October 30, 2024 | With the 10-year Treasury note now 75bp above recent lows after the Fed’s September rate cut, market participants are exhibiting confusion. The subliminal guidance from on high has suddenly stopped. No longer can equity traders discern the future direction of markets by reading the last FOMC press release. With Fannie Mae 6.5s for November at 102, mortgage rates will be above 7% by year end, at least if you are concerned about profitability.
Into this intellectual vacuum, hordes of Buy Side economists and allied media are focusing their painfully conventional perspectives onto a key national issue. Will the election of Donald Trump cause higher interest rates in the US? Not necessarily. VP Kamala Harris is about business as usual, as illustrated by the fact that Treasury Secretary Janet Yellen failed to mention the budget deficit once during her remarks to the American Bankers Association yesterday.
Donald Trump is a change agent, but you may not like the change. Most Americans really don't want to see the size of the federal government reduced because it implies lower living standards going forward. Our historical analog for President Trump is President Andrew Jackson (1829-1837). As we write in the upcoming Second Edition of “Inflated: Money, Debt & the American Dream” to be released by Wiley Global (WLY) in 2025:
“Jackson was opposed by most of the nation’s newspapers, bankers, businessmen, and manufacturers, especially in the Northeast, but still won 56 percent of the popular vote in 1828. Comparisons between President Jackson and Donald Trump’s surprise victory over Hillary Clinton in the 2016 race and Kamala Harris in 2024 are not unreasonable. Thus began the Jacksonian Age.”
If President Trump and his loyal boy wonder, Elon Musk, make progress cutting the federal deficit, then the likelihood is for interest rates to fall even as the dollar soars. The global bid for dollars and, more important, risk free Treasury collateral is so strong that a sudden reduction in new issuance by the Treasury will cause interest rates to fall sharply. The FOMC will become superfluous. Decades of deficits and related inflation will suddenly reverse and become deflationary. The chart below from SIFMA shows total securities issuance. The Treasury is the dark green line at the top of the chart and accounts for half of total issuance today.
Source: SIFMA
Remember, this market is used to absorbing $1.7 trillion (FY 2023) per year in new mostly short-term Treasury securities. What happens to demand for Treasury bills and also "AA+" Ginnie Mae MBS when we turn off the new issue spigot at Treasury? The chart from FRED shows the assets of money market funds (blue line) and RRPs (red line).
If Treasury reduces T-bill issuance, government-only mutual funds will need to change their investment criteria. Many executives of banks and money market funds will beg the FOMC to allow them to return to the subsidized world of reverse repurchase agreements (RRPs). But imagine if a future Treasury Secretary publicly tells the FOMC to keep RRPs inside of T-bill yields going forward. Just imagine.
With economic data pointing to a robust economy, the bears are struggling to maintain their calls for immediate and deep rate cuts by the Powell FOMC. The US economy is not doing a "soft landing" but rather a "touch-and-go," a maneuver we've done more than once at La Guardia Airport in NYC. Since quality IPOs are now a very distant memory, starving equity traders have adopted an even more brazen and aggressive form of “pump and dump” strategy for extracting value from the clueless retail crowd.
Source: SIFMA
Consider the case of two refugee stocks, Fannie Mae and Freddie Mae. These two captive GSEs have been pumped and dumped several times in the past year. The catalyst for this action? The distant prospect of a political decision by former President Donald Trump to release the GSEs from government conservatorship. As we've noted several times in The Institutional Risk Analyst, the GSEs were the two best performing mortgage stocks in the past year and more.
Source: Google Finance
We’ve explained ad nauseum why neither of these finance companies will be released from government control in the near term, but that makes it all the easier for certain Wall Street firms and their consultants to pump up the stock. Brokers reveal fictional non-public meetings in Washington where the release of the GSEs is being discussed, right now. Firms distribute "white papers" and other email missives to retail investors, all with little or no disclosure.
Think of the beauty of Fannie Mae and Freddie Mac from the perspective of some disreputable equity trader working for an equally prestigious securities firm. Since the prospective decision about releasing the GSEs is a question of politics and, thus, largely unknowable, you can tell your clients whatever crap story pops into your little head. You can tell lies and damn lies about the idea of releasing Fannie and Freddie, but the SEC and FINRA cannot and will not say a word. It’s all about politics, after all.
Fannie Mae peaked a little shy of $2 back in March 2024, then fell down to ~ $1.30 in June, but rebounded to a little over $1.60 by mid-October. Then the pump and dump crowd bailed, sending the penny stock into a swoon. One equity maven asked The IRA earlier this week: “Why is Fannie falling.” More sellers than buyers. Another mutual fund CEO asked if investing in the preferred stock of the GSEs is advisable. Only if you understand that it is just a speculative "flutter" and not an investment.
And no matter how many times you may hear from this securities firm or that consultant that former FHFA Director Mark Calabria is going to "take the GSEs out," it ain’t gonna happen without legislation from Congress and years of preparation. The odds of legislation on the GSEs and housing reform more generally are slightly worse than the prospects for crypto currencies to be declared legal tender by Congress this January.
But remember, even the intelligent and righteous Mr. Calabria can come up with all kinds of fanciful statements and ideas about GSE release, but it does not matter. It’s all political. When it comes to Fannie Mae and Freddie Mac, members of FINRA can dress in clown suits, don the Mickey Mouse ears that the head of Enron once wore to investor meetings, and tell lies and lies. And it does not matter.
Meanwhile in the kingdom of fintech, the practitioners of pump and dump have been very busy indeed. Both SoFi Technologies (SOFI) and PayPal Holdings (PYPL) got the sudden dump treatment after reporting earnings. The content of the earnings does not matter, but the steady runup in the stock prior to the earnings release tells the tale. At $11 billion in market cap, SOFI is a small stock, but PYPL at over $80 billion market cap was pushed around just the same, as shown in the chart below.
Source: Bloomberg (10/29/2024)
What these examples of excess liquidity illustrate is that there is a lot more demand – aka, inflation – than there are opportunities to earn that expected 2 & 20 return (or maybe just 1 & 10). A drop in the federal budget deficit will put sustained downward pressure on interest rates, so much so that President Trump may not even need to browbeat the Fed. Now imagine that.
And a sustained drop in interest rates will make the deficit easier to finance, may improve the quality and breadth of the equity markets, and will also make the solvency issues of the US banking system fade into memory. If LT interest rates continue to rise, on the other hand, then the US banking system is going to be in big trouble come Inauguration Day. With the 10-year Treasury note at 4.3% this AM, the US banking system is insolvent by a couple of trillion dollars, as shown in the table below from The IRA Bank Book for Q3 2024.
Source: FDIC/WGA LLC
The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.
Comments