bonds Markets

Nomura’s McElligott: Don’t Mistake Curve Steepening For Something It’s Not

"Cash crunch issuance realities."

There’s been quite a bit of hand-wringing and breathless pontificating this week over the self-evident fact that until such a time as the world comes around to the reality that borrowing is voluntary for countries with sovereign currencies, spending $3 trillion to bolster an economy in free fall entails a deluge of Treasury supply.

We’re still laboring under what might very fairly be described as a series of medieval beliefs about deficits and their financing, which is why weeks like this one provide for endless headline fodder. My take, for those interested, can be found in “As US Gears Up To Borrow $3 Trillion In 3 Months, Here’s The Truth On Government Spending“.

On Wednesday, after the official unveil of the quarterly refunding announcement, the financial media (and some actual market participants) feigned incredulity at the nod to maturity extension even as i) the recent tilt towards bills provided the “setup”, if you will, ii) long-end rates are low, and iii) Donald Trump has said, explicitly, that Jerome Powell should cut rates to zero so that we can “refinance our debt“. Trust me when I tell you that when the self-declared “king of debt” talks up “refinancing”, he means exactly what he says. He wants to drop rates to zero (or less) and issue a bunch of long-term bonds.

In any event, what’s important to note is that any bear steepener that goes along with this is a function of supply, not some indicator of an improved economic outlook or, necessarily, a reflection of inflation jitters associated with “money printing” (a misnomer).

Nomura’s Charlie McElligott drives the point home on Thursday.

“The cash crunch issuance realities for both governments and corporates is the catalyst behind the recent incremental bear-steepening seen in curves, particularly accelerating in the US after the May Treasury refunding announcement, which surprised the Street on the magnitude of long-end issuance announced”, he writes, in a short note.

So, you have Treasury flooding the market to “fund” the stimulus (and I will continue to use scare quotes around the word “fund”, because it too is a misnomer), while corporates take advantage of a suddenly open market (thanks to the Fed) to build cash buffers amid the worst downturn since the Depression.

“We have spoken to the incredible rush to market from corporates due to the crisis, seeking operational funding to stay liquid or even ‘alive'”, McElligott goes on to say Thursday.

The IG supply bonanza will likely continue, even after two straight months of record-breaking issuance.

Charlie adds that there’s been “remarkable demand for [corporate] paper from investors, who realize there will be no escaping from central bank ‘financial repression’ this time around, and are thus grabbing into any ‘safe’ yield they can find”.

He also jokes that there may never again be a true Fed “hiking cycle”.

Read more: Forget Stocks, IG Credit’s Half-Trillion, Back-To-Back Bonanza Is The Real Story

So, the crucial takeaway from this brief discussion, is that you shouldn’t be fooled into interpreting any nascent bear steepener as some kind of upbeat signal from the market on growth.

Nor should you be tempted to suggest it’s somehow a signal that people are “coming around” to the idea that the current policy mix is an inflationary tinderbox.

And if you don’t believe me, just ask McElligott.

“The point here, however, is to be very clear in stating that despite Brent crude now +35% off late April lows, the bear-steepening is a SUPPLY phenomenon and NOT about a more upbeat view on growth or [the] inflation trajectory”.

After all, Charlie writes, 10Y Breakevens [are] effectively ‘unch’ during the past 10 sessions”.

Finally, as a reminder, the primary reason governments sell bonds today is simply out of habit and to reinforce a pernicious myth. As Stephanie Kelton puts it, bond issuance is done in part to protect “a well-guarded secret about the true nature of [government’s] fiscal capacities, which, if widely understood, might lead to calls for ‘overt monetary financing’ to pay for public goods”.

“By selling bonds, they maintain the illusion of being financially constrained”, she notes.


5 comments on “Nomura’s McElligott: Don’t Mistake Curve Steepening For Something It’s Not

  1. I remember in grade school learning about “Wampum”. Illusions. Gift shops at Civil war sites sold Confederate money for pennies. Money changes. Go with the flow. Illusions work. Gold is too slow. No going back to old currencies once the illusion fades.

  2. “We’re still laboring under what might very fairly be described as a series of medieval beliefs about deficits and their financing”

    It’s our Calvinist legacy where debt and borrowing is considered sinful.

    Though, if a US company or entrepreneur declares bankruptcy it’s called the “magic of US capitalism. You can walk away and start over!”

    That does not hold when it is an individual, however. Student loans, credit card bills etc are all marks of moral failing. Think bacdk to Rick Santelli and the spawning of the Tea Party movement. “Borrowers must be punished for their slothfulness!”

    • And look, nobody is suggesting sending every American $40 million in the mail. I continually chuckle at the belabored attempts of MMT critics to resort to the silliest extremes in order to refute something they can’t otherwise refute.

      It reminds me of how frustrated some people get when, confronted with the actual, verbatim policy ideas from Progressives (as opposed to caricatures of those ideas from conservative media), people always just resort to digitally shouting; “So you wanna be Venezuela?!?”

      It’s just so disingenuous, because nobody is under the impression that making every American a millionaire overnight with a direct deposit from Treasury is a good idea just like nobody wants to be Venezuela. Every argument against MMT is a straw man. And it’s not because there aren’t good arguments against it. Rather, it’s because those good arguments are deep in the economic weeds, where everyone is too intellectually lazy to go.

  3. There’s a policy difference between Right: “Trickle down from Oligarchs”, Center: “Corporations First, Middle Class and Up Covered”, and Left: “Take Care of Everyone (via Government)”

    Thus we all are using MMT, it’s just a matter of how it’s distributed.

  4. I had to chuckle when I saw the “spike” in bond yields yesterday. As if J-Pow won’t be there to stand on top of the curve and smother it into submission. And after chuckling, I bought some TLT. Thanks Fed.

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