Despite the rally in stocks that left the S&P 500 up for the fifth day in a row, the longest such series since December, there was, at the other end of the spectrum, a whiff of panic.
It wasn’t that visible in ten-year Treasuries, though intense buying drove them higher, with the yield dropping to 1.989% Monday morning, the lowest since April, before ending the day at 2.06%. It was in short maturities, the safest and most liquid financial assets in the world: The US Treasury was able to sell $21 billion of six-month bills at a minuscule yield of 0.065%.
It also auctioned off $21 billion in three-month bills. Each dollar of the bills offered got chased by $4.14 in bids – the highest bid-to-cover ratio since June 22 when China was in full-crash mode. With buyers jostling for position to grab whatever they could, these bills sold at a yield of zero for the first time in history.
Even more liquid one-month bills have sold at zero yield in five of the six most recent auctions. And in the secondary market, some bills have traded at slightly negative yields for a while; investors who hold these bills to maturity end up with a guaranteed loss, the price they’re willing to pay to keep their money save and liquid.
But this was the first time for the Treasury to sell three-month bills at zero yield.
OK, there’s a supply issue. The gross national debt has been bouncing into the debt ceiling for months. So the Treasury can only sell new debt to replace maturing debt. The actual borrowing needs of the government are not met by selling more Treasuries but by temporarily siphoning money from other government accounts – “extraordinary measures,” as it’s called. But there is a limit. Beyond it lies the official out-of-money date, which the Treasury now projects to be November 5.
So tight supply meets desperate demand. Even cash in bank would earn more. But for these large investors, such as money-market funds, their cash in bank would be uninsured and could go up in smoke during a crisis.
Which leaves us with a quandary: The stock market rally says folks believe that the bonanza will continue, that risks have disappeared, that the economy is hot, and that the Fed will never take away the punchbowl.
But the Treasury market shows that others are desperate to put their money into highly liquid and safe places, even if it costs them money – a behavior normally visible ahead of a looming crisis. Even then, the Treasury had never before been able to auction off three-month T-bills at a yield of zero.
Why are these people so spooked? Why don’t they get the drift that momentum is back, that everything is under control, that it’s time to plow back into risk?
Fed flip-flopping has something to do with it. By now, no one believes anything the Fed says, one way or the other. It doesn’t matter how many Fed heads come out and proclaim that a rate increase is still on the table for later this year. It doesn’t matter how often they claim that inflation will once again rise. No one believes them anymore.
On Monday, Fed funds futures – where Wall Street rate-hike beliefs turn into money – put the likelihood of a rate hike during the Fed’s October 27-28 meeting at 6% and at 32% for its December 15-16 meeting.
Traders have been searching for confirmation that the Fed would never raise rates. They’re clamoring for ZIRP infinity. Most of our corporate heroes, after using the ZIRP years to load up on cheap debt, won’t be able to roll over this debt at “normalized” rates without skidding into serious trouble. And today’s highly leveraged investment models don’t work when there is suddenly a real cost of capital.
They found what they were looking for: a crummy but not catastrophic jobs report on Friday, a steepening deterioration in corporate revenues and earnings, and a swooning manufacturing sector. They brush off other data such as booming auto sales, a steamy housing market, or rents that are getting closer to the stratosphere in a world where real wages have been stagnating.
So it doesn’t matter that Fed heads are beating the bushes, trying to get markets to believe that a rate hike is still on the table.
“We’ll have to see whether the employment report was a little anomalous or whether it turns out to be more of a broader pattern,” Boston Fed president Eric Rosengren told MarketWatch. “If this is an anomalous report then, if the data came in sufficiently, I would be comfortable possibly raising rates by the end of the year.”
On September 24, when the Fed decided to keep its benchmark rates at near zero, it added the huge caveat that 13 out of 17 Fed officials – “including myself,” as Fed Chair Janet Yellen emphasized – expected a rate hike this year.
Rosengren pointed out that the jobs report was just “one report,” and that other data would have to confirm this weakness. He wasn’t convinced it was a broader pattern. Much of the weakness was in manufacturing and mining. That’s not a new development.
“I think the real question is whether the domestic economy offsets some of the headwinds we’re seeing from the international sector,” he said. “I don’t think we have enough data yet to know whether that actually is going to occur.”
So, according to him and numerous other Fed heads, rate hikes are still prominently on the table for this year. But after all the flip-flopping, no one believes the Fed anymore. The Fed’s credibility has gone to heck. The Fed is never going to put its foot down, ever again. That’s what the market is increasingly sure of.
And if it does put its foot down – as it has been indicating for months, only to flip-flop at the last moment – it will be a wild “surprise,” the kind that markets don’t like.
So if the stock market shows that investors once again are getting drunk at the Fed’s punchbowl, why is there another group of investors who are spooked, who want to put their money into the safest and most liquid asset even if it costs them money? Is it because they think that the Fed will raise rates despite market expectations to the contrary, and that the ensuing “surprise” will trigger market gyrations of the kind where safe and liquid assets suddenly become priceless?
These spooked folks might see the stock market rally as yet one more element that would make the Fed feel at ease about raising rates, and thus one more reason to seek safe and liquid assets for that period.
For companies, it’s tough out there. Revenues and earnings are shrinking. It’s a global problem, rather than just the fault of the strong dollar. Read… Last 2 Times this Happened, the US was Falling into Recession
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