☀️☕️ US Treasuries, a “meme” bond and a “Pain Trade”

📝 Focus

• US Treasuries, a “meme” bond and a “Pain Trade”

📊 In the Markets

• Netflix and Hike

• Belt Up!

📖 MoneyFitt Explains

🎓️ Bond Yields and Interest Rates (not the same!)

📝 Focus

US Treasuries, a “meme” bond and a “Pain Trade”

It’s been two weeks since we wrote about how “the soft landing may be hard” as yields🎓 on longer dated bonds finally went shooting up (and affect the real economy the way short term interest rates🎓 simply don’t), but after that, there was something of a lull on suspiciously coordinated soothing words from otherwise “hawkish” Fed officials talking more about for how long rather than how high rates should go. (Plus some safe-haven buying on Middle East tensions.)

But the last few days have seen Treasuries selling off and yields roaring back up. Benchmark US Treasury yields soared to their highest levels in 16 years as investors digest a slew of strong economic data from the US, resurrecting fears of the Fed keeping rates higher for longer.

Higher yields and interest rates are typically bad for risk assets like stocks compared with good, effectively zero risk returns, and from a valuation standpoint, hurt the present value of future earnings (or cashflows), especially of fast-growing companies.

..... ▷ Among the reasons put forward for the relatively sudden collapse in “long bond” prices is the volume of Treasuries being issued to finance the US’ huge fiscal deficits.

This year's net Treasury issuance is the second-highest on record and it seems likely that supply will continue to grow rapidly next year.

More supply means more downward pressure on prices (as in most things) and when bond prices fall, yields go up. Foreign Treasury demand actually seems to be relatively steady, but isn't rising by enough to offset the increased supply.

..... ▷ Whatever the specific causes (the FT points to many other potential reasons), one thing is sure: crowd-following traders betting on the imminent reversal of the Fed’s hiking campaign have been experiencing massive losses.

With the recent market swing to actually believing that interest rates really would be “higher for longer” (as Fed Chair Jay Powell has been saying for over a year), retail traders have been caught holding ETFs (Exchange Traded Funds) that are positioned for falling rates.

Lower interest rates🎓 imply lower Treasury yields🎓, which means that Treasury bond prices go up since bond prices and yields go in opposite directions. So, an ETF holding Treasuries would go up. (And the longer-dated the bond, the more it tends to move.)

BlackRock’s iShares 20+ Year Treasury Bond ETF (TLT, tracking the ICE US Treasury 20+ Year Index) has been the go-to vehicle for retail punters in the trade, with $39bn under management. At the end of 2022, TLT had $36.4bn, so since the price is down 17% year-to-date, billions and billions will have been piled in (and lost) since then.

In June, a Bloomberg writer referred to a triple leveraged version of that ETF called the Direxion Daily 20+ Year Treasury Bull 3X Shares ETF (TMF) as having “big Cocaine Bear energy” and that one is now down 48% so far this year… but when interest rates finally do “turn south”, could this “pain trade” be the first retail meme bond?

..... ▷ But it may have to wait a while.

As a worst case scenario rather than a prediction, JPMorgan Chase CEO Jamie Dimon has been saying that interest rates could hit 7% along with stagflation, first raising this in an interview with The Times of India in September. (Fed Funds are currently set at 5.25-5.50%.)

He warned that The Fed may be far from done with its aggressive interest rate hike battle with still-above-target inflation, and if the Fed raises interest rates too quickly in order to combat inflation, it could trigger a recession.

His ominous tone echoes former Treasury Secretary Larry Summers’ post on Twitter just a month earlier.

Mini-Explainer - The Pain Trade

- A "pain trade" is an informal term used in financial markets to describe a situation where a majority of market participants have positioned themselves in a particular direction, only to see the market move against them.

- This usually happens when there is a prevailing consensus or overly crowded positioning. If the reversal occurs, it can be very swift and violent, catching most participants off guard.

- The concept of the pain trade is based on the idea that markets have a tendency to inflict maximum pain on the largest number of participants.

- The same term is also used for a trade against the consensus. This typically happens with a contrarian position, betting that market positioning is wrong.

What We’re Reading 📚

📊 In the Markets

Oil and gas prices pushed sharply higher on Wednesday on concerns of escalating geopolitical fallout from the Israel-Hamas war and Tuesday’s deadly explosion at a Gaza hospital. Prices surged 3% after Iran’s Foreign Minister pushed for an oil embargo on Israel after the blast, but even after easing from session highs, international benchmark Brent crude stayed back above $90, up $1.60, or 1.8%, to $91.50 a barrel. Larger than expected drawdowns from US storage contributed to the strength.

Markets across Asia closed about flat in choppy trading on Wednesday despite stronger-than-expected third quarter growth in China at 4.9% compared to a year earlier. It was slower than the previous quarter, which saw 6.3% year-on-year, but better than economists’ forecasts of 4.4%, suggesting the recent round of policy measures actually are helping to spark a tentative recovery.

By coincidence, Beijing was hosting the Belt and Road Forum for International Cooperation, known by nobody as “BARFFIC”, with representatives from 140 countries marking the 10th anniversary of President Xi’s legacy-building Belt and Road Initiative (below.)

Less happily, Country Garden’s already extended $15 million coupon payment deadline expired without any word of payment, fueling expectations that China's biggest private real estate developer has indeed defaulted on its offshore debt, underscoring the depth of the sector’s dreadful state. Only $15 million!

Over in Europe and then in the US, stocks tumbled on rising Treasury yields and Middle East tensions, both leading to risk-off sentiment and driving gold to a two-month high. Wall Street’s Fear Guage, the Cboe Volatility Index (VIX), also surged.

As if strong retail sales data the day before wasn’t enough, strong US single-family homebuilding data supported the narrative of prolonged high-interest rates that has been pummelling longer-dated US Treasuries for months (above).

In results, United Airlines Holdings plummeted 9.7% due to a lower profit forecast while Morgan Stanley reported a hit from sluggish dealmaking and trading revenues and slower growth in wealth, sending its shares down 6.8%.

Both Tesla and Netflix reported “after the bell”, with Tesla down 4% on weak core margins thanks to the price war, while Netflix surged 12% on a beat and a hike in after-hours trading.

Netflix and Hike

Having spent the last three months watching Wall Street’s highly-paid analysts downgrading Netflix, after-hours traders drove up the value of Netflix by $18bn (more than two Paramounts) on better-than-expected results with earnings-per-share of $3.73 well ahead of the expected $3.49.

Netflix also announced that it is hiking subscription prices in the US, UK and France, with the premium plan in the US seeing a $3 monthly increase to $22.99.

The price hikes reflect Netflix's quest for revenue amid domestic market saturation and rising competition from Disney+, Warner Bros Discovery’s HBO Max, Paramount+ and NBCUniversal’s Peacock (all of whom copied Netflix’s ad-supported tier) as well as others.

..... ▷ Like the introduction of its ad-supported tier back in May, the password-sharing crackdown turned out much better than analysts were fearing, delivering 8.76 million new subscribers globally, very comfortably beating the 6.2 million forecast.

Netflix maintained dominance in viewership, accounting for 8% of screen time, second only to YouTube and had 247 million global subscribers in September.

..... ▷ Despite Hollywood labour issues with both writers (since resolved) and actors (ongoing), Netflix claimed it managed strikes better than rivals due to global production locations, though estimated content spending in 2023 was reduced to $13 billion from $17 billion.

..... ▷ One unexpected outcome of the strikes is that some of Netflix’s competitors are reversing a streaming war tactic by licensing their old TV shows and movies back to the streamer. This boosts Netflix's programming offerings but also potentially squeezes its profit margins.

Netflix relied heavily on programming that it licensed from other companies when it launched its streaming service in 2007, but after Walt Disney, NBCUniversal, Paramount and WBD launched their own streaming services, they pulled many of their shows from Netflix to avoid feeding a company that had grown into an arch-competitor.

The “Netflix effect” on older shows has been seen in Friends (1994-2004) for years, but newer old shows like Suits (2011-19) have also been given a new lease of life, topping the Nielsen Streaming top 10 for three months after NBCUniversal licenced it to Netflix in June.

Belt Up!

Chinese President Xi Jinping addressed Wednesday’s opening ceremony of the Belt and Road Forum for International Cooperation.

..... ▷ It marked the 10th anniversary of his Belt and Road Initiative and is also intended to cement China’s position both as a leader among less developed countries and as a global power. The path to modernisation proposed by China, he said, is a “modernisation of mutually beneficial cooperation and common prosperity”.

..... ▷ Neither Russia’s Vladimir Putin, who spoke after him, nor Xi referenced major global issues such as the conflicts in Ukraine and Gaza, and kept the focus strictly on economic and belt and road matters.

..... ▷ In total, Xi’s plan consisted of eight key points, mostly closely tied to achieving “high-quality” growth over the long run:

1. A logistics corridor across Europe and Asia.

2. A “silk road e-commerce zone”, with more free-trade agreements and investment treaties.

3. A US$47.8 billion financing pledge from Chinese development banks.

4. A push for green development.

5. Pledges on scientific development and artificial intelligence.

6. More cultural and people-to-people exchanges, including a tourism alliance.

7. More “clean cooperation” to improve transparency.

8. Efforts to establish belt and road institutions including a secretariat.