October 2021

Wednesday November 10th provided a proverbial “gut punch” to the capital markets. The day started with the inflation report for October that was way above expectations and was capped with a 30-year bond auction that was an absolute disaster.  Year-over-year CPI came in at 6.2% versus the 5.4% registered last month.  Fed Chairman Powell continues to believe that the uptick in inflation is going to pass but it’s not happening, and people are not happy about it.  In the latest release, energy had an outsized effect on the result, climbing 4.8% month-over-month, but that represents only a little over 7% of the total.  Reviewing the various subcategories, not a single category was down on the month, and the largest, housing, rose 0.7% for the month.  That component has been relatively subdued to date and seems to be finally reflecting what has happened with home prices over the last year.  As a reminder, the Bureau of Labor Statistics measure of housing inflation uses what’s known as owner’s equivalent rent (OER), not actual sales.  It’s no secret that OER consistently under reports home price inflation but the BLS has never seemed to care.

After digesting the inflation news, the Treasury Department auctioned $25 billion 30-year bonds and as one observer put it, “it was an unmitigated disaster!” The auction cleared at 1.94%, 5.2 basis point away from where it was trading at auction time.  In the Treasury market, the to be auctioned note is traded for several days before the actual auction occurs, in what is known as the “when issued” market.  Through this methodology, the Treasury hopes that there is no surprise at auction time.  A sloppy auction is a symptom that something is not right in the market.  This is the fourth sloppy auction this year and the Fed should be highly concerned.  The weak seven-year auction earlier this year was an “eye-brow raiser,” but it was explained away as being an odd maturity with no natural buyers.  But the 30-year bond is a different story.  It, along with the 10-year note, are benchmark interest rates and bank and insurance companies have an ongoing demand for them.  The number of bids, at 2.2 times the size of the auction, was on the smaller side, but posed no threat of causing the auction to fail.  However, we deem the enormous tail as an indication that Wall Street is worried about who will finance the ballooning debt once the Fed exits secondary market buying.

Meanwhile the Bank of England befuddled investors by leaving the overnight rate unchanged.  Just days before the BOE met to discuss monetary policy, they suggested that a rate rise could be expected at the November meeting.  The reaction in the secondary market was an immediate move higher in interest rates with the 2-year Gilts rising 20 basis points on Monday.  Investors had bet it would not be a one and done rate hike either.  The futures market priced in 100 basis point rate rise by next September.

The BOE, however, did not raise rates as they had hinted just the week before, and instead decided to leave the rate unchanged by a vote of 7 to 2.  The yield on the 2-year Gilt reversed the previous week’s action and fell 30 basis points on the stunning lack of action.  Not surprisingly, the English Central Bank lost an enormous amount of credibility and, with it, the ability to “jawbone” the market; a useful tool to persuade markets to move at their will.

Lastly, at the post-FOMC meeting press conference, which is typically a non-controversial “softball” affair, the tone of the Q&A got a bit confrontational.  Powell reiterated repeatedly that the Fed was in no way prepared to raise the Fed Funds rate.  After driving home that point, the line of questioning turned to the trading scandal that cost Fed Presidents Kaplan and Rosengren their jobs.  We had thought the matter had been put to bed but apparently the media thought otherwise.  Powell was put through the rhetorical wringer with questions like how he’d restore the confidence of the American people and if he felt the new policy went far enough.  He got through those questions with an even tone, but when asked if the trading scandal would hurt his chances for President Biden to renominate him as Fed Chairman and for Congress to approve his approve his nomination, there was decidedly a bit of annoyance in his “I’m not going to answer that question” response.  From our perspective, we think the bigger issue is that he has failed as the Chairman of the Central Bank and the U.S. is going to ultimately suffer for the excessively easy money policy the Central Bank has pursued.


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