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Market Snapshot 7/9/24 – Bonds Are Leaking

Good Tuesday morning from your Hometown Lender,

Bonds are leaking a bit for no real reason.

Chairman Powell was speaking to the Senate committee today on day 1 of a two day testimony, and confirmed that the economy is slowing, inflation is moderating, and jobs are not adding inflationary pressure. Still, he said, the Fed needs more data to confirm a rate reduction is appropriate. The speech was released to the press yesterday so there were no surprises today, but maybe markets wanted more from the Chairman. Maybe the ever-growing concern over President Biden’s reelection is causing markets to leak as well. Depending on what the CPI and PPI reports come in at on Thursday and Friday, the case could be made for the Fed to cut in July, but it will likely be September before the Fed makes its first cut.

This is a very interesting (wearing my nerd pajamas loud and proud here) piece from Bloomberg this AM…

The US yield curve should steepen significantly in the second-half of 2024. US policy — both fiscal and monetary — would seem to make such a move inevitable. The catch is that this is a directional view that many (including me) have suggested incorrectly several times previously, and it’s starting to appear worryingly consensus again. It was on July 5, 2022 that the 2s10s curve inverted, and two years is quite long enough.

An inverted curve has a real economic impact in its own right, by disincentivizing the standard financing model of borrowing short-term to lend/invest long-term. That delivers knock-on (albeit slow and subtle) negative effects for corporate/entrepreneurial behavior. Chair Jerome Powell has made it clear the Fed will have a very dovish reaction function under his watch — seeking to ease policy if the economy is cracking, even if there’s a lack of certainty inflation will return to target. That makes a bull-steepening yield curve in a true growth slowdown almost a fait accompli, as front-end rates will get slashed, something Garfield Reynolds highlighted as the easiest path for a disinversion.

However, if the economy remains surprisingly resilient, that would prove monetary policy isn’t overly restrictive (and that the neutral rate is higher), meaning the economy is particularly vulnerable to another inflationary wave. This would result in a potential bear-steepening (long-end yields rising faster than front-end) if people believe Powell’s Fed hasn’t credibly shown the ability to ever bring inflation under control.

Speaking of inflationary impulses, we are heading toward a US presidential election where both candidates show no concern for fiscal deficits or pro-cyclical government expenditure. And that is intensifying valid fiscal concerns at a remarkable pace. As colleague Ed Harrison highlighted Monday, even so-called deficit owls are getting worried. And so they should — the estimated annualized payments to service the US government debt surpassed $1.1 trillion and are still rising almost parabolically:

As always, please let me know if you have any questions and if there is anything we can do to add value to your day.

Stay safe, and make today great!