What is the Treasury Market Telling Us?

0:00People are going to lose their minds. This is a moment in history unlike anything humanity has gone through. It's a very different world for humans to come. Take a step back and see the broad picture, which is the way all these technologies are interlinked. Because this is all about exponentiality, and humans can't think in exponential terms. How consequential do you want to say machine intelligence is? It's almost certainly as consequential as writing. How long did writing take to disseminate through the human population? You know, hundreds, thousands of years. And we're dealing with it now on a scale of months.

0:33But in this kind of world, you're compounding 100 % growth every year, and the numbers become astronomical. AI is going to spot patterns in the world that were just completely invisible to us. Even if you think that the AI and the robots are your demise, you might as well bloody invest in them and make some money out of it. If not, you're just going to be angry man shaking your fists at the clouds.

1:09has jay powell doused the rally welcome to real vision daily briefing it's thursday november 8 2023 i'm ash bennington i'm joined today by warren pies co-founder of 314 research warren welcome great to be here thanks for having me warren i teased it a little bit at the top of the show obviously we got a little bit of news flow let me just catch folks up here a little bit and see sort of tee it up. And this is a quote directly from Jay Powell, quote, the Federal Open Markets Committee is committed to achieving a stance of monetary policy that is sufficiently restrictive to bring down inflation to 2 % over time.

1:45We are not confident that we have achieved such a stance. If it becomes appropriate to tighten policy further, we will not hesitate to do so. We will continue to move carefully, however, allowing us to address both the risk of being misled by a few good months of data and the risks of over tightening. Here's what's happened after that bit of suasion from the chair of the Fed. We got the Dow off about, call it a little over half a percentage point. S &P 500 trading right now at the end of the day at close, 4 ,347 off about eight-tenths of 1%. NASDAQ off almost a full percentage point down to 13 ,521.

2:26Russell 2000 taking the worst beating off over 1.5 % to 1 ,686. We got some moves on the 10-year Treasury. Yields jumping about 13 basis points. Warren, that's the backdrop on this day from commentary from Jay Powell. What's your thoughts, big picture? Where do you think we are right now? Well, I think it's big picture, all one big trade. And rates are driving everything. They're driving everything. They drove the sell-off in Q3. They've driven the rally that we saw post-Treasury QRA announcement. And I kind of think that's the regime we're going to be in for a little bit here. And you started the show by saying that did Powell douse the rally?

3:11And I would wonder if we could add in did Yellen douse the rally today? And was that really the cause? Because I think it's really about the Treasury auction that didn't go so well today and the fact that this is - Explain that. Jump in and give us a little detail about that for people who aren't following the bond market as closely as you are. Well, I mean, the big picture on the bond market is that there is a lot of issuance. And that's what I think you really need to go back to. We had an auction today.

3:42They're veteran bond watchers, people who watch the bond market more closely than I do, get detailed into the auction results. And we've tried to model this before a little bit at 314. And traditionally, auctions are kind of, unless you're trading a specific bond issuance before and after that auction and doing things that, quite frankly, us and our clients are doing, then they don't really make it onto your radar screen. But in this new era, I think things like last week's QRA announcement from the Treasury and today's huge 30-year bond auction, which I don't know if you're grading it, you could grade it as a D because at least it cleared.

4:20But by almost every metric that any bond veteran follows, it was a poor auction. There was really just a lack of demand, and dealers took down a big part of it, and however you want to slice it. And I just think that's the near term. That's the news of the day. But the real story is what the Treasury said last week, which is we have a huge funding hole about in our estimate at 314 research is about$2.5 trillion annually, as long as QT is going on that the Treasury has to fill. And last week, Yellen said we're going to fill that hole with about 43 % coupons. So that's long-term debt that pays a coupon.

5:01That's a pretty low number. Historically, we can get into that. And that gave the relief. Well, we're talking about just that. Let's bring up those charts, because I think one of the great things about having you on today, Warren, is that you can talk about what's happening in the news cycle, but you have a longer-form, detailed thesis about what's been happening on a longer-term basis. Let's bring up those charts. We've got two good ones that refer, I think, exactly to the points you're making. There we go. Yeah, so this is really setting the table exactly what I was talking about. So this is the what's the big picture that's sitting on top of us where you can get down and lose yourself in the details of an individual bond auction that didn't go well.

5:38But the big picture is this chart right here. This is total Treasury debt not held by the Fed. So you can call it private sector treasury debt held and how much it's increased over the years and how much we see it increasing going forward. And whenever the Fed does QT, where they allow their balance sheet to bonds to roll off their balance sheet, it's putting pressure back onto the rest of the private sector. So it's putting pressure onto the banks, onto pension funds, onto foreign governments, onto hedge funds, onto households. These are the people that have to pick up the slack when the Fed does QT, which is$720 billion a year of an additional hole on top of the deficit that we're running and the United States on the fiscal side.

6:25So this is a huge hole. And this is what Yellen is charged with covering. She has to navigate this world and decide how many bonds is she going to issue? How many bills is she going to issue? What's the auction size going to be at different tenors and things like that? it becomes a much more interesting world for the Treasury once the Fed steps out of the bond market and you have this kind of a deficit to fill. And so, as I said, our estimate is$2.5 trillion whole over the next 12 months. And as long as the Fed's doing QT, you go by CBO numbers, anything like even any official number, that looks to be about right,$2.5 trillion.

7:04ED HARRISON So what you see on the top there is the total private sector Treasury debt. And then what you see at the bottom is your analysis, your estimation of the hole, essentially, that Treasury has to fill. And you can obviously see what the trend looks like there going back to call it about 2021, the beginning of the unwind of QE. ED HARRISON Right. In the top chart, the top clip is the stock of debt. So we have by, you know, we're going to hit 24 trillion of Treasury debt held by not the non Fed Treasury debt. That's what the top clip showing in the bottom clip is kind of a flow. So it's stock on the top, how big is the pie?

7:47And then how is that pie going to grow? And I think that the number just to spin it forward and to play into what happened in markets today. And what really matters is how much we're looking at total non-Fed debt issuance. The real issue is how much non-Fed coupon issuance will the Treasury try to push into the market next year and in the years that follow. I think that's the number. That was the number last week that the Treasury announced that sounded pretty low, honestly, and allowed this relief rally. And then today's huge 30-year bond auction that didn't go well kind of pulled that issue back into the market's psyche and reminded us all that, yeah, we got a reprieve last week.

8:34Yellen basically said, OK, we're not going to put the max pressure on the bond market, but there's still a lot of issuance. I don't think this issue is going away is the bottom line. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

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9:54or that's so well said and obviously these are complicated questions that we're sorting out here brian if we go back to the first chart let me tell you how i think about this and it's kind of just a kind of a mental trick that i use to explain it to myself and when people ask me so i think of when you mentioned stocks and flows which i think is probably one of the most important concepts in economics. It can sound a little bit complicated to folks who are new to it. But a really simple way to think about this is if you just imagine a bathtub, the level of the water in the bathtub is your stock.

10:22The faucet is your inflow. The drain is your outflow. What you're looking at there is the level of water in the tub. That's the total debt outstanding. That's the purple line you see on the top of the chart. And the bottom line, what you see is the inflow of new debt into the system. So that's essentially the rate at which the bathtub is filling up. That's what you got on top. Yeah, it's a great way of mentally picturing it. And I would agree with it. It's just we're filling that bathtub up right now. And it's going to keep we're going to keep pushing water into it. To use your analogy over the next few years, I don't see any way out of it.

10:54So yeah, and like and like a bathtub, this is a bit of a stretch on the metaphor, but like a bathtub, you know, when there's an inch of water in the bathtub, or when there's six inches of water in the bathtub, maybe you don't notice it. But you darn well do notice it when the bathtub overflows. Exactly. It's spilling out onto the floor right now. All right, let's go to the second chart, Brian, because this talks about the coupon issuance, the debt mix. Warren, talk a little bit about this. Explain these bills versus coupons. This is about the nature of the debt structure itself, the term, the tenor, and whether they're interest-bearing or non-interest-bearing.

11:30Right. Any kind of debt-to-treasury issues that's 12 months or less is a bill. And so that's by definition, there doesn't pay a coupon. It just matures at par. And that's kind of why we say coupon versus bill, because everything else pays a coupon interest payment. And so that's just by the way, if you're wondering how that works, how you could get something that doesn't pay a coupon, it's because it's issued as a discount on face. So if you get if it's like you buy something that's worth a buck for 98 cents, you redeem it at the end for the dollar. That's how you essentially simulate a coupon payment without paying out a periodic rate of interest.

12:05Precisely. And so it's a shorthand way when we talk about coupon issuance of getting that duration. And in our view at 314, the thing that I've said to clients for years, really going back to the years ago when QE started after after COVID, is that our view of QE and QT now is that it works through the duration channel, that you're either pulling duration out of the market via QE or you're potentially pushing duration into the market via QT. I mean, a lot of people looked at these Fed balance sheet operations and focused on reserves and liquidity and things like that. And I think that side of it is overstated as far as an impact on assets.

12:47But from my point of view, if you're pulling duration out of the market, you're pulling down risk premiums, you're bidding up assets in general. If you're pushing duration into the market, then you're doing the exact opposite effect. You're causing risk premiums to blow out, and you're discounting risk assets. And so if you keep that kind of framework in mind, that the most important factor here in Fed balance sheet policy is duration, then we want to look at coupon issuance. Because when we start doing QT, where the Fed is letting the balance sheet shrink and bonds roll off their balance sheet, it passes the baton back over to the Treasury.

13:27And the Treasury now gets to make the decision whether they actually push duration into the market. So just to reiterate, there's$720 billion rolling off the Fed's balance sheet every year due to QT. Janet Yellen and the Treasury could, at this point, decide to either issue a bunch of bills, short term debt, which wouldn't have much impact on the duration channel we're talking about, or they could decide to fill it all back up with duration coupon issuance. And so that goes to this chart. It goes back to what happened last week, where ultimately the Treasury announced this funding split that they saw going forward.

14:08And their funding split was 43 % coupons, 57 % bills, which is actually a historically low number of percentage of coupons, which is why, in our view, the market rallied. Why you saw long bonds yields come down. You saw asset markets, which have been selling off, begin to rally because that was the Treasury saying we're not going to put the pressure in that duration channel. But you can see, if we go back to that chart for just a moment, you can see that even with this Treasury backing off, and they've been trying to hold back duration, that non-Fed coupon debt is creeping higher. And so to me, that's the number.

14:55And that goes back to today. Like, what does that look like in reality? It looks like much larger auctions over time that have a bigger, a larger chance of going belly up like the 30 year today. So that's how you take that. What is all this arcane academic T-back funding stuff? What does it look like in reality when it causes stock market to sell off? It looks a lot like today. That's what happened today, is that the market had a hard time digesting a big slug of supply. And if you're an equity investor, you've got to look out and say, there'll be more days like this, more likely than not. Yeah, Warren, that's so well said.

15:34And thank you for bringing it back to equity markets. Talking of which, I want to pivot to the third chart here. Because I know when folks are listening to this, they may say, well, listen, this is really interesting. But I don't really follow the institutional stuff. I don't really follow fixed income. Let me show you why this all matters to you if you're interested in equity markets. And this is just an incredible chart. This is the 10-year Treasury versus market breadth chart. Let me just give you a little bit of information if you're relatively new to this stuff. So you got the NASDAQ 100.

16:04These are the largest cap stocks in the NASDAQ, up on a year-to-date basis, 39.8%. Call it 40%. NASDAQ 100 up on a year-to-date basis, nearly 40%. S &P 500 year-to-date basis up a little under 14%. Here's the killer. Here's the thing that should make you question what you think about these markets. S &P 500 equal weight index down over 1.5 % on a year-to-date basis. That sets this up brilliantly here to talk about what's happening in terms of market breadth. Yeah, so this chart was one of ours from a recent report. And we're basically trying to understand what's driving the market. And just like you said, it's been a tale of two markets, where you have mega cap tech causing broad indices to do one thing, and then under the surface, things like equal weighted S &P, Russell 2000, moving a different direction.

17:01And so I think that detecting market breadth and how it moves is really important to telling us what's driving the market at any given time. And so this chart goes back to what I think was really a tale of two markets. So we had early June when the May jobs report came out, which was a plus 300 ,000 jobs report. That's the first red vertical line that we got there. And that report came out. The market rejoiced because it said, you know what? There's no recession coming in 2023. We can bid up not just the big cap tech stocks, but everything. And so on the bottom clip, that's the percentage of stocks above the 200-day.

17:38That number ramped higher. The market ramped higher. We peaked at the end of July at like 4 ,600 on the S &P 500. But we had broad participation at that point. The rally looked legitimate when you look at it on a breadth perspective. Then we had this Treasury issue come into play. That was the first time we saw the market really pay attention to that was back in the end of July, beginning of August for Q3, Q4 funding announcements. And I'll leave that for right now. But then we got another September. Back in September, we had another jobs report that was positive. We had an initial blip in breadth, but that faded.

18:19And what we've really seen since that time is that economic data is not driving the market. It's not driving breadth. What's driving breadth at this point are rates. And what's driving rates is all this issuance stuff that we talked about for the first 15 minutes of the show. So you're going to have to honestly be, I think, get into the weeds on the bond market and this issuance stuff if you want to have an idea of what's really driving the markets, It's what's really driving breadth. If you're in the markets, you need to, I think, and you want to see new highs or hit the highs from earlier this year, you need the breadth to expand.

19:00You need more than just those top seven stocks to participate. In order to have that, at least in recent history, that means you're going to need rates to calm down. And so that's why a day like today, when you have a bad bond auction, rates spike, is so important, I think, to this regime that we're in. It's all one big trade right now. So important, such an important point, understanding the integration of what's happening in a holistic way. Monetary policy, fiscal policy, fixed income, stocks, it's all connected. talking of which I wanted to take a look at a conversation between Alex Campbell and Andreas Steno-Larsen here on the Real Vision platform that aired yesterday that talks about the 60-40 portfolio split.

19:42We're going to get your analysis on that when we return, if we could take a look at that. Yeah, I think the 60-40 portfolio will be okay after this rip. I think people aren't counting how many, what I say is like how many bonds are in the stocks, right? There's bonds in the real estate, there's bonds in the banks, there's bonds in the stocks, and the bonds just got murdered. And so, yes, Powell could go to seven and treasuries could go to seven. You might lose another 200 basis points, but it's probably not going to 10. You know what I mean? It can't really go to 10 without the whole thing exploding.

20:16So I think at a certain point, bonds are going to be a great buy. I don't know if they're as much of a buy as maybe other people because I'm a little bearish because of this inflation and conflict theme. But I think that what you really saw as a challenge to people wasn't even necessarily 60-40, it was risk parity. The last two years was a huge challenge for risk parity, because risk parity is essentially the idea of you have too many stocks, you need to go buy up more bonds and lever them. And how did lever bonds do just now? Not that good. So you have this kind of dynamic where even in beta portfolios, investor psychology in and out of these themes really drives a lot of this.

20:55Alex Campbell there with Andreas Steno-Larsen. Maybe the most important point that he makes during that clip, Warren, maybe the first sentence, I think the 60-40 portfolio will be OK after this rip. Any thoughts or are you a little more skeptical? I'm more skeptical. There's a nice little debate that kind of takes place, is the 60-40 dead? And it seems to trigger a lot of people when you say the 60-40 is dead. So instead, what I'd say is the negative stock bond correlation that's been with us from 1998 to 2021 is dead. And that's going to increase the volatility and drawdowns of a 60-40 portfolio.

21:34That would be the way I'd say it to trigger fewer people. But that is a long-winded way of saying the 60-40 portfolio is dead. And so that's my take on it. He's right there. are bonds in the stocks, that's just another way of saying these things are going to move together, that bonds control asset markets. And that's going to be the way that markets work for the foreseeable future until we bring a recession into view. And at that point, you'll see more of bonds cushion stocks. But until then, bonds are going to push stocks around. It'll feel good when rates go down, bonds are going to rally and stocks are going to rally together.

22:15But that's not the kind of price action you should really be celebrating if you're a traditional 60-40 investor. You want a low correlation world, not a high correlation world. And that's the point we've been making. And I think the price action of second half of 2023 has really confirmed that view of ours. And by the way, that thesis, if it plays out, is precisely why retail investors need to understand the points that Mr. Warren Pies is making here about these correlations. between fixed income and US equity markets and the broader macro thesis, which involves not just the monetary policy aspect of it, but also the fiscal side.

22:55That's why all this matters so very much. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing.

23:10Warren, we've got a lot of questions coming into us. You want to jump in and start grabbing these? Sure. Yeah, fire away. Here's one that comes to us from Joshua S. from YouTube. Could all of this have been avoided if they didn't kick the can? If so, when? 2020, 2015? Maybe 2008? Josh is essentially asking you here, what's the moment when everything went irretrievably wrong? that we could rewind back to and fix things? Well, I want to try to be optimistic. And there's always a path that things work out just fine. And I could construct that path. But if I had to go back and say, when did things get kind of nutty?

23:51It would definitely be COVID. We increased total treasury debt outstanding over those COVID years by$9 trillion. It was a 50 % increase in a few years. I haven't really ever seen that before going back through time. And I think that, to me, is going to be the point in time that we all point back to and say this marked the end of an era. It changed asset markets and the economy and things forever. So in other words, we could have gotten through not just the global financial crisis, but the policy solutions to the global financial crisis were it not for the response to COVID. Yeah, I mean, that's my personal belief, which it gets a little bit political.

24:33But my honest belief is that we didn't stimulate, we didn't provide enough fiscal stimulus coming out of the GFC. And then we provided way too much and COVID. And so there is like, you know, MMT, I think they had it right coming out of GFC. And it doesn't mean that their policy prescriptions are right. It means that they were correct that the Fed was basically pushing on a string and we needed fiscal to come in and push the economy along. But, oh, my gosh, what we did during COVID and the way we did it, I think was, I mean, disorderly would be an understatement. Yeah, it sort of reminds me of the old military axiom that generals always fight the last war.

25:16You wind up overcorrecting for the mistakes that you made on the backside. and you make the mistake in the opposite direction the next time around. And a great question, Joshua, really. Here's one from TrillionXMacro. Another great question. Warren, what do you make of the pullback in oil price? Is it an opportunity to add on that sector and commodity? I guess the flip side of that question. Or is it an index of what's to come in terms of declining aggregate demand? WTI on my screen right now, 75.54. Yeah, we're out of the oil trade for right now. And I think that it's basically we're caught up in a speculative cycle when this happens in oil.