Banks Selling What They Can

Sell What You Can

The August CPI report did not alter the broad disinflationary trend, though it lowered the probability of the death of the last rate hike DOT. CPI also whipsawed investors for the second consecutive month, the better-than-expected July report failed to reverse the August bear steepening risk-off episode, and while the UST market initially reacted negatively to the August report, the bear steepening was brief and by midday the rates in the belly of the Treasury market (2–5-year notes) fell by 4-5bp. Thursday’s retail sales report had a similarly neutral impact on the economic outlook: negative revisions to June and July offset marginally better than expected August sales, leading to a 50bp reduction to the Atlanta Fed personal consumption and GDP tracking estimate models. Negative guidance from low-cost airlines at an industrials conference triggered questions about the strength of the consumer, our view remains that goods spending is likely to improve marginally, but the larger services sector is likely to weaken in coming quarters leading to a growth scare later this fall. The ECB 25bp rate hike, while not totally expected, was greeted with a rally in European sovereign bond markets despite President Lagarde’s unwillingness to confirm the end of the rate hike cycle. By Friday the rally in European sovereign bonds reversed, ostensibly due to divergent ECB member views, but at least in part due to the continued surge in oil prices that loosen financial conditions in Europe, while tightening them in the US as detailed in our note last week, The Petrodollar.

We spent the week in New York City, and the tone of the discussions was generally equity market positive, but more negative on the Treasury market and economic outlook. While a negative outlook on economic activity and the Treasury market might appear incongruous, the Treasury market risk most investors were concerned about was similar to our note detailing Treasury Secretary Yellen’s additional $500 billion of issuance this fall with her best customers, the Fed, banks and Asian central banks, all better sellers. Investors were concerned about the growing federal debt and deficits; however, we did not get much pushback on our view that the near-term risk was primarily the fiscal theory of the price level rather than a debt crisis, and even then, fiscally driven inflation wouldn’t be an issue for monetary policy until 2Q24 due to cooler rent of shelter inflation. Nevertheless, our view that the 60bp increase in 30-year real rates in August was the same adjustment that occurred in January to March ‘21, and 10-year nominals, TIPS and breakevens were at reasonable levels given the ongoing effects of the Fed’s balance sheet, was generally accepted. However, the tail risk of another leg higher for longer maturity Treasuries is a risk many of the investors we met with believe is reasonably fat (high, sorry for the statistical jargon). The fact that 10s rallied after testing the October ‘22 high of 4.36% in August, but are back at 4.33% in September is concerning; double tops can be a powerful technical reversal pattern, but in our view a triple top is just resistance more likely to be breached than not.