Shouldn’t US Treasurys rally in the face of the dangerous realities on display in the Mideast?
It’s a good question, and one that’s vexed bond longs over the past week. As you might’ve heard, US bases in Syria and Iraq came under drone attack in recent days, surely from Shiite militia, and a US destroyer had to intercept Houthi missiles fired in the general direction of Israel.
Long story short, Iran is projecting and posturing, and although we know from the meek (and also tragically bungled) response to the Soleimani assassination that when push comes to shove, the IRGC actually wants no part of an outright confrontation with the US military, a lot of bad things can happen in the lead up to any “final warnings” communicated through back channels with Tehran.
Relatedly, saying Iran doesn’t want to risk “shock and awe” in its capital isn’t the same thing as saying Hezbollah doesn’t want to risk US airstrikes on its positions in Lebanon if it means forcing Israel to fight on two fronts. They’d surely risk that, and indeed they already have. That, in turn, raises the specter of US warplanes vaporizing a non-negligible number of Hezbollah fighters. Where things go from there is anybody’s guess, but the al-Tanf garrison (in Syria) would probably become even more dangerous than it already is, and US positions in Iraq could conceivably be attacked with rockets or even ground forces. That sort of thing doesn’t go over well at the Pentagon, and typically prompts the kind of back-channel “final warnings” mentioned above.
Given the gravity of all this, you’d be inclined to think the world’s safe haven asset par excellence would be bid. But, no dice. It was another rough week for Treasurys, and that’s putting it politely.
Headed into Friday, 10-year yields were 35bps higher versus last Friday, with 20bps of that increase attributable to reals. As the figure shows, this week was rough, even by the high standards of the worst bond bear market in US history.
“The bearishness is notable when considered in the context of the steady increase in geopolitical uncertainties over the course of the last several months,” BMO’s Ian Lyngen and Ben Jeffery remarked, noting that “10-year yields at 5% implies the safe haven premium typically embedded in Treasury yields is trading at a deep discount.”
I’d generally agree, but the problem (or one problem, anyway) is that fiscal profligacy is a factor in the Treasury selloff, and war spending is an example of fiscal profligacy. America can’t afford to solve its homeless problem or feed its own hungry children, but as Janet Yellen indelicately put it, the US can “certainly afford” two wars. (It’d be funny if it weren’t so sad.)
Making matters worse, House Republicans still hadn’t managed to elect a Speaker as of Friday, underscoring the governance concerns at the heart of Fitch’s downgrade, which preceded the sharp repricing in the term premium.
The largest Treasury ETF was on track for its worst week in over a year, fully erasing its best week since March — plus (or minus, depending on how you want to look at it) 1.5%. The drawdown now stands at 99%. I’m just joking. But it does feel that way.
“Aside from a widening deficit and larger nominal auction sizes on the horizon, there is very little to imply Treasurys have lost their status as the go-to flight-to-quality asset in the global fixed-income market,” Lyngen and Jeffery went on.
This is topical enough that Lehman veteran Mark Cudmore felt compelled to weigh in on Friday. “It’s important here to distinguish between a haven asset and a risk-aversion hedge, as the concepts normally overlap perfectly and hence we tend to use the term ‘haven’ when we are really talking about risk-aversion hedges: Those assets that outperform as most financial markets tank,” he wrote.
The upshot of Cudmore’s argument was that there’s no real threat to the US economy from what’s going on the Mideast, and it’s far from obvious how the situation, even if it deteriorated further, could translate into easier monetary policy.
“With the US now the world’s largest oil producer (by far), and with the economies in the region being relatively small (globally), the net-growth impact on the US is unclear, especially as any extra defense spending will be stimulative, and there’s no direct threat to the US financial system,” he said. “To the contrary, the situation is inflationary and it should also add to term premium because it puts further pressure on budgets.”
So, the world’s burning. And US Treasurys can’t save your portfolio, even if the US Treasury can (allegedly) save Ukraine and Israel.
My rudimentary earnings season tracking
– 16% of S&P 500 names have reported 3Q
– of those, 40% seeing positive revisions for 4Q rev and 27% seeing positive revisions for 4Q EPS
Dear H, at what level do you estimate that rates on treasuries actually become prohibitively high for the US government? I’m aware of your views expressed in earlier articles that it’s a fiction that these rates actually reflect credit risk given the US’s position in the world, but surely, at some point a further rise in rates becomes problematic, no? I am of the view that the end to this cycle will be a strong increase in taxes ultimately ending inflation, but wonder if / when that will actually happen
Well, I mean the Fed can cap these rates any time it wants by just saying “We’re buying unlimited bonds at 5%.” The whole thing’s a fiction, including the idea that anything is “prohibitively” high. What does that even mean in the context of a sovereign that can issue the reserve currency at will? If your credit card interest was denominated in a currency that only you were legally allowed to issue, and you could issue it at will, what rate of interest would be “prohibitive”? In theory, there is no such rate. The rate could be 10000000000000% and it wouldn’t matter because the payments are denominated in J.K. bucks. The reason nobody likes to say this stuff aloud isn’t because it’s inflationary or “dangerous,” the reason is that it’s uncomfortable to admit that the whole thing is made up, just like every other myth that orders our daily lives. It’s all fiction. Stocks, bonds, money, companies, laws, nations, religion, all of it. We made it all up. And then we retroactively pretend these fictions we conjured somehow constrain us or otherwise exist outside of our own minds. What is “the bond market” without humans? Nothing. It doesn’t exist. So how is it that we, humans, are beholden to something that only exists in our imagination? A couple of years ago a few scientists thought they might’ve found evidence of life on Venus, and one excuse for why we couldn’t investigate that further was that it would cost too much. Ask yourself: How insane is that? If there was a 0.0000000000001% chance that there was life (any kind of life, no matter how rudimentary) on the planet right next to ours, how totally crazy do we have to be to say, “Well, that’s interesting and all, and sure, we have every, single thing we would need to send more advanced probes to check it out, but it’s too risky because we’d have to conjure more digital pieces of green paper with George Washington’s face on it.”
If your next question is: Well, ok, does that mean that all the topics discussed here, in these very pages, on a daily basis, from equities to rates to credit to FX to money in general, are all totally meaningless and that we’re all just wasting our time? The answer is a resounding “YES!” But, unfortunately, there are only a relative handful of people alive who understand that. Everyone else is super-excited about wasting time on the fictions we created for ourselves, so I go along with it. What else am I supposed to do? I tried wandering around the beach aimlessly pondering issues that are actually important and that wasn’t very fulfilling somehow, so I decided to write about this stuff. Ideally, I’d spend my time writing about ethics and metaphysics. At least that’d be challenging. But who’s gonna read it? Nobody. Whereas, “Famous Bank Indicator Flashes Rare ‘Buy’ Signal”… boy, they come running for that. We’re a silly species. We really are.
That is why I am such a big fan of yours and would definitely read your philosophy if you wrote it. But the fact is you do write philosophy here
Don’t tell anybody. 🙂
Excellent comments. Really cuts through to why I find myself reading this website nearly every day. Your writing really resonates with the feelings generated from my absurd professional life.
And, for what it’s worth, I’d would love to read your thoughts on ethics and metaphysics.
-Thanks H.
Sir, I would happily read ethics and metaphysics and find that far more interesting than the macroeconomic stuff. As we see the turmoil in the world today, it’s obvious to me that the prevailing world views are causing a lot of harm. Many metaphysical assumptions require aggressive dismantling after rigorous analysis. Conventional religion should be first on the chopping block as our survival requires that any claims that the Almighty favors one tribe over another has to exposed and abandoned as a vestige of a darker tribal age before real civilization. Yet I’m not advocating a secular materialistic post-modern nihilism. Anyways, even though we may disagree occasionally, and I fully expect to incur Ur wrath, I emphatically invite and encourage U to write about ethics and metaphysics.
You reminded me of a film I saw recently , The Banshees of Inisherin.
“I do worry sometimes I might just be entertaining myself while staving off the inevitable.” – Colm Doherty
Bring it on (philosophy, ethics and metaphysics)!!
I am pretty much buy and hold anyway 🙂
Joe took the words out of my mouth. But, as you discovered, the problem with solipsism is that it’s lonely. ?
“Ideally, I’d spend my time writing about ethics and metaphysics. At least that’d be challenging. But who’s gonna read it? Nobody. “
Actually, lots of people would read it, your an amazing writer, and could educate a lot of people about the ethics(?!) or lack thereof in the financial world. I agree that the system as it is, is just a big game. The big media and yourself included just perpetuate this, wouldn’t it be better to expose how corrupt the system is since you seem to have such a close finger on the pulse of everything? Sounds like a lot more fun than just making up commentary for day-to-day events.
We maybe ready for two wars in Washington but do we have enough bullets after our recent generosity? It’s one thing to give money to people who aren’t working, of both political stripes, but quite another to risk our remaining political capital on new wars before an election.
The US aid to Ukraine to date ($75BN), and the proposed future aid to Ukraine and Israel ($100BN), are pretty small potatoes in the context of a $6.3TR federal budget. The Ukraine weapons aid is largely Lend-Lease, meaning it will be repaid during Ukraine’s reconstruction (to be mostly funded by EU + Ukraine). Eliminating the majority of Russia’s experienced combat troops, armor, and munitions (to the point that Russia is shanghai’ing convicts, pulling old tanks from museums, and wheedling munitions from N Korea/Iran) with zero US casualties is the military bargain of the century. The Israel aid won’t have the same payoff, unless Iran enters the war.
Spot on, John. What Ukraine has accomplished so far had been unimaginable to most. And this is despite that Western media can’t see past “slow advances on retaking territory.”
JL – don’t overlook how much US and EU weapons stocks have been depleted by our aid to Ukraine and now Israel is just starting with needs of their own. If Hezbollah ramps up, the cupboard will be left bare. Taxpayers will be called upon to fund a massive restocking effort.
I found your confidence that the “lend-lease” aid will be paid back puzzling. Who can forget “pas un sou d”Amerique!”
Who are the major threats.
Russia – combat power and munitions severely depleted, and completely occupied in Ukraine even with the latter’s feeble airpower. Russia has largely lost its ability to project power, it couldn’t even defend its protectorate in Azerbajian. If Russia were to attack a NATO country, it would go badly for Putin very quickly.
China – the short-range munitions US is supplying to Ukraine would be of little use in a war over Taiwan. No 155mm shell or GMLRS missile fired from any US position can reach any Chinese asset. US hasn’t supplied Ukraine any of the long-range, anti-ship, cruise missiles that would be used there.
Hezbollah/Hamas – the Iron Dome interceptors could be in tight supply, I don’t know, but the US itself makes very limited use, if any, of Iron Dome. I don’t see Israel vs Hamas/Hezbollah as involving massive artillery consumption like Russia/Ukraine. H/H together only have as many fighters as the Russians lose every month. Indeed, Ukraine wouldn’t be needing so much artillery/short-range missiles if it had air superiority, which Israel has. (I don’t see Iran getting involved in a major way, as it would lose its nuclear, oil refining, oil storage and shipping facilities in the first couple of weeks.)
I do think the West’s defense industry needs to shift into high gear faster than it has done, but I don’t think there is an immediate problem.
Additional thoughts
– Iran surely notices that Israel is striking Syrian airports at will. Iran has some Russian S300 air defense systems, but will be aware how poorly those have performed against the Ukranians.
How can Iran think its important infrastructure will survive, should it enter the war in a major way? Even if Iran thinks Hamas/Hezbollah will fully occupy the IDF, it realizes the threat of two US carrier groups (and US F15s, F35s, A10s also moved to the area).
Hopefully you are right.
But you may be falling into the trap of assuming every leader is rational and makes a detailed cost-benefit before acting. Like a company CEO. But our experiences with Sadaam and Putin suggest otherwise.
I think it doesn’t matter if Xi, Khameni, or Putin are rational, the munitions given to Ukraine won’t be an issue if they start a war.
Xi/Taiwan already discussed. If Iran attacks Israel, what will be used to strike Iran is not the 155mm shells, GMLRS missiles, or other short-range stuff Ukraine received from US. If Putin attacks NATO, NATO would have air superiority in a few days.
I read the WSJ editorial as well.
But what about the political will to keep funding the aid? Going…going…gone!
Excellent post (and comments) to reset after a troubling week,