Market 11/10: Strong short-covering rally after reason for failed bond auction revealed

Some key points from Fed Chair's speech yesterday (10/11/2023):

1. Labor market tight but gradually balancing + supply shock has eased.

2. GDP growth still 'quite' strong (expected to ease slightly in coming quarters) → Will continue to hike rates if necessary.

3. Not confident in bringing inflation back to 2% (recent inflation data decline may be false signal).

Conclusion: Powell's stance on interest rates has turned hawkish again!

• Powell says Fed won't achieve inflation control target if economic data remains strong (consumer spending and business labor demand still high).

• Market expectations for Fed hiking another +25bps, though slim, rose from 4.8% last week to 14.6%.

  

Bond yields fall as investors weigh inflation outlook

Bond yields mostly declined today, especially long-term bonds:

• …market has rebalanced assessment of real risks for US Treasuries, after yesterday's yields spiked more than expected due to failed 30Y T-bond auction.

  

Is Fed's inconsistent QT process enough to curb inflation?

Fed Reverse Repos (RRP) drop below 1 trillion USD, lowest in over two years. => Fed still continuing QT!

But Fed balance sheet only declined slightly -6 billion USD last week, though total decline over -1.1 trillion USD from prior peak.

And Fed's QT policy was interrupted last week: value of financial assets held by Fed rose slightly +313 million USD.

• Possible cause: Fed's emergency support fund for banks (BTFP) surged +3.9 billion USD, bringing total to new record high above 113 billion USD, largest increase since June.

=> Seems Fed still continuing QT (reverse repos held down significantly from peak) but QT is “quite weak”….

• …because Fed still injecting money into banking system via BTFP program!

Banks still needing Fed support may be due to people less interested in bank deposits when they can invest in MMFs:

For 3 straight weeks, inflows to money market funds (MMF) rose +16.9 billion USD, => total MMF value to record high 5.71 trillion USD.

• This is result of high short-term bond rates and too-low risk making MMFs more attractive to investors.

Inflows into both types of MMF funds for 3 straight weeks: retail investor funds and institutional funds.

Both MMF and government bonds becoming attractive, making it harder for businesses to borrow:

• Investors pulled net -9.4 billion USD from corporate bond funds in October - one of highest outflows in history.

UMich inflation expectations surge: Consumer sentiment declines

Contrary to expected decline, 12-month inflation expectations surged to 4.4% (vs expected 4%). Long-term 5-10 year inflation expectations also up to 3.2%.

Consumer sentiment index declined for 4 straight months, down -5% in November, mainly from young people and low-income earners.

Current financial situation saw slight improvement this month, but long-term economic outlook down -12%, largely due to concerns over negative impacts of high interest rates.

Number of consumers saying high rates affect home, car, and durable goods purchases hit new record highs continuously.

China: Rising government budget deficit, capital crisis in banking system.

China may increase the budget deficit to 3.5% or higher, signaling possibly more financial support in the coming time.

Goldman Sachs expects the deficit to remain at -11% of GDP next year. Expected additional bond issuance from local governments will be delayed due to reduced LGFV issuance.

Chinese banks are rushing to raise capital (over 137 billion USD) after the cash crisis (liquidity squeeze).

• This is the largest weekly debt issuance ever.

FYI: Summary of the liquidity squeeze situation from early October to now in China.

• Money market interest rates rose at the end of October as banks faced pressure to meet central bank reserve requirements.

  => Commercial banks rushing to borrow pushed the overnight interest rate on the interbank market to surge.

  => Increased borrowing cost stress for banks.

• In addition, taxable companies and local governments have sold a record number of bonds.

  => A large amount of cash being withdrawn from the market further tightens banks' cash demand.

Some other news:

• The world's largest bank (Industrial and Commercial Bank of China ICBC) was just hacked, forcing transactions via USB.

• Country Garden records a sharp drop in sales amid financial crisis, the largest drop in many years.

• Nvidia plans to develop AI chips for China to avoid US restrictions.

• Meta and Amazon collaborate to develop new shopping features on Facebook and Instagram.

• Commercial real estate loan delinquencies reach 10-year high at US banks

  - Commercial real estate situation in the US is becoming worse after the collapse of WeWork.