Andrew Pyle, Senior Investment Advisor and Senior Portfolio Manager at CIBC Wood Gundy, joins BNN Bloomberg to talk about finding opportunities in the fixed income markets.
Cost of capital is considered the most important input in the valuation of most assets. The core of monetary policy is the management of the secured overnight lending rate (SOFR, formerly LIBOR) by the U.S. Federal Reserve.
Almost everything in the world of risk assets is based in some way on this all-important cost of funds. The basis of fiscal policy is the US economy’s debt and deficits that are projected to increase net debt in the future.
The United States and other governments can issue as much debt as they want to buy votes and stimulate the economy. The mission of the U.S. Treasury is to maintain orderly markets and fund debt with minimal burden to taxpayers. Of course, the thing to watch out for is how much it costs to clear all that debt from the market.
This will likely be Treasury Secretary Janet Yellen’s last quarterly tax refund (QRA) this week. Donald Trump’s White House will appoint a new director.
Based on base case estimates and some basic calculations by the Treasury Borrowing Advisory Committee (TBAC), the QRA is expected to require between $500 billion and $750 billion in new debt. The deficit is estimated at about $545 billion, with buybacks and outflows needed, totaling $650 billion.
If the amount needed is less than $650 billion, there would be no pressure on Yellen to increase the size of her bond auctions, and the bond market would most likely get some short-term relief.
Since the FOMC is the anchor of the money market, setting the SOFR/federal funds rate, the biggest impact on the cost of money is an increase in the supply of bonds. And now, because they are buying long-term bonds and not reducing them, the pricing of long-term bonds is at the mercy of the “free market.”
It seems unlikely that Yellen would want to disrupt the stock market before the election, pushing the demand expansion variable for bond supply into 2025. But make no mistake: the need to fund more bonds is real and inevitable.
The recent rise in yields is driven by investor bets that President Trump’s policies require more bond financing and that he will do it early in the presidential election cycle to blame it on Democrats. There is also.
Andy Constan of Damped Springs Advisors is one of the top macro investors we follow. This graph is his estimate of funding demand and when the Treasury will need to increase the bond supply (as opposed to continuing to increase paper money).
Historically, the ratio of bonds to notes has been 80:20. That percentage is much higher in the bill since COVID-19 and the exploding budget deficit.
barman
No matter who wins the election, the budget deficit will continue to widen. Under a blue or red sweep, this would be the worst outcome for the bond market in 2025-2026.
If we get a blue or red split, overall spending is likely to be lower, which from a bond perspective means supply pressure will be minimal. We continue to believe that traditional fixed income investing in this era of slowing globalization, combined with large debts and deficits, makes public bonds a relatively bad investment in a portfolio.
Since Brexit, we’ve been telling BNN Bloomberg viewers that bonds are breaking as a real return vehicle for the risk-mitigating part of a balanced portfolio.
After inflation, real returns over the past decade have been dismal. There is no other way to see it.
barman
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