Market Recap 10/6/2023

The monthly jobs release has always been something of a random number generator.  Economists spend untold hours trying to predict the number and often times it seems a dart throwing monkey would be more accurate.  That was certainly true this month – employment growth smashed expectations in September.  Jobs were up by 336,000, the most since January while the previous two months were revised up by 119,000.



The chart below shows economists' expectations (red bars) versus the actual number (yellow diamond).  The lowest estimate was just 84K while the highest was 252K with a median at roughly 175K.  You just have to laugh.   




Bond yields spiked higher on the release and equity futures slumped, but the stock market rallied as the day progressed.   A more esoteric employment stat actually showed that job growth was negative (good news is bad news??).  Also, investors seemed to focus on the earnings component of non-farms .  Hourly earnings growth was unchanged from the prior month, indicating modest wage pressures.



This might indicate the Fed doesn’t need to tighten again this year – at least that is the market’s hope.  Certainly, the odds of another rate hike this year are basically 50/50, as you can see below.



But there’s a lot of wood to chop between now and the December Fed meeting.  Not the least of which is how does the circus in the House play out.


Getting Real


This bond bear market is one for the ages.  There are a lot of charts floating around regarding the move in yields and bond prices.   The one below shows the yield on the 30-year Treasury.  We’ve had a big spike higher in yields in a relatively short period of time.




Another shows annual returns for the Bloomberg Aggregate Bond index.  There’s never been three consecutive down years in the bond market, at least since this index started.



Not all bonds are the same though.   Long-term bonds have been hit hard the last few years.  The extreme example is the performance of Austria’s 100 year bond.   Since January 2021 this security has lost roughly -74% of its value.


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Conversely, short-term bonds are actually up YTD.  We are at the point where relatively generous yields at the short end of the curve are more than compensating for the price risk.


Why are yields up so much?  The headlines talk about inflation, but what’s really pushed rates up is the move in real yields.   This is the return on a bond if you strip out the inflation component.  



Real yields went negative during the COVID crisis as investors flocked into the perceived safety of Treasury bonds regardless of valuation.  They were willing to lock their money up and lose on an inflation adjusted basis for having the peace of mind knowing they’d get their money back.  That’s no longer the case.


Why are real yields up?  There are a number of theories.   The end of quantitative easing and the beginning of quantitative tightening plays a part.  Also playing a part if the higher for longer narrative.  If the neutral Fed Funds rate is something much higher today than what it was in the post financial crisis world, it would make sense that real yields should be higher as well.  


How big a role is the deficit playing?  It’s awfully hard to say, but it has to be a factor.  The chart below shows daily fiscal spending going back to 2014.  There’s the now very familiar spike during the COVID crisis followed by a retrenchment as things got back to normal.  



However, spending has taken off again and is running at roughly 2X the pre-COVID rate.  Why?   It mainly comes down to rising social security payments (which are up due to inflation) and rising interest costs.




Does this impact the bond market because it means greater Treasury issuance?  You would think almost certainly?  After all, Treasury issuance in August of this year was enormous. 



But how much is increased bond supply pushing up yields?  That is a much harder question to answer.  In a normal world, today’s real yields actually look pretty generous, implying bond yields don’t have much upside left.   But what about today’s world is normal??


(Other) Charts We Found Interesting


  1. Another bond related table from BofA showing all the bond bears going back to 1811.  Apparently the war of 1812 (and the burning of the White House) didn’t trigger safe haven buying of U.S. government bonds?



  1. Where does government spending go?  Mostly to mandatory programs like defense, social security and health related items.  The discretionary piece is very small (and getting smaller each year).



  1. Another factor driving yields higher the last few weeks has been the surprising move in crude oil and gasoline prices.   This week’s correction is very welcome in this context.


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  1. This won’t shock anyone, but financing costs matter when it comes to buying a house.  The payment required to buy the average home is up roughly 4X!!




  1. There is one group that benefits from higher rates – pension plans.  Low rates mean plans are typically underfunded due to higher present values.  Higher interest rates means future liability are worth less today.   



  1. More and more homeowners are being dropped by private insurers and turning to state plans.  In Florida the Citizens Property Insurance last-resort plan is the biggest home insurer in the state.



  1. I love maps like this.  Why was the Austro-Hungarian Empire located where it was and why did it last so long?  Natural fortifications certainly played a part.   



Have a good weekend


Charles Blankley
Chief Investment Officer
Gemmer Asset Management LLC

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