Bonds Break Up, Markets Slide Down, and Metals Bore
From The Maven Letter | August 25, 2023
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Quiet markets are often sliding markets and that is certainly true today, though people being on vacation is not the only reason. Rising bond yields and worries about Chinese growth are also hampering risk assets.
And anyone who is paying close attention to the macro picture was likely waiting to hear what Jerome Powell had to say at Jackson Hole – would he lean hawkish? – before making any doldrum moves. That speech happened this morning. Powell did say that inflation remains “too high” and so the committee is “prepared to raise rates further if appropriate”, but he also pledged to proceed “carefully.”
And so he should. Inflation is still too high…but the bond market is doing the Fed’s job at the moment, boosting the cost of debt notably, so the Fed should absolutely sit on its hands.
We got a bit of a break from incessant inflation talk in the late spring and early summer, when inflation behaved nicely (maintained a gradual decline), but now inflation has resumed its position as the question de jour. With robust demand for goods, unemployment staying low, and a preponderance of fixed-rate mortgages limiting the impact of rate hikes on households, concerns are rising that inflation will turn up again.
That’s why Powell’s speech in Wyoming mattered. A truly hawkish bent would have further juiced already soaring bond yields and made it harder for risk assets like stocks to turn back up. But he wasn’t really hawkish; he was more of the same.
The thing is, even though Powell didn’t give a clear reason to send bond yields higher, more of the same means rising bond yields will remain the biggest topic of conversation among investors. Bond yields have surged, sending shudders through riskier areas of the market and leaving investors to wonder how much the flow of money toward yield will dampen everything else.
The benchmark 10-year Treasury yield climbed to a 16-year high of 4.36% on Tuesday. And the rise is not over given that the underlying cause remains in effect: unprecedented, crisis-size deficits in the US federal budget. Massive deficits stretch ahead as far as the eye can see, even though the economy is in pretty good shape. Understandably, that contrast is making investors uneasy…and unease makes for higher borrowing costs.
The other thing that pushes yields higher is more supply than demand and this is also in play. The US Treasury has ramped up debt issuance, kicking off a supply deluge expected to last into next year, and when there aren’t enough buyers a bond’s price goes down and its yield goes up.
Record deficits and rising yields mean the US will soon spend 15% of its revenue on debt interest. It’s setups like this – with no fix in sight – that prompted Fitch to downgrade America’s credit rating recently.
So yields are rising because the economy is doing well but the government is overspending. Meanwhile, stocks are dropping. The thing is, the stock market was priced for perfection. Inflation persisting and rates therefore not getting cut is not perfection, hence the drop. Add in the appeal of bonds that are handing out significant yields for the first time in decades and it makes sense.
This doesn’t bolster metals and mining stocks. It isn’t a direct headwind either, but a good mining market happens when generalist investors decide mining stocks offer strong upside relative to the other stocks they are buying. In other words, they must be buying stocks in general.
I’m not freaking out about this. Let’s get through summer, let’s see another inflation print and hear another rate decision, and let’s watch fund flows and yields for a while longer before throwing in the towel on stocks. After all, this stock bull market has lasted longer and survived more challenges than anyone could have predicted a decade ago.
From that angle, the common comment from money managers today – that clients expect another 10% decline in the market lasting until mid-fall before things turn upward again – makes sense. Miners will chug along until the turn; gold might do better or might not.
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