Today was an absolute bloodbath in the markets. Especially for investors who are currently holding US treasuries. It seems that the dam is truly beginning to burst as investors begin to internalize the precarious situation of the markets as the Fed seems dead set on holding rates higher for longer. Despite what many who are considered by the mainstream to be a part of the economic cognoscenti would lead you to believe, inflation has not been tamed yet. This fact coupled with structural issues in government and corporate debt markets that manifested during more than a decade of interest rates hugging the zero-bound is breaking the markets.
Bond yields are soaring as it becomes clearer by the day that inflation has not been tamed, the hands of foreign holders of treasuries, like Japan, weaken as they are under immense pressure to put their own houses in order, corporate bankrupties continue to increase month-on-month, and the housing market is screeching to a halt as mortgage rates approach 8%. Throw in an ongoing debt cieling crisis that has been temporarily delayed and chaos in the House of Representatives and you have what your Uncle Marty likes to refer to as a Proper Shitshow. pinkies up
As we've discussed in the past, the Fed's current policy aims to destroy demand (read: destroy the job market) in an attempt to make it so there are less people buying goods which, in theory, should lower prices. This plan has run into a buzzsaw due to the structural supply chain issues that emenated after the COVID lockdowns coupled with higher rates that are making it more expensive to actually bring goods to market. The worst case scenario is beginning to materialize; demand destruction with no end to real inflation in sight.
This is leading to a sell off in bonds. People aren't confident in the US economy at the moment and are actively offloading US debt as a result. All coming at a time when a material amount of US Treasuries are about to roll over. As that debt rolls over the Treasury is going to have to issue new debt at higher rates, which will exacerbate a problem that is already getting out of control; the interest expense the government pays on all of the debt it has issued. This problem seems primed to reach a point of epic proportion if a prolonged recession materializes. If it isn't already here.
With corporate bankrupties reacing level not seen since the 2008 financial crisis and the cost of capital only continuing to rise, it seems pretty clear that a recession is imminent. And when it becomes an undeniable fact that the US economy is in a recession the realization will cause a cascading effect of layoffs that will shock the market into recognizing how bad things really are. The government will then have to come in with fiscal stimulus in the form of entitlements to lessen the blow for the newly unemployed, which will mean more debt issuance at the highest rates the markets have seen since 2007. As Jim Millstein pointed out on Bloomberg yesterday morning, this is a classic recipe for a debt crisis. A cascading doom loop that feeds on itself as it becomes glaringly obvious that there is no way to gracefully unwind the knot the Fed and the Treasury have been creating since the 2008 bailouts.
To make matters worse, we were reminded earlier this year that the banks that sit at the foundation of our interconnected economy are holding obscene amounts of treasuries as liquid reserves. As the market drives those bond prices lower and lower, the amount of reserves in the banking system shrinks materially. Of course, due to the accounting standards in this country, banks aren't being forced to mark those treasuries to market. Since they are considered "low risk" marking those assets to market on an ongoing basis has been deemed unnecessary.
Well, these assets don't seem very low risk at the moment. And with the sell off beginning to accelerate, one has to wonder what happens when the stress on banks becomes so immense due to their inability to derive revenue from lending since it has become much riskier with higher rates that they have to begin marking those treasury assets to market because they are forced to sell to try to protect the value of their reserves. Once one hand is forced, all of the others will be too and it will make 2008 look like child's play.
Again, this is a Proper Shitshow. Hold on to your butts. Get your hands on some bitcoin if you haven't already.
It was a heavy Mac Miller day in the studio. I think I'm much more productive when I have music on in the office.