The One to Watch 

In the face of ’no news’, we have seen a continuing rise in long term treasury bond rates (and decline in bond prices). This week, markets were squarely focused on the potential for this trend to continue that sent stock prices reeling once again, putting a crimp on diversified portfolios. So why are long term interest rates rising so much? There are several structural economic changes that are either inherently inflationary or tend to create an oversupply of Treasuries, each of which will tend to drive interest rates higher.

Inflationary Trends

• Deglobalization: Bring supply chains back the US or to other friendly countries will tend to increase costs. Deglobalization focuses on  secure suppliers, not the lowest cost suppliers.
• Increasing power of labor over capital: Unions are becoming more aggressive and are winning larger contracts. That increases costs.
• Green Energy: The transition to green energy is massively expensive, again adding to the core cost structure of business
• Rising oil prices: What draws attention here is that other key commodities (copper, steel, nickel) continue to trend lower. The rise in oil appears out of character. The reality is that despite what you may read, oil and gas is not going away anytime soon and a haphazard (at best) transition to global green energy is choking off the investment needed to bridge the gap to clean energy. OPEC reducing production and U.S. inventories at Cushing near tank bottoms doesn’t help the situation. This is the one to watch. If any of these can significantly impact inflation expectations over the next 6 months, this is it. The Fed likes to focus on core inflation (ex-food and energy) but if higher oil prices are structural, it will be very hard to keep inflation down. Energy prices eventually affect everything.

Supply/Demand Issues

• China/Japan are less interested in buying US Treasuries: China and Japan have traditionally been significant buyers of US Treasuries. China is now reducing their Treasury holdings for political reasons (they want to limit their exposure to possible US sanctions) and Japan is also reducing their holdings because Japanese rates are beginning to move higher, making US Treasuries less attractive to Japanese investors.
• Mounting US budget deficits need to be financed: This forces the Treasury Dept. to increase the size of the regular Treasury auctions, thus increasing the supply of bonds.
• QT: The Fed’s Quantitative Tightening program continues unabated. As Treasury held bonds mature, the proceeds are not funneled back into new bonds, reducing overall demand

We own long term Treasuries as a standard in our portfolios, which has been painful the last 1-2 years as rates rose. Of course, that was after a massive run-up 2020-21 and we scaled back our position when rates were very low. Net, net we are still ahead of the game, despite the recent rise in rates. At this point, the main question is when do we want to rebalance portfolios to add more long-term Treasuries.

Yes, that’s counterintuitive. Don’t worry, we have no great desire to attempt to catch a falling knife, but at the same time we recognize that the best time to buy most assets is when everybody else is selling. As Mr. Buffett has said many times, be fearful when others are greedy and greedy when others are fearful.

Shut Down!

Otto von Bismark supposedly said “Laws are like sausages, it is better not to see them being made.” Assuming he really said that, he was completely correct. Unfortunately, the state of American politics forces us to watch.

Government shut downs, or at least the threat of a shut down, are now commonplace. With all due respect to those who suffer from such an action, when it happens, it doesn’t last long. Markets are now used to this and it is really not much a factor in the stock or bond market.

The good news is that Speaker McCarthy had some successes (and a failure) at passing bills on Thursday night. We’ll see if he was able to pull a rabbit out of his hat on Saturday morning. To us, what is most disturbing is that we are at a political impasse, where the center left and center right are both unwilling to make the extremists in Congress irrelevant by working together. That is bad for the country, but until there is a price to be paid for such positions, it is likely to continue and will not make our lives better.

What We’re Reading

China Blocks Executive at U.S. Firm Kroll From Leaving the Mainland

GOP Faces Shutdown Risk, but Both Parties Vulnerable in a Long Standoff

Evergrande’s New Woes Signal Long Slog for China’s Economy

United Airlines pilots approve new contract with up to 40% raises

The Fed’s favorite inflation indicator rose less than expected in August

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By: thinkhouse