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Is This Time Different – Unpacking Bond Yields

Is This Time Different – Unpacking Bond Yields

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

In Our Elevator Pitch For Bonds,…

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4 weeks ago

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Is This Time Different - Unpacking Bond Yields

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

In Our Elevator Pitch For Bonds, we ask, “is this time different.” 

Our view of the attractiveness of bonds can be honed into an elevator pitch. It essentially boils down to a straightforward question – Is this time different?

Have the forty-year pre-pandemic economic trends reversed, and the economy’s inner workings changed permanently over the last three years? expectations

More specifically, are slowing productivity growth, weakening demographics, and rising debt levels about to reverse their prior trends and become a tailwind for economic growth?

NO, this time is not different. Yesterday’s economic headwinds have not vanished. They will eventually overcome the massive pandemic-related stimulus that continues to prop up the economy.

This article employs a classic bond model that allows us to solve for the expected economic growth as implied by bond yields. As you will see, the bond market believes economic growth will be significantly higher than expectations for the last 20 years. If they are correct and this time is different, current bond yields may be fair or even too low. However, if this time is not different, the market is grossly offside in its growth expectations, and bond yields are too high.

Decomposing Bond Yields

U.S. Treasury bond yields are a function of three factors: term premium, inflation, and economic growth expectations. Because Treasury securities are considered risk-free, credit risk is not a factor. For more on that, please read our recent article, Risk Free Government Debt- Fact Or Fiction.

Term Premia

Term premium, also called term premia, is the amount by which the yield of a long-term bond exceeds the expected yields of short-term bonds. It quantifies the amount investors expect to be compensated for committing to one long-term interest rate versus a series of shorter-term interest rates.  

Term premia is not an exact science, but there are many models that calculate it, including the Fed’s Three-Factor Nominal Term Structure Model. We use this model to decompose yields later in this article.

The Fed model, graphed below, shows a steady decline in the term premium for the last 30+ years. Since rates have been reliably trending lower, long-term bond investors have been increasingly willing to accept less of a term premium because they expect short-term yields to continue to trend lower. As shown, the premium has primarily morphed into a discount since 2018. Such indicates that a series of short-term rates over the next ten years will average less than current long-term rates.

Inflation Expectations

Gauging inflation expectations is done via numerous surveys of consumers and business leaders. They can also be calculated through the difference between TIP and nominal bond yields. Further, the Fed updates its outlook for longer-term inflation rates quarterly.

This analysis uses the difference between TIPs and nominal bonds, known as the breakeven inflation rate. Unlike surveys and Fed estimates, the breakeven rate is based on investors and traders putting their money where their mouths are. Thus, we might claim it to be a little more credible.

The following graph shows the long-term trend in 10-year inflation expectations and the actual rate of inflation that followed in the subsequent ten years. Other than during recessions, the market tends to overestimate future inflation rates by a quarter to half a percent. The chart ends in 2013, as we do not have ten full years of future inflation data after that year. 

Economic Growth Expectations

The third factor is economic growth expectations. Like inflation expectations, there are many sources for this data.

To put context to our opening question, “Is this time different?” we solve for economic growth expectations using the Fed term premia model and ten-year breakeven inflation rates.

Before we look at expectations, let’s look at the historical economic growth trend.

As shown, real GDP has been trending lower since 1990. Assuming the trend holds, real GDP will average 1.65% over the next ten years. The trend currently resides at 1.90%.

Decomposing Bond Yields

The following graph uses the current ten-year yield and decomposes the rate based on term premia, inflation expectations, and the implied economic growth rate we solve for.

The following chart singles out real growth expectations (green above), which we solved for.

Bond yields imply the highest economic growth rate in the last 20 years!

The next graph allows us to compare growth expectations, as shown above, to the trend growth rate over the 20-year period.

The last time the bond market implied such a high forecast for economic growth was around the financial crisis and recession of 2008-2009. However, real GDP was trending 0.5% higher during that period than today. On a relative basis, the current expectation is .75% higher.

Our analysis assumes the Fed’s term premia and the market’s 10-year breakeven inflation estimates are correct. They are not, nor will they be accurate in the future. As a result, growth expectations, as we solve for, have been about 1.50% short of reality.

However, context is essential. While the growth estimate will likely be too low, the current deviation versus prior readings is what matters. Currently, yields imply almost 2.50% more growth than its average forecast for the last 20 years.

Summary

The bond market implies something has changed in the last couple of years to reverse the nation’s downward economic growth trajectory. There is nothing that leads us to that conclusion.

The pandemic only aggravated the debt burden, which reduces future growth rates. Demographics continue to worsen slowly, detracting from economic growth. Given debt, demographics, and other social and political factors, we see no reason productivity growth won’t continue to decline, which also weighs on economic growth.

Can AI be a productivity game changer and rationale for higher economic growth rates? Maybe, but productivity growth has declined over the last 25 years despite the internet, robotics, and numerous other productivity-enhancing inventions.

Can the economy grow 2.0% to 2.5% faster per year over the next ten years than the last 30 years? We don’t think so. Therefore, the graphs suggest ten-year yields are about 2.0% to 2.5% too high.

This time is not different, and bond yields are too high. 

Tyler Durden Wed, 09/20/2023 - 08:30

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California Gov. Newsom greenlights crypto regulation bill for 2025

The bill will mandate crypto firms to uphold financial records and allow regulators to conduct audits on these entities.
California…

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October 14, 2023

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The bill will mandate crypto firms to uphold financial records and allow regulators to conduct audits on these entities.

California Governor Gavin Newsom has approved a cryptocurrency bill that enforces stricter regulations on businesses conducting crypto operations set to begin in 18 months. 

In a statement published on October 13, Newsom declared that the bill titled the ‘Digital Financial Assets Law,’ would make it mandatory for both individuals and firms to obtain a Department of Financial Protection and Innovation license to engage in digital financial asset business activities.

The bill is scheduled to come into effect on July 1, 2025.

It draws a comparison to California's money transmission laws, which forbid individuals from conducting money transmission business without a license from the Commissioner of Financial Protection and Innovation.

The new crypto bill will allow the department to impose stringent audit requirements on crypto firms as well as force them to uphold recording requirements. The statement noted:

“[This bill] would require a licensee to maintain [...] for 5 years after the date of the activity, certain records, including a general ledger maintained at least monthly that lists all assets, liabilities, capital, income, and expenses of the licensee.”

It furth clarifies that firms not complying with the bill will face enforcement measures.

Related: CoinShares says US not lagging in crypto adoption and regulation

Around this time last year, Newsom declined to sign a similar bill that aimed to establish a licensing and regulatory framework for digital assets in California.

Although the bill passed through the California State Assembly without opposition, Newsom expressed that he was sending the bill back "without my signature."

Newsom turned down the bill, suggesting it wasn't flexible enough to keep up with fast-changing crypto trends.

At the time, Newson stated that he was waiting for federal regulations to come into place before working with the legislature to establish crypto licensing initiatives.

Meanwhile, Cointelegraph recently reported that the U.S. is exploring the possibility of applying the Electronic Fund Transfer Act (ETFA) to cryptocurrencies as a measure to combat fraudulent transfers.

In a recent speech, Rohit Chopra, the director of the Consumer Financial Protection Bureau (CFPB), expressed his intention to grant authorization for this to "reduce harm of errors, hacks and unauthorized transfers."

Magazine: US gov’t messed up my $250K Bitcoin price prediction: Tim Draper, Hall of Flame

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Second Largest US Lab-Grown Diamond Producer Goes Bust 

Second Largest US Lab-Grown Diamond Producer Goes Bust 

The second-largest US producer of lab-grown diamonds has filed for bankruptcy amid…

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October 14, 2023

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Second Largest US Lab-Grown Diamond Producer Goes Bust 

The second-largest US producer of lab-grown diamonds has filed for bankruptcy amid a massive glut of fabricated gemstones and plunging prices. 

Financial Times reports that Washington-based WD Lab Grown Diamonds filed for Chapter 7 in a Delaware bankruptcy court and had total liabilities of around $44 million and assets of $3 million. The company listed it had between 100 and 199 creditors. 

In 2020, WD Lab Grown Diamonds became the first diamond company to be certified under the "Standard for Sustainable Diamonds" by third-party verifier SCS Global Services. Operations began in 2008 and have played a pivotal role in innovating the lab-grown diamond industry, generating roughly $33 million in revenue last year. 

Paul Zimnisky, an independent diamond analyst, said the collapse of WD Lab Grown Diamonds is a sign it struggled to compete with Chinese and Indian producers. 

In the last seven years, a single-carat lab-grown diamond has plunged more than threefold due to a flood of supply, a massive relief for mining companies who have seen natural diamond prices crash. 

Real diamond prices 

The slide in real diamond prices comes as consumers pivot to cheaper lab-grown stones. Also, there's an ongoing global luxury spending slowdown as recession risks rise. 

As for the lab-grown diamond industry, it's a race to the bottom as more supply only pushes prices lower, slashes margins, and ultimately results in business failures.

Tyler Durden Sat, 10/14/2023 - 18:05

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Caroline Ellison speaks on FTX-Binance war, SEC won’t appeal Grayscale BTC ETF: Hodler’s Digest, Oct. 8-14

Caroline Ellison testifies in Sam Bankman-Fried trial, reveals more on FTX-Binance war; SEC reportedly has no plans to appeal on Grayscale Bitcoin ETF…

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October 14, 2023

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Caroline Ellison testifies in Sam Bankman-Fried trial, reveals more on FTX-Binance war; SEC reportedly has no plans to appeal on Grayscale Bitcoin ETF case.

Top Stories This Week

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

Caroline Ellison, former CEO of Alameda Research, testified for over 10 hours this week at Sam Bankman-Frieds trial, offering deeper details on the events that anticipated the FTX debacle in November 2022. From Ellison’s testimony, jurors learned that she planned to leave Alameda months before its collapse, but feared a bank run on FTX amidst the crypto market downturn. The week also featured a recording presented as evidence in the case showing the exact moment Ellison told employees about Alameda’s use of FTX customer deposits. Among the key moments of Bankman-Fried’s trial were revelations of fabricated balance sheets in order to deceive crypto lenders, as well as BlockFi CEO Zac Princes testimony. Check out this week’s highlights from Cointelegraph’s team on the ground.

Sam Bankman-Fried blamed Binance for balance sheet leak to media: Court evidence

Months before the collapse of crypto exchange FTX, former CEO Sam Bankman-Fried was freaking out about buying shares in Snapchat, raising capital from Saudi royalty and getting regulators to crack down on rival crypto exchange Binance, according to evidence presented in court this week as a part of the ongoing criminal trial. Bankman-Fried believed Binance leaked an Alameda balance sheet to the media in 2022. According to a document from Nov. 6, 2022, Bankman-Fried wrote that Binance had been engaging in a PR campaign against us. It continued, saying that Binance leaked a balance sheet; blogged about it; fed it to Coindesk; then announced very publicly that they were selling $500m of FTT in response to it while telling customers to be wary of FTX.

SEC reportedly wont appeal court decision on Grayscale Bitcoin ETF

The United States Securities and Exchange Commission reportedly has no plans to appeal the recent court decision that favored Grayscale Investments. The ruling requires the SEC to review the firms spot Bitcoin exchange-traded fund (ETF) application. The SECs supposed decision not to appeal doesnt necessarily mean Grayscales application is set to be approved. If the reports are true, the SEC will need to follow the courts August order and review Grayscales application to change its Grayscale Bitcoin Trust into a spot Bitcoin ETF.

Terraform Labs contends Citadel Securities had a hand in its stablecoin collapse

Terraform Labs has again pointed the finger at market maker Citadel Securities for its role in an alleged concerted, intentional effort to cause the depeg of its TerraUSD stablecoin in 2022. On Oct. 10, Terraform Labs filed a motion in the United States to compel Citadel Securities to produce documents relating to its trading activity in May 2022, when TerraUSD Classic depegged. In its motion, Terraform argued that the documents are crucial for its defense in the lawsuit filed by the U.S. Securities and Exchange Commission in February, which alleged Terraform Labs and its founder, Do Kwon, had a hand in orchestrating a multi-billion dollar crypto asset securities fraud. Citadel Securities has, however, previously denied trading the TerraUSD stablecoin in May 2022.

Mastercard announces successful wrapped CBDC trial results

Mastercard has completed a trial involving wrapping central bank digital currencies (CBDCs) on different blockchains, similar to wrapped Bitcoin and wrapped Ether. The trial was conducted with the Reserve Bank of Australia and the countrys Digital Finance Cooperative Research Centre CBDC. Mastercard said the solution allowed a CBDC owner to purchase a nonfungible token (NFT) listed on Ethereum. The process locked the required amount of a pilot CBDC on the RBAs pilot CBDC platform and minted an equivalent amount of wrapped pilot CBDC tokens on Ethereum, the payment processor wrote.

Winners and Losers

At the end of the week, Bitcoin (BTC) is at $26,892, Ether (ETH) at $1,551 and XRP at $0.48. The total market cap is at $1.05 trillion, according to CoinMarketCap.

Among the biggest 100 cryptocurrencies, the top three altcoin gainers of the week are Loom Network (LOOM) at 86.71%, Trust Wallet Token (TWT) at 16.72% and Tether Gold (XAUt) at 5.16%. 

The top three altcoin losers of the week are Mantle (MNT) at -17.27%, Rocket Pool (RPL) at -14.39% and Avalanche (AVAX) at -13.39%.

For more info on crypto prices, make sure to read Cointelegraphs market analysis.

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Most Memorable Quotations

Thats our homework, actually. To really educate people about the benefit of using blockchain.

Grace Sabandar, co-founder of the Indonesia Blockchain and Metaverse Center

Crypto-assets markets, including DeFi, do not represent meaningful risks to financial stability at this point.

European Securities and Markets Authority

I was worrying about customer withdrawals from FTX, this getting out, people to be hurt. […] I didnt feel good. If people found out [about Alameda using FTX funds], they would all try to withdraw from FTX.

Caroline Ellison, former CEO of Alameda Research

Its alarming and should be a wakeup call for lawmakers and regulators that digital wallets connected to Hamas received millions of dollars in cryptocurrencies.

Elizabeth Warren, U.S. senator

Bitcoin and Ethereum may seem like opposites, but they can co-exist and complement each other.

Willem Schro, CEO of Botanix Labs

People who believe SBFraud is a good guy who made mistakes, and FTX grew too fast and it all got away from him, should NEVER be in charge of other peoples money.”

John Deaton, attorney and crypto advocate

Prediction of the Week 

Ethereum losing streak vs. Bitcoin hits 15 months Can ETH price reverse course?

The price of Ethereum’s native token, Ether, is trading around a 15-month low versus Bitcoin, and the lowest since Ethereum switched to proof-of-stake. The ETH/BTC pair dropped to as low as 0.056 BTC earlier this week. In doing so, the pair broke below its 200-week exponential moving average (200-week EMA; the blue wave) near 0.058 BTC, raising downside risks further into 2023.

The 200-week EMA has historically served as a reliable support level for ETH/BTC bulls.

ETH/BTC stares at similar selloff risks in 2023 after losing its 200-week EMA as support. In this case, the next downside target looks to be around its 0.5 Fibonacci line near 0.051 BTC in 2023, down about 9.5% from current price levels.

Conversely, ETH price may rebound toward its 50-week EMA (the red wave) near 0.065 BTC if it reclaims the 200-week EMA as support.

FUD of the Week 

Mistake or money laundering? User pays $1.6 million for CrypToadz NFT

One of the CrypToadz NFTs, whose average price doesnt exceed $1,000, was bought for an astonishing 1,055 wrapped Ether, an equivalent of $1.6 million. The CrypToadz collection was launched during the NFT boom of 2021 and surpassed a trading volume of $38 million worth of Ether during its first 10 days on the market. The price paid by the anonymous user for the NFT raised questions among the community. Two weeks ago, this item was acquired for 0.95 ETH (around $1,600), only to be sold for a price a thousand times higher.

USDR stablecoin depegs to $0.53, but team vows to provide solutions

Real estate-backed stablecoin USDR lost its peg to the United States dollar after a rush of redemptions caused a draining of liquid assets such as Dai from its treasury. USDR, backed by a mixture of cryptocurrencies and real estate holdings, is issued by the Tangible protocol, a decentralized finance project that seeks to tokenize housing and other real-world assets. During the crisis, a trader reportedly exchanged 131,350 USDR for 0 USD Coin, resulting in a complete loss on investment.

HTX claws back $8M in stolen funds, issues 250 ETH bounty to hacker

Huobi Globals crypto exchange HTX has confirmed the return of the funds stolen by a hacker in late September and issued a 250 Ether bounty after resolving the issue. One of HTXs hot wallets was drained of 5,000 ETH on Sept. 25, worth roughly $8 million at the time. Shortly after the hack occurred, the firm contacted the hacker and claimed to know their identity. HTX ultimately offered to pay a 5% bounty worth around $400,000 and not to take any legal action if they returned 95% of the funds before a deadline of Oct. 2.

Beyond crypto: Zero-knowledge proofs show potential from voting to finance

An emerging cryptographic technology may provide help with two gaping 21st-century needs: Privacy and truth.

Eleanor Terrett on impersonators and a better crypto industry

Fox Business producer Eleanor Terrett’s following exploded after she began providing commentary on the SEC v. Ripple lawsuit.

SBFs alleged Chinese bribe, Binance clarifies account freeze: Asia Express

SBF allegedly bribes Chinese officials with $150 million to unfreeze accounts, Binance justifies blocking Hamas users, meanwhile, Huobi hacker returns all $8M in stolen assets.

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