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The bond market says ‘meh’

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welcome back. This week is almost over and I promise I won’t talk about inflation at all next week. This time it really means that. But today I will.

Email me your thoughts: robert.armstrong@ft.com

Why higher inflation is being ignored

Consumer price index Came in It was a bit hotter than expected on Thursday, with core inflation of 3.8%, but government bond yields remained unchanged. As a rule, this is a bit strange. Inflation is bad for bond prices and should raise yields. But bond indifference is not unexpected. Bond yields peaked in March. Since then, the story has said, “Looking at 10-year bonds, inflation is temporary and everything is cool.” Or “Looking at the 10-year Treasury, investors think inflation is temporary. But the boys, to their surprise, bought canned goods and guns. ”

I am closer to the former camp than the latter. Again, most of the things that pushed the index up in May were crushed pandemics, including hotel rooms, or bottlenecks such as cars. Capital Economics had a neat chart in the hot category:

It should all be temporary. But we can’t be completely relaxed. Three comments on why this is not the case.

First, as a natural result of resumption, not all hot categories can be completely rejected. One example is housing costs (“owner-equivalent rent”) that have risen at an annual rate of 4% or more. This isn’t a crazy number (“so far, it’s been normalized, not a surge,” Strategas wrote in a reassuring note). But I want to see what the numbers will look like next month.

Second, there is a lot of price-insensitive demand for US government bonds, and yields may not be able to meet inflation concerns. They are the most liquid assets and are used for all kinds of purposes except maximizing returns. These are safe cash alternatives and a form of collateral for almost everyone everywhere.

Example. My ex-colleague Tracy Alloway, who is currently in Bloomberg, Nice article This week we’ll cover the growing demand for US Treasuries at banks that need to store large amounts of highly fluid and safe paper. The collapse of yields on other options has shifted bank demand to the Treasury, which has bought hundreds of billions of dollars in the past year or so.

Moreover, keep in mind that US Treasuries still yield far more yields than other government bonds. Japanese bonds basically produce nothing. The German one has a negative yield. So, if you have a secure sovereign debt allocation that you need to fill, what are you going to fill it with?

And yeah, on top of that ItThe Federal Reserve buys $ 80 billion in government bonds a month. This is almost half of the net issuance over the last 12 months. data From the Securities Industry Financial Markets Association or from approximately 4 percent of the Treasury’s outstanding shares.As a trader tweeting as 5 minute macro In summary:

“The Fed kneels in the bond market at every maturity, but people still want to analyze what every wiggle in the bond market says about the economy and investor expectations. Old habits work hard. The combination of dying to death and the alternative being fairly void. “

So if the 10-year Treasury yield doesn’t tell you much, what am I doing to make a living? Anyways . .. ..

Finally, I’ll give you a complete brief explanation of what’s happening. In short, the impact of inflation concerns on yields is hidden by lower real interest rates. This is a five-year market-derived inflation forecast starting five years later, plotted against a 10-year yield (FRB data).

Simply put, yields may be flat and inflation expectations may rise as investors demand inflation-adjusted returns on money, or real interest rates, are declining.

I wrote about the real interest rate yesterday.. Since then, thinking about it, I find that very low and falling real interest rates are hard to tell from investor nihilism (and waiting for something to happen will dismiss me, Is it drink time? “) But that’s another hour’s problem.

Banks and cryptocurrencies

Basel Committee on Banking Supervision Think Banks that hold cryptocurrencies need to keep their capital equal to the total amount of their digital assets.Speaking in Basel: “Capital [should be] Sufficient to absorb the full amortization of crypto assets exposure without exposing bank depositors and other senior creditors to loss. ”

This makes perfect sense and makes cryptocurrencies a terrible business for banks.

Cryptocurrencies (except those that Basel has excluded from heavy capital demand and are permanently tied to more stable assets) are so volatile that it makes sense. Bitcoin lost almost half of its value in the weeks of May for no apparent reason. Banks cannot avoid leveraging something that behaves that way.

This is obvious and adds to the technical or criminal risks associated with encryption (“Cryptography key theft, login credential breaches, distributed denial of service attacks”).

But banks basically make all their money from leverage. The return on total assets is about 1 to 2%, and by utilizing about 10 times that, we will reach a return on equity that is slightly higher than the cost of capital. They seem to make a lot of money at good times, but that’s an accounting illusion. Throughout the cycle, it’s a pretty tough business. Assets that cannot be leveraged do not fit into the business plan, at least on a significant scale.

This is generally not a critique of Bitcoin or crypto assets. And it shouldn’t care too much about crypto followers. An important part of cryptocurrency marketing is that users will be able to talk to government-controlled banking and money systems. Well, if the system wants to talk about cryptocurrencies as well, everyone should be happy. Bitcoin didn’t move much in the news from the committee.

But the Financial Times found a banker who was happy to say that the committee was wrong in the background:

“We’ve all seen what happens when you drive activity from a fairly well-regulated system to the wild west … Do regulators want adults to do business? Or do you want teenagers to do business? “

This is a cheerful and bad argument (“If you don’t let bankers smoke cracks, who smokes all the cracks? Kids!”). Yes, we want it to be handled by some sort of self-contained system where you don’t have to sell your mortgage to fill the holes left by the explosion if the crypto blasts. An interesting question is how to regulate and tax the self-contained system.

One good reading

FT Martin Sambu Think There is no labor shortage, widespread wage pressure, and tenacious inflation. He supports his argument with a wealth of data and sound logic. If you’re panicking, read his column.

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