5.29.13 futes

Originally: Look Out Below, Spiking Yield Edition

I am working on a longer piece today on how to invest after big rallies, but I had to address the increase in yields we are seeing this month:


10 Related Factors, Issues and Concerns Regarding Yield Increases

1) Large bond portfolios (think PIMCO, DoubleLine, etc). are getting out of the way in advance of Fed tapering. You can debate if they are early or not, but it is what it is.

2) Watch the impact this has on credit driven purchases: House (especially) but also Autos and CapEx.

3) The pop in home prices is more a function of constrained supply than excess demand. With by some estimates 43% of mortgaged properties either having low, none or negative equity, a big source of traditional buyers (and therefor sellers who put inventory into the RRE market) are missing

4) Given the big run in equities so far this year — up 16% before Q2 even ends — we should expect to see some corrective action. This suggests backfilling, shallow selloffs, lack of forward motion as gains get digested.

5) Is this the end of the cyclical bull that started in March 2009? Its too soon to tell. We continue to give the rally the benefit of the doubt, but we watch the internals for signs of significant breakdowns.

6) Eventually, higher yields are a competitor for stocks. (That’s not what the case is at 2% 10 year treasuries). However, upticks in borrowing costs will also affect corporate profitability — and that will impact not only earnings but the psychology underlying P/E multiple expansion.

7) Please use some context: Yields have moved up from the absurdly low level of 1.5% to 2% after a 30 year moved down from 17%. Some people will scream that “yields have skyrocketed 25%” (but these are the same folks who have been yelling POMO! POMO! POMO! for 146%). Its just as silly to claim that yields have retraced only 50 bips of the 1400 basis point move.

8) A better context is to note that yields have backed up 1/2 percent from the lows, and that will affect economic activity, earnings, and psychology in ways we may not fully recognize yet.

9) Yields go up for 3 reasons: a) Fed tightening, b) higher inflation, c) increased demand for capital.

10) That last point might be the most overlooked: Increased demand for capital. If that is what underlies this move upwards, than it would be a a positive sign for the economy and equities, and (surprisingly) not a negative one. We simply do not know which yet.

More on this later . . .

Note: Bloomberg Futures don’t seem to be updating so this morning we used CNN’s.


Treasuries exhibited some relatively sharp moves
Source: FT Alphaville


Category: Fixed Income/Interest Rates, Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

31 Responses to “10 Related Factors, Issues and Concerns Regarding Yield Increases”

  1. Rightline says:

    Here is a major front page contrary indicator from USA Today…..


  2. Gonzop says:

    i like your angle Barry :D

  3. george lomost says:

    I don’t get 9c “increased demand for capital.” We have repeatedly been told that companies have more cash than ever and central banks are flooding their economies with liquidity. How would increased demand for capital move the needle?

    BTW the last few times you have begun the morning with “lookout below” it has been followed by higher end of day closings. Let’s see if it happens again today.

  4. Mike in Nola says:

    Random thoughts:

    Lots of contradictory stuff going on in a world dependent on QE:

    While QE is in effect, get a wealth effect, rates rises in anticipation of recovery, QE ends and economy crashes and rates go back down til new QE is announced.

    Yesterday, both the Richmond and Dallas numbers were negative but ignored. Yeah, it’s noisy, but everyone claims things are booming.

    PIMCO has always been so right about Treasuries :) Gross can move the market short term because of his size, but he’s mostly been wrong.

    Low interest rates have fueled stocks and housing bubble 2 (despite BR’s tweet which only compared current rises with depth of crash and not long term numbers) with attendant wealth effect. If rates rise, what happens to those? Where will the flippers and PE get the capital to keep housing up? Lots of talk about how the big money that’s been buying houses has plans for ipo’s and selling interests to pension funds. If housing levels or declines, how will they do that?

    What happens to junk bonds and corporate issuance, which have been filling corporate coffers?

    BTW. read yesterday that some of the PE firms are now planning bond issuance so they can pay the insiders big dividends. I’m sure those buyers will be happy.

  5. Old Rob says:

    Regarding #3 and #10, in eastern MA I am seeing 30% to 50% price increases for previously owned homes from the ‘investors/flippers’ as well as from long term owners looking to ‘get out’.
    What happens when the investors leave.
    There are lots of new homes put up in the recent euphoria (some early ones sold) that are now sitting idle for a few months. Is this the ‘burp’ in RE or a pause?

  6. Concerned Neighbour says:

    Re: #9, I believe “risk” should be added as a cause of increasing yields. The Fed and others have tried their best to make every asset go up (see junk bonds yielding below 5%), but if they ever step away people may rediscover that there is in fact risk involved in the act of investing.

  7. Pantmaker says:

    This is certainly the discussion to be had for our current situation. well done. one more thing…the investors in “safety” bond funds are going to freak the fuck out when rates really start to climb and the funds all start to take principal hits.

  8. Super-Anon says:

    > The pop in home prices is more a function of constrained supply than excess demand.

    I think what’s going to be important here is that the constrained supply is “artificial” in the sense that the foreclosures are being bought up by speculators and placed on the markets as rentals. Ultra-low mortgage rates are stimulating tons of speculative front-running of the housing market. So there’s still a lot of housing out there it’s just not showing up in the pipeline in a traditional way, though at some point I think you have to expect it’s going to get dumped back in to the resale market, probably at the worst possible time.

  9. constantnormal says:

    If we look on the (somewhat) bright side, and assume that Congress and the White House table their efforts to further shrink the US economy — what the hell, so long as I’m fantasizing, why not say that a modest amount of the money being wasted in Afghanistan is redirected into infrastructure — perhaps the struggling economy can struggle less and grow more, which would allow Bernanke to wind down QE (if that is really possible).

    That is certainly going to toss some serious gravel into the gears of the stock and bond market rally … so where should one be looking to move money? Into foreign investments? There are not very many that look attractive — fewer and fewer all the time, IMHO — but there are surely some things that would beat burying money in mason jars in the back yard …

    Ideas, anyone?

    • Mike in Nola says:

      You really are a dreamer :) What are all those defense contractors who contribute so much to Congress and employ so many ex-defense people gonna do if we stop warring? Profits are too high to give up easily.

  10. ZevCapital says:

    You are 100% right about capital demand. The “uncertainty bubble” of the last few years have stopped companies from spending on capital equipment. They have not been investing and, just like housing, there is a ton of pent up demand. It is one of the reasons why I can’t wait for the market to flush out all these weak hands so I can buy.

    • rd says:

      It’s not uncertainty.

      Its just lack of demand due to tapped out consumers with rising un- and under-employment, reducing disposable income, underwater home values, and sky-rocketing debt loads.

      Once those go away, the uncertainty will disappear pretty quickly.

      • ZevCapital says:

        I was referring the the whining and crying about “uncertainty” in 2011 and 2012 (notice quotes). Life is uncertain, that’s why they call it risk taking.
        Many companies talked about political uncertainty regarding “sequester” and “fiscal cliff” and sat on their collective asses instead of investing during record low borrowing rates. They would also only hire people who matched their needs perfectly instead of hiring good people regardless of background. Maybe it would be better to call it “the cult of uncertainty”, in honor of BR.
        Some companies understood that risk is part of the game. Some didn’t. We’ll find out the winner and losers over the next few years.

  11. Willy2 says:

    Rising interest rates will be the most profound shock for the entire financial system. The US economy has adapted to rates going lower and lower over the past 32 years. EVERYTING credit/debt related will feel that shock as well. Not a pretty outlook going forward.

    I believe we could see a drop on the 10 year yield to about 1%. I consider that to be the final low of the 30+ year bull market in T-bonds. And after that, I believe, the US bond market is going “to hell in a handbasket”. And that will be a humbling experience for the spendthrift politicians in Washington DC.

    What will be the most surprising thing to watch is that WHEN US rates go higher it WILL be confirmed with a rising USD(X).

  12. rd says:

    The 10-yr T-bond hit a similar yield low in about 1940. It took about 20 years to move back up to the long-term median/mean 4%-4.5% range of yields. It took another 20 years to spike to the 15% 1981 peak. It has taken 30 years to drop down to these low yields.

    Big moves, like we see regularly in the stock market, don’t happen fast in the T-bond market. Too many big players hold them until maturity (banks, insurance, nations etc.). I expect the Fed taking the foot off the gas pedal will raise yields some, but I don’t think we will see median values 4% until household formation has increased significantly, unemployment rates has dropped a couple more points, and labor participation starts to rise again.

  13. Super-Anon says:

    > There are lots of new homes put up in the recent euphoria (some early ones sold) that are now sitting idle for a few months. Is this the ‘burp’ in RE or a pause?

    It’s interesting that in my market prices haven’t really rebounded at all but liquidity has come back. And just the return of liquidity has stimulated the homebuilders in to putting up tons of new subdivisions — they don’t seem concerned about flooding a market that is already saturated so long as they can make a profit.

    I have a number of co-workers who are complaining that they’re waiting for home values to come back up because they’re underwater and want to sell but now homebuilders are spamming out new houses next door to their underwater property and keeping the values down.

  14. TizzyD says:

    Mite have missed another catalyst for higher yields (#9). Declining credit quality.

  15. Willy2 says:

    “Inflation pushes interest rates higher”.

    Another myth that simply won’t die. See e.g. the 1970s. Yes, during the 1970s both (commodity) prices & interest rates went higher. And all the inflationistas & monetarists (e.g. Milton Friedman) use that as the proof that (price and/or monetary) inflation pushes interest rates higher.

    But those same folks fail to provide an answer why in the timeframe from 1981 onwards rates went – on average – one way only: Down(wards). In spite of rising inflation (taxation, food, energy). Remember when oil went from $ 20 in 2001 up to over $140 in mid 2008 ? But in that same timeframe, rates went – on average – lower. The inflationistas are crying “Conspiracy” !! Even bright persons/deflationistas like Robert Prechter & Hugh Hendry fail to provide a good answer for those falling rates after 2000. The only person who provides a good/satifactory answer for this rates conundrum is Gary Shilling in his excellent book “The age of Deleveraging”. It all boils down to “Demand & Supply”. Nothing more & nothing less.

    • Willy2 says:

      Gary Shilling already predicted in the late 1970s (1978 ?, 1979 ?, 1980 ?) that there was a “bull market in T-bonds of a lifetime” coming. He predicted that rates would go lower and lower over an extended preiod of time. He even wrote a book about it in those days.

  16. RW says:

    After deemphasizing it for years, unemployment now appears to be a key metric for the Fed and that means tapering QE is still some distance off albeit on the horizon: I’m thinking 1Q, 2014 at the earliest if current trends hold but, Tim Duy, who sure knows a lot more about macroecon and the Fed than I ever will, thinks it could be as early as this 4Q.

    More Fed – It Never Ends

    Bottom Line: Assuming current data holds, the beginning of the end of QE is coming. But not immediately. Maybe three meetings out in September assuming that the impact of fiscal drag remains largely contained to the GDP data. The Fed does not want us to jump to conclusions about future policy moves based on that initial shift. But I am hard-pressed to see a forecast that would allow for up-and-down moves once the Fed pulls the trigger. Up-and-down moves cannot be their expected policy path.

    NB: Improved employment picture implies the economy will be considered strong enough to waddle along a bit more on its own so capital will be moving out of cash and bonds. I await the event with some anticipation as there will doubtless be many folks married to the CW that rising bond yields are invariably a bad sign and will trade accordingly (figure they’re out there since each uptick in yield generates news but downticks virtually never make it past the back data pages).

  17. b_thunder says:

    “5) Is this the end of the cyclical bull that started in March 2009? Its too soon to tell.”

    Ok, that cycle is certainly important, but it’s not the one that worries me most. I’m much more worried about the 30+ year bond bull market. Is it over? Or this is just a pause and we’ll relapse in Japan-style sub 1% rate environments for another decade? If bond bull is over for good, IMHO, the governments and central banks are in a heap of trouble: if the markets sense that the FEd/BoJ/ECB have to print and buy bonds to defend the low rates as opposed to ending deflation, there will be hell to pay. In fiat money anyway.

  18. RW says:

    IOW Rate Stories

    …several alternative stories that might explain what’s happening in one market, and then ask what those stories imply for other markets.

    So when long-term interest rates rise, there are three main stories you hear. One is that the bond vigilantes have arrived, and are selling US debt because they now believe in the horror stories. Another is that the Fed has changed, that it may be ready to snatch away the punch bowl sooner than previously believed. And the third is that the economy is looking stronger than expected, which means that the Fed …will …start raising rates sooner than previously believed.

    All three of these stories would imply falling bond prices, that is, rising interest rates. But they have different implications for other markets, in particular for stocks and the dollar. …Here it is in a table: [img].

  19. swally says:

    Dear Mr. Ritholtz,
    Could you please explain/elaborate on your statement:
    “1) Large bond portfolios (think PIMCO, DoubleLine, etc). are getting out of the way in advance of Fed tapering.”
    What actions are being taken by Pimco, Doubleline, etc., and what are the effects for investors in these ‘bond portfolios?’
    Thank you

    • Joe Friday says:


      On yesterday’s Nightly Business Report, PIMCO’s Mohamed El-Erian said they were “walking away from risks”. “We’re not running away, we’re not sprinting away, because central banks are committed, but we’re walking away”.

      Asked what categories of ‘risks’ they we’re walking away from, he responded:

      Stocks and high-yield bonds”.

  20. Apropos of #3, “With by some estimates 43% of mortgaged properties either having low, none or negative equity, a big source of traditional buyers (and therefor sellers who put inventory into the RRE market) are missing”

    I think if folks think that through for an extra five seconds you’ll realize that someone selling one place to buy another is NOT a source of net supply for the market.

    The sources of marginal net supply are (a) new construction less demolition of older buildings, and (b) foreclosures. I think Construction is not up that much yet, and Foreclosure processing has slowed recently. The marginal net demand comes from (a) net household formation and (b) speculation (both buy-to-rent and flipping). Net household formation is perhaps coming out of the doldrums, and we know there is a fair amount of speculative activity in a number of regional markets.

    In terms of interest rates, there’s a possible transmission channel which goes like (1) rising house prices enable marginal underwater owners to refinance at lower rates, and attract flippers, causing (2) demand for mortgage credit to increase, resulting in (3) yields rising. However, refi applications are way down in the last few weeks (Calculated Risk), so this demand doesn’t seem strong enough to drive rates higher in any sustainable way.

    I also don’t see net Federal demand for credit driving yields up.

    Personally I think there’s some substance to the Japan spectacle and its impact on global markets. Bond portfolio managers are far less fond of volatility than stock fund managers.