today’s yields. Further, if one believes the economic and inflation trends of the past thirty-plus years return, current yields are well above their potential lows. Only three years ago, the ten-year Treasury yield was 0.50%!

It’s important to note that just because one invests in a long-term bond does not mean they hold it until maturity. We envision holding long-term bonds until yields revert to pre-pandemic levels. At that point, we may sell the bonds, monetize the yield change, and reinvest the funds into another asset class or even higher-yielding corporate bonds.

The post Headwinds To Lower Bond Yields appeared first on RIA.

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Ferrari to accept crypto payments in the US

Ferrari’s decision to accept cryptocurrency payments was driven by market demand and dealer requests, with numerous clients investing in digital currencies.
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30 mins ago

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October 14, 2023

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Ferrari’s decision to accept cryptocurrency payments was driven by market demand and dealer requests, with numerous clients investing in digital currencies.

Ferrari will accept cryptocurrency payments for its luxury sports cars in the United States due to customer demand. The carmaker also plans to accept crypto payments in Europe.

According to an Oct. 14 report from Reuters, Ferrari’s chief marketing and commercial officer, Enrico Galliera, confirmed the intentions of the luxury car brand. Ferrari’s choice to accept cryptocurrency payments was driven by market demand and dealer requests, with numerous clients, including crypto-savvy young investors, having invested in digital currencies.

Although Galliera didn’t specify the number of cars Ferrari expects to sell via crypto payments, he reportedly stated that the carmaker’s strong order portfolio is fully booked until 2025. Ferrari aims to test this expanding market to connect with potential buyers beyond its usual clientele. The luxury automaker plans to introduce cryptocurrency payments in Europe by the first quarter of 2024 and expand to other crypto-friendly regions after.

For its initial phase in the U.S., Ferrari has reportedly partnered with major cryptocurrency payment processor, BitPay. This collaboration enables transactions in Bitcoin (BTC), Ether (ETH) and USD Coin (USDC).

Galliera confirmed that there will be no additional fees or surcharges when using cryptocurrency, as BitPay will promptly convert cryptocurrency payments into conventional fiat currency for Ferrari’s dealers, ensuring they are shielded from cryptocurrency price fluctuations.

BitPay will also verify the legitimacy of the digital currency, ensuring it does not originate from illicit activities, money laundering or tax evasion.

Related: Madeira announces creation of Bitcoin business hub for innovation

Many large corporations have hesitated to adopt cryptocurrencies due to their price volatility and associated transaction impracticality. Among these companies is Tesla, the electric vehicle manufacturer, which initially started accepting payments in Bitcoin in 2021. However, CEO Elon Musk suspended this payment method due to environmental concerns.

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Caroline Ellison wanted to step down but feared a bank run on FTX

Former Alameda CEO Caroline Ellison recognized she wasn’t doing a good job months before the company filed for bankruptcy, but Sam Bankman-Fried persuaded…

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2 hours ago

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October 14, 2023

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Former Alameda CEO Caroline Ellison recognized she wasn’t doing a good job months before the company filed for bankruptcy, but Sam Bankman-Fried persuaded her to stay.

Caroline Ellison wasn’t doing a good job leading Alameda Research in 2022, and she did not hide it. Excerpts from her personal notes shared as evidence by prosecutors in Sam Bankman-Fried’s trial revealed details about the trading firm’s struggles and its CEO’s desire to resign weeks and months before FTX collapsed.

Ellison spent over 10 hours testifying during Bankman-Fried’s trial this past week, notably entering through the front doors of the United States District Court for the Southern District of New York in Manhattan, joined by her attorneys. Ellison said she had not seen Bankman-Fried since the crypto empire failed in November 2022, but their communication had eroded months before.

In April 2022, their romantic relationship ended, and Caroline started avoiding meetings with Bankman-Fried even though they still lived in the same luxurious apartment in the Bahamas. Alameda’s growing liabilities with FTX and the breakup with Bankman-Fried made her consider leaving the company altogether.

“I feel like neither [Sam] Trabucco nor I have been doing a great job of pushing on stuff,” she wrote in the document to Bankman-Fried, which was shared as evidence during her cross-examination by the former FTX CEO’s defense counsel.

Bankman-Fried asked her to stay on, saying that her departure could create rumors about Alameda’s financial health, thus harming FTX’s credibility, so Ellison remained CEO.

Ellison joined Alameda as a trader in 2018. By 2020, she handled most of the company’s operations, while Bankman-Fried focused on his newly launched crypto exchange, FTX. In August 2021, she became co-CEO alongside Sam Trabucco, who stepped down a few months later, leaving her in charge of the company. In August 2022, Trabucco officially resigned as co-CEO.

Ellison was against creating FTX, she revealed. “I didn’t think of myself as ambitious before I started at Alameda, but I believe I became more ambitious” under Bankman-Fried’s incentive, she said.

As CEO, Ellison was in charge of handling Alameda’s crypto lenders. In mid-2022, after the Terra ecosystem failed, the company’s open-term loans stood at $1.3 billion. The market downturn drained liquidity from crypto assets, prompting Alameda’s lenders to demand loan repayments.

According to Ellison, Bankman-Fried instructed her to keep repaying creditors via Alameda’s line of credit with FTX. In other words, Alameda would use FTX’s customer assets to repay crypto lenders. At the time, its line of credit with the exchange stood at $13 billion.

As lenders demanded loan repayments and Alameda’s balance sheets, Bankman-Fried suggested Ellison use “alternative means” for presenting the company’s financials. In the following months, Ellison would create many additional versions of a balance sheet to deceive creditors.

Early in November 2022, an alternative version of Alameda’s balance sheet was leaked. Ellison was on vacation in Japan at the time, but she had to travel to FTX Hong Kong’s office to deal with the company’s crisis.

While the balance sheet data didn’t reflect the company’s reality, it was enough to spread rumors and trigger a bank run on FTX a few days later, exposing an $8 billion gap between the companies.

Having cooperated with the U.S. Department of Justice since December 2022, Ellison will soon receive her sentence regarding the seven counts of fraud and conspiracy to commit fraud she was charged with.

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ProShares prepares to launch unique Short Ether Strategy ETF

ProShares’ SETH ETF will start trading soon, following the first Ethereum futures ETFs by about two weeks.
ProShares introduced a trio…

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4 hours ago

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October 14, 2023

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ProShares' SETH ETF will start trading soon, following the first Ethereum futures ETFs by about two weeks.

ProShares introduced a trio of Ethereum futures ETFs in the recent weeks. Presently, the company is gearing up to provide a distinctive offering.

ProShares' Short Ether Strategy ETF (SETH) from the fund group is poised to commence trading shortly, following the debut of the initial Ethereum futures ETFs by about two weeks.

SETH, scheduled for listing on the NYSE Arca exchange, aims to achieve daily investment outcomes that mirror the inverse of the daily S&P CME Ether Futures Index performance, as indicated in a filing made on Friday, Oct. 13.

The fund does not engage in direct shorting of ether (ETH); rather, it seeks to capitalize on potential declines in the asset's value, as stated in the prospectus. On Friday, the price of ETH stood at approximately $1,540, reflecting a decrease of approximately 6% over the past week.

Screenshot of the ProShares SETH filing     Source: SEC

ProShares anticipates that the registration statement for SETH will become effective on Oct. 15 and plans to introduce the fund in early November, as reported by Blockworks.

However, the three existing ProShares ether futures funds — including two that invest in both ether and bitcoin futures contracts — debuted on Oct. 2 alongside similar products by VanEck and Bitwise.

The US Securities and Exchange Commission approved ether futures ETFs two years following the introduction of the initial bitcoin futures ETF, the ProShares Bitcoin Strategy ETF (BITO), which entered the market in Oct. 2021.

Related: SEC reportedly won’t appeal court decision on Grayscale Bitcoin ETF

ProShares continued its release of bitcoin futures ETFs with the Short Bitcoin Strategy ETF (BITI) in June 2022. As of now, BITO has accumulated around $850 million in assets, while BITI has approximately $75 million.

In August, Cointelegraph reported that Ether futures ETFs may be approved in October, causing an 11% spike in ETH prices at the time.

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