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London Quick Take - 21 Aug - Bessent bid in Treasury market unwinds as yields back up, UK deficit rises but UK PMI improves
Neil Wilson
Investor Content Strategist
Note: This is marketing material. This article is not investment advice, capital is at risk.
Yields back up: stocks fell as Treasury yields moved back up to unwind the buyback-inspired rally in bonds. 10yr and 30yr yields picked up about 5-6bps to leave them back to where they were yesterday before the Treasury announcement, slightly above 4.70% and 5.25% respectively. Front-end yields also ticked up. The move improved the picture for the US dollar somewhat as it rallied off a three-month low, though the outlook for USD since the Treasury move appears broadly weaker. The last two days have confirmed the bull case for gold in an era of rising deficits, inflation and now a quasi financial repression and soft yield curve control - spot drove higher to clear the 200-day moving average around $4,511 to hit $4,567. The Dow Jones fell 700pts, led by a decline for Walmart post-earnings, and the Nasdaq shed –1% for the session, though semiconductor shares held up ok. European shares opened a little higher Friday, with the FTSE 100 helped by advances for mining stocks.
Whilst Treasury seemingly tried to signal the market it won’t tolerate higher yields, what is essentially a tinkering of maturity schedules is not a fix for the key underlying reasons why yields have broken out higher – namely the fiscal and inflation risks, even if it does improve liquidity at the long end of the curve somewhat. A sharp move higher in oil prices, with Brent breaking out of its range to $94.50, underlined near-term inflation pressures skewing to the upside once more. The move in Brent pushed it close to closing the gap of the weekend of 24/25 July though gains were pared overnight and it last traded around $93.50.
Loss of credibility? Without fiscal consolidation the Treasury’s buyback move lacks any real power to move the needle on long-end rates. It doesn’t change the deteriorating fiscal position, nor a sense that the Fed is prepared to let inflation remain above target, nor that borrowing by tech firms to finance AI is eating up demand for debt. It could even backfire and drag long-term rates upwards if investors think the administration is trying to manage (repress) long-end rates. We could see higher risk premia as a result. And two new studies from Stanford and MIT suggest investors are less willing to hold Treasuries because of perceived safety. The worst-case scenario now for the long-end is if the Fed stands pat in September as it risks fuelling further concerns about the inflation risk setup. Given the persistence of inflation – nothing to do with a couple of slightly more moderate CPI prints – the first way to get the curve down is for the Fed to jack up the front end, which will help re-anchor inflation expectations. The problem is this means more frequent refinancing at likely higher rates. The Donald would go ballistic. And the worry is the fiscal side remains super loose with the Federal government still running a 6% deficit in an economy at full employment...there is not an easy solution to all of this but I point to the 29 July FOMC and the subsequent bear steepening as the pivotal moment in this cycle, when the market lost confidence in the Fed’s inflation-fighting credentials - which suggests that it’s still possible for the Fed to regain control. The market thinks the Fed is a White House puppet - does Warsh have what it takes? There's a lot going on here but it’s my belief that the Fed holds the key to this and it’s not a coincidence this move in the long end has really taken off since the July FOMC meeting. A more hawkish Fed doesn’t fix fiscal term premium dynamics and concerns about rising deficits, but it’s the first and vital step to fixing the inflation term premia and show that any worries about fiscal dominance are unfounded. Jackson Hole next week is going to become very interesting - though I doubt Warsh will start opening up. The key is the September FOMC.
Underlining fiscal risks over here, government borrowing figures showed the UK posted an unexpected deficit of £1.8bn in July. But activity in the economy is improving - the services PMI survey ticked up to a six-month high o 52.8 in August. Weather and investment in tech helped, but separate data showed retail sales were softer despite the World Cup.
Elsewhere, Walmart was a big drag on the DJIA yesterday, sliding –9% for its worst day sine 2022 as same store sales and guidance for the coming quarter was a bit light. Tariff refunds helped it to keep prices low and e-commerce remains strong, but pharmacy sales are a drag due to the decline in US drug pricing,. Target looks to have delivered a much stronger quarter and won price target hikes from several analysts. Lowe’s was hit by price target cuts after disappointing results. Meanwhile in the tech space JPMorgan went to Overweight on Broadcom, saying the market is underestimating the company’s “chip/package design leadership”.
Whilst Treasury seemingly tried to signal the market it won’t tolerate higher yields, what is essentially a tinkering of maturity schedules is not a fix for the key underlying reasons why yields have broken out higher – namely the fiscal and inflation risks, even if it does improve liquidity at the long end of the curve somewhat. A sharp move higher in oil prices, with Brent breaking out of its range to $94.50, underlined near-term inflation pressures skewing to the upside once more. The move in Brent pushed it close to closing the gap of the weekend of 24/25 July though gains were pared overnight and it last traded around $93.50.
Loss of credibility? Without fiscal consolidation the Treasury’s buyback move lacks any real power to move the needle on long-end rates. It doesn’t change the deteriorating fiscal position, nor a sense that the Fed is prepared to let inflation remain above target, nor that borrowing by tech firms to finance AI is eating up demand for debt. It could even backfire and drag long-term rates upwards if investors think the administration is trying to manage (repress) long-end rates. We could see higher risk premia as a result. And two new studies from Stanford and MIT suggest investors are less willing to hold Treasuries because of perceived safety. The worst-case scenario now for the long-end is if the Fed stands pat in September as it risks fuelling further concerns about the inflation risk setup. Given the persistence of inflation – nothing to do with a couple of slightly more moderate CPI prints – the first way to get the curve down is for the Fed to jack up the front end, which will help re-anchor inflation expectations. The problem is this means more frequent refinancing at likely higher rates. The Donald would go ballistic. And the worry is the fiscal side remains super loose with the Federal government still running a 6% deficit in an economy at full employment...there is not an easy solution to all of this but I point to the 29 July FOMC and the subsequent bear steepening as the pivotal moment in this cycle, when the market lost confidence in the Fed’s inflation-fighting credentials - which suggests that it’s still possible for the Fed to regain control. The market thinks the Fed is a White House puppet - does Warsh have what it takes? There's a lot going on here but it’s my belief that the Fed holds the key to this and it’s not a coincidence this move in the long end has really taken off since the July FOMC meeting. A more hawkish Fed doesn’t fix fiscal term premium dynamics and concerns about rising deficits, but it’s the first and vital step to fixing the inflation term premia and show that any worries about fiscal dominance are unfounded. Jackson Hole next week is going to become very interesting - though I doubt Warsh will start opening up. The key is the September FOMC.
Underlining fiscal risks over here, government borrowing figures showed the UK posted an unexpected deficit of £1.8bn in July. But activity in the economy is improving - the services PMI survey ticked up to a six-month high o 52.8 in August. Weather and investment in tech helped, but separate data showed retail sales were softer despite the World Cup.
Elsewhere, Walmart was a big drag on the DJIA yesterday, sliding –9% for its worst day sine 2022 as same store sales and guidance for the coming quarter was a bit light. Tariff refunds helped it to keep prices low and e-commerce remains strong, but pharmacy sales are a drag due to the decline in US drug pricing,. Target looks to have delivered a much stronger quarter and won price target hikes from several analysts. Lowe’s was hit by price target cuts after disappointing results. Meanwhile in the tech space JPMorgan went to Overweight on Broadcom, saying the market is underestimating the company’s “chip/package design leadership”.
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