Rising Uncertainty Both Here And Abroad Stifles the Bulls
Prior to Hamas’s invasion of Israel, the stock market was pretty strongly teed up for a seasonal year-end rally.
There has been lower-trending economic data to offset the still-stubbornly inflationary data that keeps the bond market in check. The dollar continues to trade higher, attracting foreign capital from around the world. And to the surprise of many, the first week of the third-quarter earnings season produced some strong results for the leadoff companies that reported last Friday.
Sadly, the call for worldwide jihad on Friday the Thirteenth by the leader of Hamas triggered a risk-off atmosphere heading into the weekend that left the broad market twisting in the wind.
But not all was shaping up to be as constructive as Wall Street would want when taking into account the most recent 30-year Treasury bond auction. At Thursday’s auction, bidders showed their lowest interest in the long bond since 2021, evidenced by primary dealers having to buy nearly 18.2% of the debt.
The yield jumped to 4.86% before the flight to safety trade took hold on Friday. As a rule, primary dealers are required to take the debt not purchased by other bidders.
This is a red flag for future bond auctions, reflecting the rising caution over the U.S. budget deficit that is generating rapid increases in the interest rates on the borrowed money that is needed to run the government.
Last week, the Congressional Budget Office reported that the federal budget deficit for the 2023 fiscal year was $1.7 trillion, a jump of more than 20% over 2022’s deficit (which came in at around $1.4 trillion). Clearly, the bond market is saying “no” to further large increases in the debt ceiling. The International Monetary Fund was the latest to chime in. “Federal deficits have deteriorated substantially in 2023,” said Pierre-Oliver Gourinchas, the director of IMF’s research department.
The White House, Congress, the Treasury and the Federal Reserve should not test the will of the bond vigilantes. It’s one thing when the underlying currency is weak, and yields rise to attract capital. But it is quite another to see the dollar engulfed in a bullish uptrend and still see the Treasury struggle to peddle its debt in one trainload-sized auction after another.
I noted in recent comments that even if inflation were to get under 3%, it would not guarantee that we would see Treasury yields coming down. America’s creditworthiness is being called into question, and while the Fed votes once every couple of months, the bond market votes every day.
Are we living in the greatest credit bubble in human history? Apparently, Treasury Secretary Janet Yellen doesn’t think so. In a recent Fortune article, Yellen said she is still “not really concerned about the impact” that recent federal spending programs — including the CHIPS and Science Act that subsidize semiconductor production and research, and the Infrastructure Investment and Jobs Act, which authorizes spending on roads, bridges and other infrastructure projects — will have on the national deficit, arguing the federal government just needs “to make sure that we stay on a sustainable course.”
Secretary Yellen is behind the curve. When you can’t sell 100% of AAA-rated U.S. debt at an auction with rates at a 23-year high, you have an elephant-size problem.
Considering the hotter Consumer Price Index (CPI) number than the market was looking for, and the lousy bond auction, the hot mess in the Middle East is driving money back into Treasuries and is shoring up a market that was on the lips of some further unwinding. In doing so, it has provided time for the White House, Congress, the Treasury and the Federal Reserve to address the fragility of the bond market and provide some assurance that they are acutely aware of how reducing the deficit is a top long-term priority. God forbid they ignore the most recent red flags.
When the world stops buying your debt, as has been the case in Japan for years, then your own central bank becomes the biggest buyer of your Treasury’s bond issuances. As of March 2023, the Japanese public debt is estimated to be approximately 9.2 trillion U.S. Dollars (1.30 quadrillion yen), or 263% of gross domestic product (GDP), and is the highest of any developed nation. 43.3% of this debt is held by the Bank of Japan.
By this time next year, when the numbers are even more elevated, and America goes to the polls, one can only hope this will be the front-and-center topic. Our kids and grandkids depend on it.
There is still potential for the market to enjoy a year-end run, but much depends on how the Middle Eastern situation plays out, the appearance of some public rhetoric that addresses the vulnerability of the bond market, the possibility that investors get one heck of an earnings season and that Washington shows real resolve in getting Iran to back all the way down.
Excessive government spending has been exposed, as has a gaping vacuum of leadership, respect and the loss of what used to be the revered “speak softly and carry a big stick” mantra of U.S. foreign policy. It’s one thing to show up with a mighty force, and it’s another for the evildoers to know and believe full and well that you will use it.
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