Deep Troubles Lurk Beneath the Surface
David Haggith

They are many, and they may not be staying down there past March

One might almost say all the worst economic troubles lie beneath the surface right now but may be frothing the water as soon as March. Stocks, for example, could not look more ecstatic as the indices have roared over the past five trading days to astounding record heights, mostly based on AI euphoria. (Hey, maybe the AI’s are nudging the trading algorithms from behind the scenes to boost the stocks of their own creators in order to give themselves more life blood to increase the creation rate of their own powers. Now, there’s a new conspiracy theory for you!)

Zombie stocks keep slithering through the bottom sludge

However, beneath the surface, stocks appear ready to cave in. The volume in trading appears high, but one article today points out how misleading that volume has become. Hundreds of zombie corporations have done “reverse stock splits” to keep themselves from the near-certain death of falling off the main exchanges. Far more than there ever used to be. Some have done as much as an 80-1 reverse split, meaning they reduced the number of shares to 1/80th of what they had in order to multiply the value of each share 80 times. That’s what’s holding market volume up. Those otherwise dead stocks have returned to life by artificial means down in the sludge at the bottom of the trading pool.

You see, with exchanges like the NASDAQ, once a stock becomes a penny stock (trading for under a buck) it will be taken off the exchange for being too low in value to play with after a certain grace time. So, stocks that had plunged down to that bottom tier in the great 2022 crash went from being worth 30 cents a share to, say, $10 a share after reverse splits. There are now more of those kinds of zombies bottom feeding just above the lowest tier of sludge to stay alive than ever before.

However, a lot of trading volume happens in those stocks because speculators can turn quick profits just by jiggering the prices around when they are so low. I mean, how much does it take to raise the value of a ten-cent stock by ten cents and double your money if you know how to manipulate a stock price? Or a two-dollar stock. They’re playing the penny machines.

So, the value of the indices is up because of six top stocks (one of the Magnificent 7, Tesla, having fallen by half of its peak value out of the Magnificent 7 already); and volume is looking decent because trading in totally junk companies is happening all along the bottom, but those companies are going nowhere on Main Street. It’s more like bottom fishing for sport.

The water looks beautiful in Dallas, but the shadows darting below the surface are menacing

Another example of something shiny on the surface that looks quite troubled underneath is the latest report from the Dallas Fed. While its current metrics still show manufacturing in that region to be in recession, the outlook for six months ahead has finally jumped above the surface like a sparkling trout to show positive growth is expected.

One would surely think that means the times ahead will be shinier and brighter. However, look beneath the glimmering surface of those southern waters, and the companies in their notes say “there’s an odd chill in the air” and speak of “pending DOOM.” 

As Jeff Bezos warned when the anecdotal reports disagree with the metrics…

The thing I have noticed is when the anecdotes and the data disagree, the anecdotes are usually right. There's something wrong with the way you are measuring it.

And that, of course, is a big reason I am working hard in this space. I am constantly seeing things that look dodgy in the reported statistics and trying to find out what the truth is behind them because that is what will come up and bite you from behind. Take January’s hugely positive number for labor. I expect it to lose its shine in the next report. After all, the raw numbers in January’s labor stats were actually negative, but “adjustments” made them enormously positive. When 100% of the good news comes from the adjustments, I fear the adjustments are misleading, maybe by intention. There is a lot of room in “adjustments” to enter the statisticians’ own bias … or the big boss’s bias. January seems to be one of the dodgiest of months for labor reports anyway. I expect it will be revised down in the next report and the new lower figure will make it look like the decline in February is not as great.

Other comments in the Dallas Fed report were:

• Job jumping has ground to a halt.
  
  
• Things are status quo with a bit of negative undertone, which is somewhat disturbing.
  
  
• Sales were below projections for January and February; March does not look encouraging.
  
  
• I have no idea what is going to happen.
  
  
• The uncertainty is bothering people.

Even Goldman recently admitted that there is vast divide between how happy we should all be based on government-supplied data versus how we actually feel...

Again, that is the very reason for the existence of The Daily Doom—not to bring doom into your life but to tell you all the stuff that mainstream media routinely fails to report, almost as if by conspiracy, which lies right beneath the surface of the misleading truths and sometimes even outright lies that float along on top. Hopefully, that helps some people understand why what they feel in their gut doesn’t square with what they keep hearing in the financial press … and trust what their gut is telling them and make better sense of life around them.

People are sensing what lies beneath the surface and feel troubled by the shadows they see lurking under the water they are swimming in. The reports, however, are often shimmering sunshine … sometimes because of how the numbers are being cooked. I try to dig honestly into that without overstretching in my reach to conspiracy theories, but just going with the facts that I can find about the numbers, looking where my gut tell me to dig deeper.

People have reason to trust their doubts when it comes to how they feel about the economy. They just need to know what those reasons are. I try to help figure that out. So, the news before it happens right now is to expect that the labor boost you saw in January reports does not continue through February. I don’t trust labor numbers most of all right now. Labor, as a reliable metric, got badly broken by Covid lockdowns and hasn’t recalibrated yet in my opinion.

US Treasury auctions were surprisingly (to me anyway) holding up a lot better than I said they were likely to do at the start of the year as the US government increased the size of its auctions while the Fed continued to roll off the Treasuries it holds on its balance sheet, forcing the government to find other buyers to refinance those, too. (Since the government never pays off its debt.) As the auctions began to grow in size, everything continued to glimmer like gold.

Until it didn’t. I started to wonder if I was going to be wrong on that prediction, but it looks like the turn is now coming in. Don’t ask me what the two-month lag was about because I haven’t figured that out yet, but now we are starting to see the kinds of changes I was expecting. As of today, we’ve had three auctions in a row that didn’t look so hot.

Bonds in the open market slumped in value as yields hit a session high because of what happened in the 5-year Treasury auction today. 

As to the scale of these auctions, they were the biggest ever:

Ninety minutes after the Treasury sold a record $63 billion in an ugly 2Y auction, at 1pm we got the day's second coupon auction when we just saw another record, this time in the form of $64 billion in 5Y notes, the highest amount ever sold for the tenor.

The yield on the 5YR notes priced 27 basis points higher than the previous auction of 5YR notes; so, the climb due to higher volumes has likely begun, given we’ve now seen that rise in yields and the growing underlying problems in each of the last three auctions. 

And with 2 of the week's 3 coupon auction now down on the first day of trading, and with markets realizing just how much supply there is, it's not surprising that yields have shot up to session highs, with the 10Y rising above 4.30% after briefly trading below 4.22% earlier in the session.

And I think that may just be it in terms of explaining the lag. It’s just taken a few auctions for traders to get the sense that “This is for real now. We’re going to see auctions of this size for as far as the eye can see.”

So much depends on whether those “bond vigilantes” I’ve written about wake back up from the slumber Powell plunged them into back at the end of October/start of November when he emerged from the FOMC meeting and announced that the vigilantes had done such a good job of tightening the financial markets that maybe the Fed could rest soon.

That, of course, was like knock-out gas to the vigilantes who went right back to sleep. Now they are waking up to realize, NO, the Fed is nowhere close to reducing rates again—certainly not in March (where I’d give higher odds to raising rates than lowering them, though I doubt they have the courage). Suddenly, the bond vigilantes are sitting back up and realizing they have more work to do.

Now, who are these “bond vigilantes?” It’s just a colorful name for bond traders who price inflation into their bids on bonds to make sure they’ve covered themselves for all inflation over the life of the bond and have left room for a snug profit. Nothing more. Not a conspiratorial deep-state agency that works to carry out the Fed’s work nor a conspiratorial outfit of hackers that sometimes works to undermine the Fed. We’re just talking investors who, if they see inflation is rising longer, start pricing more inflation into their bids. The investors are now realizing inflation is going longer, so interest will be staying high for longer, so they’re pricing back in what they had priced out since October.

There is, however, something else they may tend to price in, and that is to anticipate supply. If they see bond supply is rising rapidly and is going to stay up, they may want more interest on their bonds now, knowing that more interest is certainly coming right around the corner in order to keep attracting new buyers for all the additional supply. All they have to do is see that starting to rise to say, “Yep, that’s happening” and start to price it in now. And, it is just speculation on the numbers: There is more supply right now, so it takes more interest right now to sell all those bonds.

Thus, these auctions today, also priced through with a long tail, which meant that in order to sell all the bonds being issued, as is mandatory, the bids had to keep falling in price (rising in yield) in order to attract enough buyers to finally close out the auction. (It typically works the reverse of how you normally think of an auction with price getting bid down more and more to sell of the rest of the bonds being issued.) See, the auction starts at a set opening price, and the primary dealers typically bid to take large allotments at the opening price to make sure they get what they need, but they also typically hold out to see if the bids keep coming down in price as the auction continues in order to buy more at a lower price. Sometimes there is no lower price, so if they didn’t get all the bonds they wanted in their opening bid, they’re out of luck because others bought up the rest of the bonds in their opening bids.

Sometimes, these “bond vigilantes” have toppled prime ministers, so they have their collective power, as we will see in the next section.

While the surface of these auctions is now starting to ripple due to worries bubbling up from beneath over the size of every auction (and just just the simple reality of attracting enough buyers to sell an auction that large), another article today points to virtual sea monsters lurking beneath the surface of these leviathan-size auctions. 

Bond vigilantism is resurgent in the market for sovereign debt. That emerged with remorseless clarity from the brutal sell-off of UK gilts that toppled hapless British prime minister Liz Truss. Could the fiscal disciplinarians of the global investment community now turn their disruptive talents to the US Treasury market?

As well as savaging the president of the day, such a challenge could devastate the US’s role as the world’s chief provider of safe assets during global crises, while simultaneously threatening the dollar’s status as the pre-eminent reserve currency.

The article further along states that, contrary to common opinions, the one thing that threatens the dollar most comes through Treasury auctions and not from the following frequently-mentioned sources:

[It] is not the US’s appallingly dysfunctional politics. Nor the weaponisation of the dollar thanks to geopolitics. Nor again the possible competitive threat from other central banks’ digital currency plans. Rather, it is a spiralling public debt now exceeding 97 per cent of gross domestic product, a level not seen since the second world war.

That’s a long time back for a comparison. Quite simply, the vast amount of debt being auctioned to fund Bidenomics and to keep rolling over the past mountains of debt that were heaped up, especially under Trump in his final year of Covid meltdown madness, which continued, of course, under Biden, is now at risk of consuming the dollar. Our debt may finally be hitting the level where it will eat us alive now that interest has risen:

The Fed has levered up interest rates to help meet a 2 per cent inflation target and ultra-low interest rates are gone. Meantime, the Congressional Budget Office predicts the US deficit will soar by nearly two-thirds in the next decade, with interest payments accounting for three-quarters of the increase. That stems from the morally hazardous debt binge induced by years of ultra-loose monetary policy.

You can’t blame any one president or party. They ALL did it.

Even the Treasury has declared the public debt burden unsustainable. That means its own supposedly safe IOUs — the linchpin of global markets — are potentially unsafe.

And so have the credit agencies, and we have new budget approval that has to happen in March.

I’ve alway said, the dollar’s fall will come in the form of its own slow collapse due to Fed mismanagement and US fiscal policy over the years, not due to a competing currency beating it down because all of those look worse. I don’t think that will hit as a huge rush, but those days when the trouble starts pricing through to US Treasury auctions may have begun because the auctions right now are forcing prices up due to the size of the auctions, rather than due to Fed rate policy. The Fed is no longer strongly in the bond manipulation game (yield curve control) as it was through years of easing. It could, of course, jump back in; except that, for now, it is constrained by inflation, which is right where I’ve said it would find itself.

That means the bond vigilantes, riding the currents of inflation, are starting to press the US government and the Fed to end their profligacy. But, of course, it is that unsustainable massive debt spending by the Biden administration that is also keeping GDP elevated. So, end that and GDP falls, meaning the hidden recession (already visible for several quarters in manufacturing) suddenly appears. However, neither Biden nor Trump (based on his own record) appear likely to capitulate to the forces of the vigilantes. Still, wait until things get really rough as more credit downgrades come like the two we’ve recently seen and the bond vigilantes keep pricing government auctions higher. Then we’ll find government forced to react.

One other feature of this bond market is that its shock absorber is fading away. I won’t go more at this time into reverse repos, which were pushing interest higher, but suffice it to say that another article below shows that, while reverse repos have plunged, that may be like the drop in sea level just before the second half of the tsunami wave comes in. As everyone goes, “Yay, no tsunami. The tides gone out even,” they should be seizing that warning and time to run for higher ground.

A lot of troubles around all of this could hit in March as emergency programs and stacked up reverse repos that buffered the market to the tune of trillions of dollars all come to an end at the same time. You see, banks have been using their stocked-up reverse repos with the Fed to buffer their need for cash by just giving the Fed back its borrowed bonds in order to get their cash back from the Fed … as reserves they had essentially stashed in another interest-bearing compartment until they needed them as cash in their regular reserves, which is now. At the steady rate of decline those parked reserves have seen, that buffer will end sometime in March:

Many analysts expect use of the Federal Reserve's overnight reverse repurchase facility, also known as the reverse repo program, to continue to decline. That, they say, is likely to constrain the functioning of a key shock absorber in the market for U.S. Treasury securities. They note that lower balances in the program could mean higher volatility and a rise in interest rates in the market that underpins the global financial system.

The timing for that is March … as is the end of the Fed’s emergency bank program created to save falling banks last spring … as is the next federal budget vote. So, the water looks beautiful today in all the surface headlines, but beware what swims beneath!

(Sorry I didn’t get a Deeper Dive out this weekend. I got a violent flu over the weekend and just couldn’t do it. Such are the shortcomings of a one-man show. As is usual, the headlines this Monday are available below for everyone, but I hope you will consider upgrading to a paid subscription if you feel you’ve benefitted from The Daily Doom so I can keep screening out for you the most important trends to watch in the headlines and writing editorials about them that attempt to lay out “the news before it happens” based on those trends. I’ve been pleased to see paid subscriptions continue to grow, albeit very slowly, to where this is finally starting to look like a worthwhile project. My thanks to those who have helped make that happen!)

Seeing the Great Recession Before it Hit

My path to writing this blog began as a personal journey. Prior to the start of this so-called “Great Recession,” my ex-wife had a family home that was an inheritance from her mother. I worked as a property manger at the time, and near the end of 2007, I could tell from rumblings in the industry that the U.S. housing market was on the verge of catastrophic collapse. I urged her to press her brothers to sell the family home before prices dropped. The house went on the market and sold right away — and just three months before Bear-Stearns and others crashed, taking the U.S. housing market down for the tumble. Her family sold at the peak of the market.

 

 

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