Weekly Commentary: Safe Haven Treasuries Not So Safe


Technical issues putting together this evening’s CBB…

A “sloppy” auction saw 30-year Treasury yields surge 21 bps this week to 1.45%, an almost seven-week closing high. Ten-year Treasury yields jumped 14 bps to 0.71%, while benchmark MBS yields rose 17 bps to 1.38%. But how about in dollars? The iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT) lost 3.9% for the week. Is a so-called “safe haven” losing almost 4% in a single week really a safe haven? Sure, Treasury yields could decline more from current historically low levels. But this week confirmed the risk versus reward calculus for owning Treasury bonds these days is unattractive.

Corporate bonds somewhat outperformed but posted losses for the week nonetheless. The iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA:LQD) fell 2.4%, and the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA:HYG) declined 1.3%. We’ll see if this week’s reversal leads to any slowdown in the wall of “money” flooding into bond funds.

Perhaps of more consequence, the spectacular EM bond (price) “melt-up” came to a rather abrupt halt this week. Brazil’s 10-year (real) yields surged 51 bps to 7.27% – trading this week to the highest yields since April. Local currency Eastern European bonds were under notable pressure, with yields surging 30 bps in Romania, 16 bps in Hungary and 11 bps in Czech Republic. India’s 10-year yields rose 11 bps to 5.95% – the high since May.

Dollar-denominated EM yields abruptly reversed higher as well. Brazil’s 10-year yields surged 25 bps to 3.61%, with Mexico’s yields up 23 bps to 2.93%, Russian yields up 10 bps to 2.16%, and Indonesian yields up 10 bps to 2.12%.

Rising yields were a global phenomenon. European – “core” and “periphery” – yields surged higher, led by nine bps increases in German (negative 0.42%) and French (negative 0.13%) 10-year yields. Greek yields rose 12 bps (1.13%), and Italian yields gained six bps (0.99%). Portuguese (0.37%) and Spanish (0.36%) yields both rose eight bps. UK yields rose 10 bps to 0.24%.

Japanese JGB yields rose four bps to 0.45%, matching the highest yields since March. Yields rose eight bps in Singapore to 0.88% and seven bps in Australia to 0.93%.

At $6.911 trillion, the Fed’s balance sheet is little changed over the past three months. Granted, Fed Credit is up $3.167 trillion, or 85%, over the past year. But perhaps Fed liquidity effects have begun to wane somewhat. Meanwhile, there’s absolutely no end in sight for the unprecedented supply of new fixed-income securities (Treasuries and corporates).

August 14 – Bloomberg (Brian Smith): “With dealers calling for $30bn to price along with an already robust visible pipeline, 2020 U.S. investment-grade new issue volume is set to break 2017’s FY volume record early next week. High-grade new issue supply is up 76% YoY and less than $10bn away from breaking the new issue volume record of $1.333trl set in 2017. What started as a defensive cash grab – buoyed by the Fed’s backstop – has morphed into an opportunity to refinance, pre-fund or even add incremental debt.”

August 12 – Bloomberg (Max Reyes and Gowri Gurumurthy): “Junk-rated companies have borrowed $274.8 billion in 2020, exceeding the sum of cash raised during all of last year… The record comes after the high-yield market saw the best returns since 2011 in July, attracting hefty inflows as investors continue to hunt for yield…”

Along with never-ending supply, perhaps bond markets are also beginning to sense fledging inflation risk. July CPI and PPI readings both posted upside surprises. At 0.6%, consumer prices doubled estimates – and have quickly reversed the negative CPI prints from March and April. July producer prices also doubled estimates at 0.6%, posting the strongest monthly gain since October 2018.

Data out of China were also concerning. Challenging the bullish recovery narrative, July Retail Sales were down 1.1% (versus estimates of a small increase). This put year-to-date sales 9.9% below comparable 2019. July auto sales were up 16.4% for the month, though year-to-date sales were still down 12.7%. July airline passenger numbers were 34.1% below July 2019. Also noteworthy, July lending and money supply growth came in below estimates.

China’s Aggregate Financing expanded a weaker-than-expected $243 billion during July. This was down from June’s $494 billion. Year-to-date (seven months), Aggregate Financing expanded a record $3.240 trillion. This was 42% ahead of growth from 2019 ($2.29 trillion) and 70% above the comparable 2018 expansion ($1.91 trillion). Over the past year, Aggregate Financing expanded $4.633 trillion, or 12.9%. It’s worth noting bonds are the fastest expanding components within Aggregate Financing. Outstanding Corporate Bonds were up 21.1% y-o-y, with Government Bonds rising 16.5%.

Bank Loans expanded $142 billion, down from June’s $261 billion. This was about 20% below forecasts and 6% below July 2019. It was also the weakest lending since February. Yet year-to-date Bank Loan growth of $1.882 trillion ran 22% ahead of comparable 2019 (25% above comparable 2018). Bank Loans were up 13.0 year-over-year ($2.76 trillion), with two-year growth of 27.2% and five-year growth of 84.1%.

Consumer Loans expanded a weaker-than-expected $109 billion, down from June’s $141 billion. Yet July Consumer Loan growth was 48% ahead of net lending from July 2019. Consumer Loans were up 14.3% year-over-year, 33% in two years, 58% in three years and 135% in five.

August 14 – Bloomberg: “After receiving dozens of phone calls and text messages from banks touting cheap, unsecured and easy-to-get consumer loans, Eric Zhang visited one of China’s largest lenders in June and borrowed 400,000 yuan ($57,600) at an interest rate of 4%. But there was a catch – he had to sign a letter promising the money wouldn’t be invested in property or stocks. That didn’t stop Zhang. A few days later, he’d found a merchant who helped him make a fake purchase and move the cash to his brokerage account. ‘I don’t think the bank can track the money and identify its real use,’ said Zhang, who works at a… private equity firm. ‘It’s a great trade for me,’ he said, after seeing his fresh stock investments surge 6% in one month.”

Bank lending to corporations (“Non-Financial Corporations”) dropped to $38 billion from June’s $133 billion – the weakest expansion since October’s $18 billion. July is typically slow for corporate lending. Corporate bond issuance dropped from June’s $49 billion to $34 billion, also the weakest expansion since October.

August 11 – South China Morning Post (Georgina Lee): “Chinese banks’ net profits dropped a combined 24% during the second quarter, compared with a year earlier as banks grappled with bad loans caused by the coronavirus pandemic. The industry’s net profit stood at 426.7 billion yuan (US$61.4bn), down from 559 billion yuan during the same period a year ago. Profits were 29% down from the 600 billion yuan recorded in the first quarter… The fall in second-quarter profitability was sharper than expected, said some analysts, caused mainly by banks making higher provisions for loan losses. The industry’s loan loss ratio rose to 3.54%, up 0.04 percentage points from the first quarter. The non-performing loan (NPL) ratio for the industry rose to a 10-year high, at 1.94%, up from 1.91% at the end of the first quarter.”

China’s M2 money supply declined $136 billion during July, the first contraction since October. This followed June’s staggering $500 billion M2 surge. M2 expanded $2.00 trillion year-to-date (seven months), or 11.7% annualized. M2 was up $2.965 trillion year-over-year, or 10.7%. M2 was up 19.7% in two years, 30.5% in three and 57% over five years.

Beijing is in a tricky spot – a quite tenuous balancing act. While there are fears of waning domestic and international demand, speculative market Bubbles (stocks and apartments) are a major cause for concern. With system credit (“Aggregate Financing”) up an unprecedented $4.6 trillion over the past year, China’s bubble economy and market structures have turned only more unwieldy. July’s data support the view of a cautious Chinese consumer bereft of pre-COVID confidence.

And speaking of confidence… Booming markets have assumed endless on-demand U.S. fiscal and monetary stimulus. And this might actually hold true – in crisis environments. When markets are flying, politics make quite a resurgence. And there are reasons Fed officials have become such strong proponents of fiscal stimulus: at this point they appreciate monetary stimulus comes with major risks, certainly including more destabilizing bubble excess and worsening inequality. Along with pivotal elections (with all the potential for fiasco) only about 80 days away, market fun and games are officially on borrowed time.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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