☀️☕ The Fed’s not buying Treasuries!

📝 Focus

• The Fed’s not buying Treasuries!

📊 In the Markets

• GM and Stellantis the next to fold?

• Merc’s EV challenge is the industry’s

📖 MoneyFitt Explains

🎓 The Fed has a Balance Sheet?

📝 Focus

The Fed’s not buying Treasuries!

In early August, Treasury Secretary Janet Yellen said at a slightly obscure conference that the Treasury Department would be increasing its quarterly auctions of Treasuries by $100 billion to a total of $1.5 trillion per quarter and will sell longer-dated bonds. This was to “ensure that the United States government has the resources it needs to meet its financial obligations” and fund the ballooning $2 trillion federal deficit.

The market focus at the time was the US sovereign downgrade from rating agency Fitch, but both sent Treasury bond prices down, propelling Treasury yields up to 9-month highs.

This was the start of the sharpest selloff of longer-term Treasuries since 1982 (see below), further fuelled by comments weeks later by her successor as Fed Chair that interest rates would be higher for longer.

If the Treasury is selling more bonds, prices are expected to fall unless there is more buying on the other side. But now there is a significant buyer of Treasuries that’s gone MIA because, for the last year and a half, The Fed’s balance sheet* has been shrinking.

..... ▷ The Federal Reserve initiated its Quantitative Easing (QE) policies in response to the 2008 financial crisis to stimulate economic growth and combat deflation. By purchasing government securities and mortgage-backed securities, the Fed injected liquidity into the financial system, lowering long-term interest rates and encouraging borrowing and spending.

This is known as growing the Fed’s balance sheet🎓.

The Fed ended quantitative easing purchases in 2014 as the economy improved but didn't start to reduce its balance sheet until 2017. This process is often referred to as quantitative tightening (QT).

But then, during the COVID-19 pandemic, the Fed stepped in again to limit the economic fallout by purchasing huge quantities of US Treasury bonds and mortgage-backed securities, more than doubling the size of the Fed’s balance sheet from about $4 trillion prior to the pandemic to nearly $9 trillion at the start of 2022.

..... ▷ Now, with low unemployment and still high inflation, The Fed is normalising its balance sheet to reduce excess reserves in the banking system by actively reducing its portfolio of government securities at an annual rate of $720 billion.

But The Fed isn’t actually selling bonds. It reduces its balance sheet by NOT reinvesting the principal payments from maturing securities. Instead of buying new bonds to replace these, the money is essentially "retired," thus shrinking the Fed’s balance sheet🎓.

(The percentage of Treasuries held by the Fed ranges between 10 and 40%, but the historical average is 23.5% based on St. Louis Fed data from 1914 to 2023. It’s now at about 24%.)

And because the Fed is no longer purchasing these bonds, private markets and other buyers need to absorb those assets, especially if more are being issued.

Bond Geek Corner: Why are longer-dated bond prices more sensitive to yields?

Long-term bonds are more sensitive to changes in interest rates than short-term bonds because they have a longer duration. Duration is a measure of how long it takes to receive all of a bond's cash flows. Long-term bonds have a longer duration because their cash flows are received over a longer period of time. This means that a small change in interest rates will have a bigger impact on the price of a long-term bond than a short-term bond.

Imagine you have two investments. (Ignore coupons for this illustration):

• Investment A: You will receive $100 in one year.

• Investment B: You will receive $100 in 10 years.

Let's say that the current interest rate is 5%.

The price is calculated by discounting the future cash flows to the present value using the current interest rate. The longer the time until a cash flow is received, the more it is discounted.

As a result, a small change in interest rates will have a bigger impact on the present value of a cash flow that is received further in the future.

• The present value of Investment A is $95.23. This is because the $100 that you will receive in one year is discounted to the present value using a 5% interest rate.

• The present value of Investment B is $78.39. This is because the $100 that you will receive in 10 years is discounted to the present value using a 5% interest rate.

Now, let's say that interest rates rise to 6%.

• The present value of Investment A falls to $94.34. This is because the $100 that you will receive in one year is now discounted to the present value using a 6% interest rate.

• The present value of Investment B falls to $74.62. This is because the $100 that you will receive in 10 years is now discounted to the present value using a 6% interest rate.

Cover Image: AgnosticPreachersKid, CC BY-SA 3.0, via Wikimedia Commons

📊 In the Markets

Asia-Pacific markets saw widespread selling, with Aussie shares closing at their lowest point in over a year and the Aussie Dollar weakening to a 12-month low. Nearly all markets were down other than mainland China.

Traders across the region were reacting to US markets’ weak showing on Wednesday, but Korea was also hit by SK Hynix, the world’s second-largest memory chipmaker behind compatriot Samsung Electronics, which fell 5.9% after reporting a net loss of KRW2.2 trillion ($1.6bn) for the third quarter, a massive reversal from its KRW1.1 trillion net profit a year ago.

South Korea's Kospi index fell 2.71% to its lowest level since January 6.

Benchmark 10-year Japanese government bond (JGB) yields hit a fresh 10-year high of 0.877% ahead of next week’s BOJ meeting.

And yet the yen weakened to hit a fresh one-year low of ¥150.8 per USD, approaching the 32-year low of ¥151.94/$ it hit last October, triggering a BOJ intervention.

European markets traded a little lower on Thursday, with attention split between third-quarter earnings and government bond yields.

The regional Stoxx 600 index (which includes non-Eurozone countries) weakened with poor auto sector results but trimmed earlier losses after the European Central Bank announced that it would hold interest rates steady, breaking the unprecedented streak of 10 consecutive hikes, pretty much as unanimously expected by economists.

UK headquartered Asia / MENA bank Standard Chartered Bank was clobbered 12% after it took a $1 billion hit from exposure to the Chinese banking and real estate sectors, leading to a huge profit miss.

But clean energy giant Siemens Energy was much worse, tumbling 33.5% after asking for €15bn in guarantees from the German government to cover problems in the wind power subsidiary Siemens Gamesa, the world's largest maker of offshore wind turbines so that it can fulfil orders in its gas and power businesses. (In June, it dropped 38% in a day when it reported a "substantial increase in failure rates of wind turbine components.")

US Stocks fell on Thursday, driven by declines in large-cap tech stocks on some disappointing earnings guidance and continuing concerns about high for longer interest rates despite the surge in US Treasury yields and stock market weakness tightening financial conditions.

Growth in third-quarter GDP clocked a 4.9% quarterly annualised increase, driven mainly by consumer spending. It came in stronger than the 4.3-4.5% expected and was a sharp acceleration from growth of about 2% for the previous four quarters.

Amazon reported better-than-expected results, with its shares spiking 5% in after-hours trading before ending below the day’s close. Results beat expectations on net sales and EPS but missed on cloud revenues in its AWS unit. Operating margins rose, suggesting that, like Meta, Amazon's post-pandemic efficiency push has been working.

GM and Stellantis next to fold?

Ford was the first of Detroit’s Big Three carmakers to negotiate a settlement with the United Auto Workers (UAW) union to end strikes that grew over the nearly six-week-long strike to 45,000 workers.

Ford is calling back workers as it restarts the three assembly plants that were on strike, though the agreement struck late on Wednesday must still be ratified by union members.

The deal piles yet more pressure on General Motors and Chrysler parent Stellantis.

..... ▷ The Ford contract includes a 25% wage hike over the life of the 4-1/2-year contract, starting with an initial increase of 11% and an increase in retirement contributions.

The deal reverses many of the concessions the union agreed to in a series of contracts since 2007, when the entire auto industry was on its knees and teetering on the verge of bankruptcy.

However, it falls short of the 40% pay hike, 32-hour workweek, and return of defined benefit pensions initially sought by the UAW.

..... ▷ The Ford contract represents a significant victory for the labour movement.

But it is just one of many wins this year.

Workers, crushed by spiking inflation after years of falling real incomes, have used tight labour markets to win concessions in industries such as rail, entertainment, shipping and casinos.

Merc’s EV challenge is the industry’s

Mercedes-Benz is keeping its strategy of keeping prices high to focus on margins over volume in the face of price cuts around the industry, from Tesla to Ford and BYD. Some traditional automakers are offering battery EVs at prices below their internal combustion engine cars.

Third-quarter earnings before interest and taxes (EBIT) fell 6.8% to €4.8bn due to a “brutal” electric vehicle (EV) market marked by price cuts and supply chain issues.

Merc shares closed down almost 6%, pulling down other European automakers.

Mercedes-Benz will focus on improving returns from its combustion engine portfolio if EV margins continue to disappoint.

..... ▷ High interest rates are disrupting the entire electric vehicle industry.

While EV sales continue to grow, the pace just isn’t meeting industry or investor expectations.

Concerns about persistently high interest rates are causing companies to rethink their strategies for 2024.

..... ▷ Volkswagen cut its profit margin outlook due to raw material hedges and EV demand softening.

Other automakers have adjusted their production and investment plans.

Ford cut workers’ shifts for the F-150 Lightning, its battery-powered pick-up truck, potentially a profitable segment in the EV space for legacy automakers, particularly with Tesla’s Cybertruck continuing to see delays.

GM and Honda scrapped a $5 billion low-cost EV development partnership, and GM shifted its focus to meet demand rather than specific volume targets.

Meanwhile, CATL, the largest EV battery maker, reported weaker profits due to tough competition and slowing demand, as seen in key raw materials lithium and cobalt prices, which have declined 67% and 20%.

..... ▷ Investors have been reacting to the dramatic shift in outlook since mid-year.

The iShares Self-driving EV and Tech ETF (IDRV) has tumbled 31% since its peak at the end of July, 12.5% in the last month alone.