The Macro Movie

You Only Die Once

Back in 1986 when I traded my first bond, thirty-year Treasury securities yielded 10.50%. When those bonds matured in 2016, the newly issued thirty-year maturing in 2048 yielded 2.50%.

40 years of the 30 year Treasury bond yield

In June 2020, concerned with possible deflation emanating from the COVID lockdowns, Chairman Jay Powell of the Federal Reserve bravely vowed that the monetary authority was “Not Even Thinking About Thinking About Raising Rates” and intervened in the bond markets pushing rates to their cycle lows. The economy overdosed on cheap money and fiscal handouts and notwithstanding the Chairman's pledge, the return of double-digit inflation forced him to pivot and raise rates from 0% to 4.5% in less than a year; the thirty-year Treasury moved up to 4% in tandem, as pictured on the chart.

During COVID, both Republicans and Democrats treated Chairman Powell as a movie star for having saved the economy. Last week, his testimony on Capito Hill showed his celebrity is clearly in decadence.

The bad news he reported was that inflation, particularly in services, and activity, particularly employment, were not moving in the direction the Fed needed to bring inflation back to where it had comfortably settled for most of the 2010s, at the Fed's target of 2%.

Powell's warning sparked a spike in expectations in the futures markets, which projected the Fed’s overnight rate peaking at 6% in the middle of this year, up from the 5% priced last month. The jump in rates sent the stock market sharply lower. The correlation between stocks and bonds, which caused losses of 20% to investors with traditional 60% equities/40% bond portfolios in 2022, held firm. What was bad for bonds continued to be bad for stocks.

And then, in a cinematic sequence of events worthy of an award at last night's Oscars, a new economy bank suffered an old-fashioned bank run. To set the scene, Silicon Valley Bank (SVB), the 16th largest financial institution in the US, focused on financing venture capital, had been quietly bleeding deposits since the end of 2022. As interest rates rose from zero to 5%, money flowed from low-paying bank deposits into higher-paying money market funds. Please checking what your bank and broker are paying on your deposits. They may be still be paying you zero.

Uncertainty and instability in the high-tech industry increased investor nervousness about the quality of SVB's loan portfolio, accelerating the flight of depositors’ funds.

SVB's fatal character flaw was not its venture capital loan portfolio. In the first ironic twist of our story, it was its $120 billion of government-guaranteed bonds. The bank had more than doubled this portfolio from 2020 to 2022, borrowing from depositors at zero and investing in longer duration government bonds at 1.50%. Adhering to regulatory standards, it had classified many of these bonds as "Hold to Maturity," allowing it to avoid recognizing steep losses it suffered when the bonds fell in value as the Fed raised rates last year. The same losses you may have suffered on the boand portion of your IRA, which is marked to market.

Lights, Camera, Action!

Wednesday, the depositor outflows intensified. SVB’s management decided to increase its liquidity. In Wall Street lingo, they "smacked the bid on" (sold to the market) US$20 billion of its bond portfolio. The market price represented a $2 billion loss versus the value on its books. They would now recognize that loss and replace the hole in their balance sheet by offering new shares to the market.

You can imagine the drama when the banks' directors opened the envelope to see who the winner was...

It was empty. There was no buyer.

Trading in the stock was halted. The bank was bust. The regulators stepped in.

This 2023 made-for-Hollywood bank failure became a a sequel to 1931 (The Great Depression), 1988 (S&L Crisis), and 2008 (Great Financial Crisis).

An epic action movie always has an unforgettable chase scene, and when the news of the second largest bank failure in US history “hit the tape,” traders chased the safety of, can you guess, Treasury bonds! And at a speed I do not remember seeing in my three decades of trading those pigs.

In two and a half trading sessions, money markets went from pricing 5.50% overnight Fed Funds rate for the end of 2023 to 4.00%. Longer-term Treasuries fell in yield by 1%. SVB's panic sale of billions of dollars of US Treasuries sparked the most panicked buying spree of Treasury securities ever. Now that is a plot twist.

My readers know that my central macro theme since early last year when the market began to figure out that the Fed would start raising rates: Equities are not an attractive asset class in an environment of higher rates and a slowing economy.

Although there have been periods of decorrelation, in general stocks have traded down because of lower bond prices and higher yields. Now that bond prices are rising and yields falling, not because of receding inflation, but because of rising systemic risk, stocks have decorrelated in the wrong way, falling in the face of rising bond prices and lower yields.

Down if you do, down if you don't.

Last week, the S&P, currently trading at 3870, sliced through its 200-day moving average (the blue line below) at 3950 without any supporting actor or actress. As discussed last week, this is a significant technical sign that the trend to lower prices is back. Volatility spiked from depressed levels, with the VIX index up from 18.50% last week to 24% on Friday and touching 30% Monday morning.

During the two years of the forty-year bullish bond cycle, it was difficult for anyone (especially myself) to watch risky assets appreciate and not partake profitably in the millennials’ madness. Whether it was Tesla or Bitcoin, millennials and their little Gen Z brothers and sisters made huge paper profits borrowing cheaply or using government handouts to watch their investments go, as Elon Musk put it,  TO THE MOON.

I often and enviously read their posts and watched their videos. Often, they would sign off with "YOLO."

I had no idea what “YOLO” meant. After all, I am a boomer, a dinosaur stuck on the set of Jurassic Park, or even better, on a drawing board of a Flinstones episode. So I googled it.

YOLO means “You only live once."

In a market with bank failures, historic bond volatility, and geopolitical risk, I say,

YODO. "You only die once."

Does this sound like the title of a new James Bond movie?

Forgive the pun and preserve your capital.

Cash at 5% is king.

The next post will focus on the Fed's measures to insure uninsured depositors nationally. It will be titled: "Everything, everywhere, all at once."

Regards,

David, the wolf of wall street, lower case