These manias and the rising long-term interest rates are on collision course.
By Wolf Richter. This is the transcript of my podcast last Sunday, THE WOLF STREET REPORT.
Everyone can see what’s going on: speculative manias everywhere. This includes the most worthless delisted stocks of companies that had no activity for years that suddenly surged several hundred percent in hours, driven by pump-and-dump schemes in the social media, before re-collapsing.
And it goes all the way via real estate, junk bonds, the most-shorted stocks, cryptos, and well, sneakers, to the newest thingy, so-called NFTs, or non-fungible tokens, that are now being hyped to high heaven.
But facing these manias are long-term US Treasury bonds and high-grade corporate bonds that have been getting crushed for months – as their yields have surged.
For example, the bond market ETF that tracks US Treasury bonds with maturities of 20 years or more with the ticker TLT – its shares are now down 20% since early August last year. When prices of bonds drop, by definition, their yields rise.
A 20% drop in share price of what is promoted as a conservative investment in US government bonds is a big step down.
The Fed has bolted down short-term interest rates pretty well. They’re near zero and haven’t budged.
But long-term interest rates have been rising for months. The 10-year Treasury yield on Friday rose to 1.63%, the highest in over a year. Since August, the 10-year yield has more than tripled.
And mortgage rates turned around in early January and started to follow the 10-year Treasury yield higher. The average 30-year fixed rate mortgage interest is now nearly 3.3%.
This is happening even as the Fed is still buying about $120 billion a month in Treasury securities and mortgage-backed securities as part of its QE, designed to push down long-term interest rates. And yet, they’re rising.
The Fed has been unanimous in accepting and even welcoming the rise in long-term interest rates as a sign of economic growth and rising expectations of inflation – as long as it remains “orderly,” and doesn’t veer into “disorderly” markets, as Jerome Powell emphasized.
And Secretary of the Treasury Janet Yellen has chimed in, also welcoming rising long-term bond yields as a sign of economic growth and rising inflation expectations.
The Fed sees these manias too. While it cannot admit to seeing them, and while it can never say that it would let the steam out of them, it is letting long-term yields rise because that is a form of tightening, and it will take some steam out of the manias. And letting long-term yields rise is a prelude to tapering its bond purchases, which is a prelude to raising its short-term interest rates.
So, there is the latest craze, the non-thing called “NFT” – the non-fungible token. Which means it is unique. It is unique like every dollar bill is unique because every dollar bill has a unique serial number. Every car is unique because it has a unique VIN number. Serial numbers have been around forever.
But now new hype has broken out about non-fungible tokens because these are essentially serial numbers combined with digital entities, such as a PDF file or a video clip, and instead of being in a database somewhere, the code is part of a blockchain, usually the Ethereum blockchain.
And how do you get everyone to talk about NFTs and spread the stuff all over the front pages of the big papers, and how do you get it to show up on TV news and on Google, Facebook, Twitter, various discussion bords, and what not?
You create a big hoopla deal that blows everyone’s socks off, and you do that systematically, and you get one of the biggest art auction houses in the world, Christie’s, to help you promote this non-thing, and voila.
It was masterfully done by some crypto hype mongers. And a crypto hype monger that goes by the handle of Metakovan, whose legal name Christie’s refused to disclose, bought a digital collage created by an artist who goes by Beeple – and the work of art is a PDF file combined with a fancy serial number, and the whole thing is an NFT.
Metakovan paid $69.3 million in ETH, the cryptocurrency on Ethereum, for the PDF file after a two-week online auction whose purpose was to drive up the price and create a sensation. And it worked.
NFTs can be anything digital. People have turned video clips on YouTube and Tweets into NFTs and sold them and traded them, and prices of these digital files have soared.
Obviously, since it’s digital, you can still endlessly copy the video clip, a tweet, or the $69-million PDF file, and you can download it, and share it a million times, for free.
You can copy a Picasso too, but it’s either a photograph of a real Picasso, or a painted fake of a real Picasso. And they’re physically different from the real Picasso. Alas, the digital copies of videos and PDF files are exactly the same as the original, and that $69-million PDF can be copied a million times.
I mean, it’s great to support living artists. The more the better. But a tweet that has been around for years? Or video clips that have been around for years? So now we have an inexplicable speculative mania in NFTs.
Then there’s bitcoin and the many thousands of other cryptos that have cropped up, whose prices soar to unimaginable highs on nothing but hype, with their combined valuations now approaching $2 trillion. This is serious money. Some of these positions are leveraged, in various ways, from buying cryptos on credit cards or with the proceeds from cash-out mortgage refis, to institutional borrowing against cryptos, such as by hedge funds.
And there are the SPACs. These Special Purpose Acquisition Companies are blank-check outfits that go public with no operations and no employees and no nothing, and people who buy these shares to fund the SPAC hope that the SPAC will acquire some startup over the next 18 months. Everyone is doing SPACs now and selling them to the public – star athletes, Hollywood celebrities, rappers, former politicians, including the former Speaker of the House….
It boils down to this: if you’re not doing your own SPAC, you’re no one.
Even the SEC, which has long been asleep, warned retail investors about SPACs.
The sponsors of these SPACs rely on retail investors to come along and buy this stuff at the appointed time. If the SPAC croaks after the hype dies down, and after retail investors get cleaned out, the sponsors are likely to have walked away with a bundle of money beforehand.
And there is the speculative mega-mania in the stock market, across the board. There are the most shorted stocks that suddenly skyrocket several hundred percent in just days, only to spiral down again, and then they jump again, powered by pump-and-dump schemes in the social media.
There’s Tesla, a small automaker with a market capitalization that is worth more than that of the biggest automakers in the world combined. The Tesla mania has been going on for years.
There are the other EV stocks, or anything related to EVs, often tiny companies with nearly no revenues, that suddenly and inexplicably skyrocket. The auto industry is a brutal industry with two decades of no growth in unit sales in the US and the rest of the developed world. Automakers have relied on price increases and China to get their revenues up. EVs are precisely in that space, and now all legacy automakers are making them. And yet there has been a mania in EV stocks. And it even pulled along the legacy automakers stocks
The entire stock market is ludicrously overvalued.
A lot of these manias are driven by deep-pocket speculators, such as hedge funds and crypto promoters and others, and they’re driven by millions of retail investors trying to make lottery-type returns, and they’re using the social media to spread the word and get enough folks to bet in the same direction, hoping to be able to get out in time.
Then there’s the current mania in real estate, where people buy houses sight-unseen by bidding over asking price, and home prices have skyrocketed across the nation, with double-digit year-over-year increases. In some areas, year-over-year gains clocked in at 20% or more.
And there’s the mania in junk bonds, the riskiest end of the bond market. Junk bond prices have skyrocketed, thereby pushing yields down to record lows. The peak was likely in mid-February, and prices have edged lower since then, and yields have come up, but are still very low.
These manias have a few things in common:
First, a huge amount of liquidity that the Fed and other central banks have created. This money is trying to go somewhere. Many trillions of dollars, euros, yen, etc.
Second, a huge amount of leverage. Draconian interest rate repression encouraged everyone to go whole-hog on borrowing, and it’s everywhere, from record skyrocketing stock market leverage to real estate leverage. Cash-out refis have hit the levels just before the mortgage bust that led to the Financial Crisis. Are people taking cash out of the house, and loading the house up with more debt, to buy NFTs or cryptos with that borrowed money?
I get the willies just thinking about the implications of that.
And then there is the stimulus money in various forms, including stimulus checks. Some people used them to pay for rent or food. Others went speculating with it, chasing after lottery-like returns, of 5,000% or something in three days. And they’re spending a lot of their time on the social media to dig up the latest hoopla deal.
While all these manias are going on, the US Treasury market and the top end of the corporate bond market have been getting crushed as long-term yields have surged, and highly leveraged bets on long-term Treasury securities have blown up.
The 10-year Treasury yield rose to 1.63%, the highest in over a year, more than triple the yield in early August.
The 30-year Treasury yield jumped to 2.4% at the close on Friday, the highest since November 2019.
The difference between the two-year Treasury yield and the 10-year Treasury yield widened to 150 basis points, one-and-a-half percentage points, the most since September 2015. This spread is a measure of the steepness of the yield curve. In other words, that end of the yield curve is now the steepest since September 2015.
The average 30-year fixed-rate mortgage interest rate is now nearly 3.3%, according to the Mortgage Bankers Association. They’re still ludicrously low, given the outlook on inflation, and given the Fed’s insistence that it will let inflation run over 2%.
So long-term interest rates are marching higher. And the Fed is letting them. It’s the Fed’s unspoken way of acknowledging the manias and of allowing some hot air to hiss out of them, before it begins tapering the bond purchases and raising short-term interest rates.
Is 2% the magic line for the 10-year yield? Is 3% the magic line? That 3% Treasury yield would mean 30-year mortgage rates in the range of around 5%, give or take a little. Is this housing mania ready for 5% mortgage rates, when they were 2.8% three months ago?
A 10-year Treasury yield of 3% would do a lot of damage. Last time it hit 3% was in October 2018, and it entailed a nasty sell-off in stocks and a sharp drop in home sales. And a year later, the repo market blew out.
Now there is the scenario of vigorous inflation getting baked into the economy and into inflation expectations by companies and consumers alike. Inflation of this type would power long-term yields higher. And if inflation hits 3% or 4% as measured by CPI, and if the Fed sticks to its promise at those levels that it would let inflation run hot for a while, then the thinking about long-term yields may have to change entirely.
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