Treasuries Blow Out: We don’t agree

By: Uri Estrin - October 22, 2020 03:21pm EST
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Over leveraged borrowers and corporates already showing signs of distress
Over leveraged borrowers and corporates already showing signs of distress

Yields on long dated Treasuries have climbed over the last few sessions. The markets are nervous all round – especially with on again, off again stimulus promises. But such angst is misplaced, in our opinion, towards the long term outlook for Treasuries, rising yields nothwithstanding.

MacroTOMI has written prolifically about the inherent risks in the economy and a recurring theme is just how over indebted and over leveraged the world economy is right now – it’s unprecedented. This has been predicated by the access to cheap and available debt.

What keeps debt cheap and available is falling yields. As we recently wrote – Debt is like NYC Tap Water:Cheap and Plentiful – the ever flow of cheaper and cheaper debt means the game can continue. The Fed knows this too well, which is why it’s become a current compulsion to ensure rates trend lower and lower – which is also why we believe the Fed will back itself into a corner and rates will ultimately go negative.

One of the current market sentiment that is tarnishing Treasuries and blowing out yields is based on a ‘blue wave’ that would control not only the Presidency, but both chambers too. This, it is beleived, would unleash a massive amount of Fiscal Stimulus, the likes unseen, precipitating into inflation or stagflation – depending on whether you believe the underlying economy improves or not.

We have written about this too – no inflation, no stagflation, yields and bonds. While we agree, we could get a bump up in short term transitory inflation – price increases (which we’ve also previously written on) unless the Stimulus is in the immediate and of a $10T plus region – the enormity of the economic damage is far too great to seed long term robust economic activity. We’ve seen in Europe – with Furlough programs and up to 90% of wage payments made by governments - and now minimum income programs in Spain – but all the fiscal stimulus hasn’t warded off deflation. Inst other words, it still isn't big enough to create inflation against a struggling economic backdrop.

But let’s say the stimulus is big enough and the markets react violently and negatively towards Treasuries with a huge spike in yields – where does that leave an economy so addicted to cheap debt? It’s inconceivable that Treasury yields spike but corporate debt remains at current levels. It’s also inconceivable that mortgage rates don’t balloon in tandem. So higher Treasury Yields brings higher borrowing costs across an economy that isn’t able to sustain even at near zero rates. (If it was able to sustain, we wouldn't need more stimulus - right ?).

It would push zombie companies, over leveraged borrowers and corporates already showing signs of distress into a very difficult predicament. How analysts predict stagflation is a scenario where companies are going bankrupt and creating a supply shock while consumers are so flush with stimulus money in their pockets they are chasing too few goods. Yes – with enough stimilus we may get to that point (highly unlikely)– but it would have created such an economic distortion that that too would be unsustainable and short lived.

We believe there are no good options. Big stimulus, small stimulus, no stimulus – blue – red – doesn’t matter. We are in extraordinary times with an economy that was due for correction before any of this. To me its clear, long term, yields can only go down – that’s why i’m heavily positioned in long dated Treasuries and TMF.


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