Big Short’ Investor Michael Burry Bets On Higher Inflation With A Slew Of Bets Against Treasury Bonds
Michael Burry bet against Elon Musk’s Tesla last quarter, and backed up his warnings of higher inflation with a slew of bets against Treasury bonds. Big Short’ Investor Michael Burry Bets On Higher Inflation With A Slew Of Bets Against Treasury Bonds
Don’t Discount Bond Vigilantes, Says Economist Who Named Them
The once-feared bond vigilantes have been quiet lately. In Wall Street lore, they’re the investors who take matters into their own hands when the government isn’t protecting the currency. If inflation rises, deficits grow, or a country’s creditworthiness is at risk, the bond vigilantes sell bonds en masse, pushing up interest rates sharply and forcing the government to get serious.
The vigilantes were nowhere to be seen on June 9, a day when interest rates went down instead of up. The yield on the 10-year Treasury note fell to 1.48% after having gotten as high as 1.74% at the end of March. That was in spite of economists’ predictions that on June 10, the Bureau of Labor Statistics would report that consumer prices rose 4.7% in the year through May.
Edward Harrison went so far as to write a June 9 article, “The Death of the U.S. Treasury Bond Vigilante,” for the Credit Writedowns newsletter, which he founded. “The bond markets aren’t intimidating anyone right now,” he wrote.
Are the vigilantes really pushing up daisies? I put that question to economist Edward Yardeni, president of Yardeni Research Inc., who coined the term “bond vigilante” in 1983, when they were a force to be reckoned with. His short answer was no. His long answer was full of the kind of strong opinions you’d expect from a guy who’s been following the markets since receiving his doctorate in economics from Yale in 1976.
Here’s A Condensed Version Of What He Said:
* Their heyday was in the 1980s when we had four episodes where bond yields went up and subsequently nominal GDP went down. … As has been widely known, the Clinton administration feared the bond vigilantes. As a result it maintained a fair amount of fiscal discipline. We actually ran surpluses.
* Meanwhile along the way some very powerful anti-inflationary forces came into play. The need for them to be vigilant dissipated in 1990s through 2000s. Then we had the global financial crisis, a big increase in the deficit. They still remained quiet.
* The vigilantes rose up in Greece. In 2010-11 the sovereign bond yield rose to 40%. Draghi [former European Central Bank President Mario Draghi] calmed them down.
* Coming out of 2008, the central banks adopted unconventional monetary policy. They increased balance sheets. The bond market was no longer a market. The supply and demand for bonds was no longer being determined by free-market forces. Central banks, some would say, were rigging the bond market.
* Even if the vigilantes wanted to express an opinion, they were stymied by the actions of the central bank. Then again, there wasn’t much to complain about.
* The vigilantes may very well have come back from the dead starting last August. The Fed was buying all these notes and bonds, but the 10-year yield popped up to 1.7% earlier this year. Arguably somebody was selling while the Fed was doing all this buying, and they had enough clout to push the bond yield up. It had to be private investors.
* In March, MMT [Modern Monetary Theory, which is relaxed about budget deficits] was embraced by the Fed and the Treasury. You might as well put them in the same building and consolidate their statements.
I Asked Him If The Vigilantes Are Dead
* I don’t think they’re dead. Let’s see what happens tomorrow [with the inflation report]. Anecdotally my 22-year-old son walked into my home office. He just got a haircut. He said they raised the price from $20 to $26. When the barbers start raising prices, you have to worry about broad-based inflation.
* I’m sticking with my call of 2% [yield on 10-year Treasury notes] by yearend. Inflation is going to be a little bit longer-lasting than the markets are anticipating.
* It’s not as easy being a bond market vigilante now as it was in the 1980s. Then, the Fed didn’t intervene directly in the bond market. Give them even more credit for a valiant attempt to express an opinion when they’ve been gagged for so long by the central bank.
* In a free, competitive market, the price mechanism works. But this is not a free market.
* The longer the Fed keeps buying bonds, the more [potentially] powerful the bond market vigilantes are going to get because the compounding effect of higher rates on debt-service payments would be just a killer. We got a glimpse of that in 2017-18 when rates were going up.
Today, After The Government Reported That Consumer Prices Rose 5% In May, Yardeni Emailed Me This Paragraph:
* May’s higher-than-expected CPI report, like April’s, was dominated by base-effect increases in used car prices, car rental fees, hotel and motel charges, and airline fares. Over the next few months, I believe that we will see signs that inflationary pressures are more broad based reflecting higher labor costs. Furthermore, the jobless claims data suggest to me that payroll employment will be rising at a faster pace in coming months.
The Fed’s $120-billion-per-month of bond purchases has been flooding commercial banks with deposits that they’ve been forced to invest in Treasuries since loan demand is weak. Loan demand is weak because corporations raised a record $1.5 trillion in the bond market during the pandemic when the Fed backstopped the corporate bond market and yields fell to record lows.
The Fed has flooded the financial system with liquidity contributing to the demand shock and inflationary pressures, while keeping a lid on the bond yield around 1.50%-1.70% in recent months.
JPMorgan, TD Securities Urge Treasury Bears To Hold Firm
Despite a short squeeze that pushed benchmark Treasury yields to a three-month low last week, Wall Street sees plenty of reasons for bonds to sell off again.
Strategists at JPMorgan Chase & Co. turned bearish on 10-year Treasuries ahead of Wednesday’s Federal Reserve meeting, saying markets are now pricing in a too shallow rate-hike outlook. Their peers at Morgan Stanley are bracing for a hawkish surprise from the U.S. central bank and a team at TD Securities is also calling for a “tactical short” in benchmark bonds.
“Given rich valuations and a benign implied tightening pace, we turn bearish in 10-year Treasuries,” wrote a JPMorgan team including Jay Barry. “The pendulum has swung over the current quarter as Treasuries have moved from extremely cheap to extremely rich.”
Bond investors have been abandoning short bets in recent weeks on an expectation Fed officials will reaffirm that an ultra-loose policy remains appropriate, and that it’s too soon to start even considering tapering purchases of Treasuries and mortgage-backed securities. Still, officials could project interest-rate liftoff in 2023 amid faster economic growth and inflation, according to economists surveyed by Bloomberg — something the swap-market is pricing for April that year.
Ten-year yields rose one basis point to 1.46% 11:29 a.m. in London on Monday after hitting the lowest since March on Friday. That coincided with a key Fibonacci technical support level, stemming from the rise in yields from last year’s pandemic lows.
While market expectations for the Fed to hike rates are more hawkish than the central bank’s own guidance, swaps are pricing in less than 100 basis points of tightening over the next four years, according to the JPMorgan strategists. That suggests markets see a relatively low pace of normalization, they said.
TD Securities see the potential for the central bank’s median “dot” for 2023 — a gauge of its expectations for rates that year — to move higher, according to a note from strategists including Priya Misra. That would likely surprise the market, which is priced for a dovish Fed, they said, calling for benchmark yields to bounce back to the 1.70% level.
Fed Dot Plot Seen Shifting To 2023 Rate Liftoff, Economists Say
The slump in Treasury yields after last week’s U.S. consumer-price data suggests markets are completely ignoring inflation as transitory, just when a case can be made for its sustainability, wrote Morgan Stanley’s head of U.S. interest rate strategy Guneet Dhingra in a note Friday.
“Given the shift in the mix of inflation from transitory towards sustainable, the risk of a hawkish tilt within the FOMC has increased, exposing the rates market to a hawkish surprise,” he said.
Michael Burry Warns Retail Traders About The ‘Mother of All Crashes’
The fund manager of ‘Big Short’ fame issued a stark series of tweets about cryptocurrencies and meme stocks.
Michael Burry, who became a household name after his winning bet against mortgages was featured in “The Big Short,” issued a series of tweets on Thursday warning individual investors about losses “the size of countries” in the event of crypto and meme-stock declines.
“All hype/speculation is doing is drawing in retail before the mother of all crashes,” Burry wrote on Twitter before the posts were deleted. “When crypto falls from trillions, or meme stocks fall from tens of billions, #MainStreet losses will approach the size of countries. History ain’t changed.”
Burry, head of Scion Asset Management, is closely followed by the meme-stock crowd. He took a bullish stance on video-game retailer GameStop Corp. in 2019, which helped lay the foundations for an epic retail-investor frenzy earlier this year. His views have switched this year though, to warnings about dangers in the market.
“If I put $GME on your radar, and you did well, I’m genuinely happy for you,” he wrote in a tweet in January. “However, what is going on now — there should be legal and regulatory repercussions. This is unnatural, insane, and dangerous.”
Burry has a haphazard relationship with Twitter. He doesn’t post frequently from his account, but when he does his comments can be controversial. Last spring, he wrote on the social-media platform that lockdowns intended to contain the spread of Covid-19 were worse than the disease itself.
He has a habit of deleting his tweets soon after posting them. And earlier this year the investor told his followers that some of his Twitter activity had triggered a visit by the U.S. Securities and Exchange Commission.
Burry isn’t alone in his recent warnings about the cryptocurrency space. Mark Cuban, the billionaire owner of the Dallas Mavericks and an early crypto adopter, revealed to his Twitter followers this week that he’d been hit by the drop from roughly $60 to $0 of the DeFi Titanium token, part of a stablecoin project called Iron Finance.
“There should be regulation to define what a stable coin is and what collateralization is acceptable,” Cuban wrote to Bloomberg News in an email.
As for Burry, he has also placed a bet against Elon Musk’s Tesla Inc. Scion Asset Management owned bearish puts against 800,100 shares of the electric-car maker as of March 31, according to a regulatory filing.
Burry, who was played by Christian Bale in the film version of Michael Lewis’s best-selling account of the 2008 financial crisis, “The Big Short,” was originally a doctor. After gaining his M.D. at the Vanderbilt University School of Medicine, he was an early adopter of discussing stock trades on online message boards and switched to professional investing.
Inflation And Supply Shortages Are Waking Up The Bond Bears
Debt yields are rising, along with concerns about faster inflation.
Central bankers continue to insist that the recent price pressures that are driving inflation higher will prove temporary. But based on what’s happening to bond yields and in the inflation swaps market, investors are growing less convinced. Something’s got to give.
Supply chain disruptions, soaring energy prices and a rebound in consumer demand thanks to progress with vaccinations have conspired to bestir prices. Annual inflation is running at 5.3% in the U.S. and 3.2% in the U.K., and is forecast to have reached 3.3% in the euro zone. In all three regions, prices are rising at a pace way faster than the 2% central banks are supposed to target.
That’s awakened the animal spirits of the bond bears, who’ve driven benchmark yields higher in the past few weeks.
A Wild Month
Benchmark 10-Year Yields Have Surged In The Past Four Weeks
But the guardians of monetary stability remain unperturbed by prices rising higher. “These effects have been larger and longer-lasting than anticipated, but they will abate,” Federal Reserve Chairman Jerome Powell said in testimony to the Senate Banking Committee released Monday.
“Our view is that the price pressures will be transient,” Bank of England Governor Andrew Bailey said in a speech the same day.
“The key challenge is to ensure that we do not overreact to transitory supply shocks,” European Central Bank President Christine Lagarde said Tuesday.
While Their Persistence Can Be Debated, There’s No Question That Cost Constraints Are Widespread. A Few Examples:
* FedEx Corp. said last week that there’s been no easing of a labor shortage that’s driving up costs for the delivery company, with one sorting hub suffering understaffing of 35%.
* A survey by the U.K. Office for National Statistics showed 40% of Brits said there was less variety than usual in shops, with 25% saying they hadn’t been able to find non-essential foodstuffs and 18% saying they couldn’t buy essential food items.
* Costco Wholesale Corp. imposed rations on toilet paper, paper towels and cleaning supplies amid experiencing delivery delays.
* A.P. Moller-Maersk A/S has raised its profit guidance three times in five months. The world’s largest shipping line is on track to post annual earnings of $16.2 billion for 2021 — equal to its combined profit in the past nine years, Bloomberg News reported last week.
* Cotton, used in everything from jeans to T-shirts, is trading at its highest price in a decade.
* Nike Corp. said it used to take 40 days to ship sporting apparel across the world; now, that’s taking 80 days, with the rising cost of ocean freight hurting margins.
Consumers are most likely to feel the pinch in the supermarket, where inclement weather in one of the biggest crop growers is also contributing to higher prices. Brazil contributes four-fifths of the world’s orange juice exports, 50% of its sugar exports and 30% of its coffee exports. This year, the nation suffered its worst drought in a century, followed by freezing conditions that left farms shivering under blankets of frost that crippled crops, Bloomberg News reported this week.
That helps explain why the United Nations world food price index has climbed by a third in the past year, and why the cost of breakfast staples has surged in recent months.
In financial markets, a key set of gauges used by central bankers points to a further acceleration in prices. The five-year forward inflation swaps rates in dollars, sterling and euros have all surged this year, with the euro zone rate climbing to its highest in more than six years and the U.K. level reaching a decade high.
Perhaps the most troublesome aspect of the current economic environment is the risk that inflation is accelerating at the same time that growth is stumbling. The danger of stagflation seems to be making its way onto the collective radar of traders and investors; Bloomberg’s News Trends function, which can tally the occurrence of keywords from more than 1,500 sources, shows monthly usage of the term is at a record high.
Of course, fixed-income bears have been burned before. The years following the global financial crisis have seen repeated warnings that unprecedented economic stimulus would unleash inflation, only for prices to fail to rise and bond yields to continue to plumb new depths.
Time will tell who’s right this time — the central bankers insisting that the current increases in consumer prices are transitory, or the bond vigilantes seeing danger ahead.
In Bond Market Rout, Investors See Overdue Correction
Recent Fed meeting marked a turning point, as widely expected, with 10-year Treasury yield climbing above 1.5% in subsequent sessions.
Investors often claim the U.S. government bond market is the best place to look for insights into the shifting outlook for the economy and interest rates. Right now, some think it isn’t.
In the waning days of the third quarter, yields on U.S. government bonds shot higher. That might be taken as an encouraging sign about the prospects for the economy because yields, which rise when bond prices fall, generally tend to climb with forecasts for growth and inflation.
Many analysts, though, don’t believe that yields are rising now because much has changed about the economic trajectory. Rather, they see the bond selloff as an overdue correction to an overdone rally—the product of profit-taking more than a major shift in thinking.
The reason that yields rise matters because it can influence how investors respond in other markets. All else being equal, higher yields can hurt stock prices by lifting corporate borrowing costs and reducing the value of future earnings. But investors can also welcome them if they feel rising yields reflect an improving growth outlook.
In this case, investors have registered a mixed reaction. Most are optimistic about the economy, but their views haven’t changed much since last week, when yields were lower. Stocks have been volatile, first climbing when yields started rising, then falling sharply to start this week.
Many investors have been waiting for bonds to take a hit. After reaching a pandemic high of 1.749% on March 31, the 10-year yield dropped as low as 1.173% on Aug. 2 and remained safely below 1.4% until the end of last week. But even in August, many continued to believe that yields were unnaturally low and bound to snap higher.
“I don’t think there’s really anything particularly fundamental going on,” Blake Gwinn, head of U.S. rates strategy at RBC Capital Markets, said on Aug. 2 when yields were tumbling.
Some investors, he said, were buying bonds while they still could, aware that prices would likely decline at some point but confident that they wouldn’t in the very near future. Others with longstanding short positions were inclined to sell but skittish after being burned by the rally.
Mr. Gwinn had guessed that momentum would only really shift after the Federal Reserve’s Sept. 21-22 meeting. Before resetting their positions, he said, investors were almost waiting for that meeting when the Fed would likely take a “tangible turn” to tighter monetary policy.
Seven weeks later, that is more or less what happened. The Fed on Sept. 22 signaled that it would likely start scaling back its purchases of Treasurys and mortgage-backed securities as soon as November. Officials also indicated that they could raise short-term interest rates sooner and faster than they had previously expected.
Neither development was shocking to investors, and yields were little changed right after the meeting. The next day, though, investors began dumping Treasurys, bringing the 10-year yield back above 1.5%, with the yield settling at 1.528% Thursday.
As the selling began on Sept. 23, Mark Lindbloom, a fixed-income portfolio manager at Western Asset, posited that people like him were driving it. That day, Mr. Lindbloom’s team had scaled back bets on the outperformance of longer-term Treasurys.
“Our portfolio position has benefited our clients,” he said, but it was time “to take some of that off, just to hedge our bets a little bit.”
Many analysts still ascribe at least some of the recent rise in yields to an actually improving economic outlook.
Recent months have featured some disappointing economic data, including a retail-sales report in August that came in well below expectations. In September, though, the same report, covering sales in August, was much more encouraging—suggesting the economy was weathering the rise in Covid-19 cases spurred by the highly contagious Delta variant.
Signs that the Delta wave might have peaked in the U.S. have also given investors hope that more workers will return to their offices, spurring additional economic gains, said Thanos Bardas, global co-head of investment grade and senior portfolio manager at Neuberger Berman.
There may be a limit to how high yields can climb from here. Many analysts in recent months have stuck to predictions that the 10-year yield could reach 1.75% or 2% by the end of the year. But their forecasts for yields beyond that point are constrained by longer-term trends.
Most important, even longer-term Treasury yields are generally dictated by expectations for short-term interest rates set by the Fed. But in recent decades, the central bank has been leaving its benchmark federal-funds rate progressively lower due to a variety of factors, possibly including a slowdown in potential economic growth, analysts said.
As it stands, the so-called neutral interest rate that neither stimulates nor slows the economy might be slightly below 2%, analysts at Cornerstone Macro estimated in a recent report. That suggests the central bank would have a hard time raising rates above that threshold, putting something of a soft cap on Treasury yields.
While investors may sometimes anticipate that the Fed might raise rates above the neutral level, “it’s very hard, mathematically, to contemplate, say, a 3% 10-year Treasury yield when the nominal neutral rate is below 2%,” they wrote.
Bond Investors Brace For Worst Year In Decades On Hawkish Fed
Global bond investors are facing their worst year at this point in more than two decades after a selloff in September triggered by hawkish statements from central bankers including Federal Reserve Chair Jerome Powell.
The Bloomberg Global Aggregate Index, a benchmark for government and corporate debt, has lost 4.1 percent so far this year, the biggest slump for any such period since at least 1999. Comments last month from Powell that the Fed could start scaling back bond buying in November and a move closer by the Bank of England to raising rates triggered a surge in bond yields globally.
There were few places for fixed-income investors to hide in September as they moved quickly to price in less central bank support and the risk of higher inflation sparked by improving economies seeing fewer Covid-19 cases. High-yield indexes for U.S. and European corporate debt suffered their first monthly declines of 2021. The Bloomberg Global Aggregate Index lost 1.8% in September, its biggest drop since March.
Monthly losses were the worst this year after reflation scourge in March.
While yields on the benchmark 10-year U.S. Treasury had by Friday retreated from their highest levels since June, markets remain positioned for more increases in the rates. Investor concerns are prevalent in global markets that central bankers are underestimating inflationary risks, as an energy crunch in countries including China pushes prices higher.
“We believe that the bias is for rates to continue to rise in October,” said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd.
The ability of Democrats in the U.S. to overcome rifts on President Joe Biden’s economic agenda, including a tax and spending plan totaling as much as $3.5 trillion, will also be key to how much higher rates go and how returns for bonds end the year.
House Speaker Nancy Pelosi sent lawmakers home Thursday night without voting on a $550 billion infrastructure bill, with plans to try again Friday after moderate and progressive Democrats failed to reach an agreement on the rest of Biden’s spending plans.
Higher rates aren’t the only concern for bond investors.
The debt crisis at developer China Evergrande Group has pushed losses on junk notes from China to 13% so far this year and dragged down emerging-market bond returns too. Gains for emerging-market dollar notes for 2021 to August were wiped out last month as markets convulsed.
“Until uncertainty surrounding Evergrande subsides, we do not expect a pronounced bounce-back in emerging-market corporate credit,” said Bank of Singapore’s Schubert.
Some are less bearish for bonds.
“Following a ‘mini tantrum’ in bonds, I expect a respite in October but not a sharp reversal lower in yields,” said Winson Phoon, head of fixed income research at Maybank Kim Eng Securities in Singapore. “Current rates pricing looks more reasonable and additional increases would require strong prints in economic data.”