“There are some people who might have better technique than me, and some may be fitter than me, but the main thing is tactics. With most players, tactics are missing. You can divide tactics into insight, trust, and daring. In the tactical area, I think I just have more than most other players.” — Johan Cruyff
A short piece this week.
Margin Debt, Treasury Yields and Lending Standards
According to the Fed’s most recent Senior Loan Officer Survey, credit conditions are tightening in the US. Historically, as shown in the above chart, tightening lending conditions translate into decreasing levels of margin lending by brokers.
On the flipside, however, tactically margin lending would normally be due for a bounce from current levels and 10-year Treasury yields would be expected to rise. The question is whether a high enough level of FOMO has been created by the rising market for margin levels to start rising again?
Although we have been more cautious in the last two weeks, Jay Powell’s interview in 60 Minutes, where he essentially doubled down on the Fed’s easy money policies, and potentially a second round of stimulus by the US Government, certainly has the makings of a FOMO-induced rally.
If such a rally coincides with rising yields, a tactical long in 10 Year Treasuries would be something we would recommend. Especially if credit conditions continue to tighten.
Margin Debt, Treasury Yields and Lending Standards
The above chart is of the 30-year US dollar swap rate spread over the 30-year Treasury bond yield versus the yield on 10-year Treasury bonds.
In a well-functioning financial system, swap rates should not be below Treasury yields (i.e. positive readings on the magenta line) because in theory US Treasury securities are ‘risk free’ and a swap carries counter-party risk. On balance, the negative spreads are indicative of problems within broader US dollar funding markets.
If swap spreads drop further into negative territory, this would be another signal to tactical increase bond allocations.
From A History of Interest Rates by Sidney Homer and Richard Sylla referring to the run up to the end of the bond bull market in 1946:
“It was a period when a large part of the liquid capital of the country attempted to crowd into the always limited areas of riskless investment. The sharp recession of 1937-38 had destroyed the last hopes of some of the most stubborn optimists that 1932 was only a traditional cyclical crisis and that the United States would, as always, recover to resumes its climb to new heights of prosperity. This pessimism was not altogether dispelled for over fifteen years.
[…]
Long bonds pegged at 100 were not only considered safe for short-term funds, but it was believed that, as they became shorter, they must rise in the market, first to 2¼% yield and finally to % yield, because shorter bonds commanded these lower yields. Thus they would capital gains. This was called “riding the yield curve”; it became a profitable sport for private and institutional investors.”
The bond bull market is not dead. At least not yet.
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.