Who is the marginal. bond buyer?

 

To price assets, you ned to know who will be the marginal buyer who will clear the market. How sensitive is the buyer to value or economic shocks? For the longest period in the US, the Fed was the marginal buyer through QE. QT was tried, but there always seems to be a hesitancy that selling would stop or slow down if rates rose too quickly. Now, the world has changed. The marginal buyers are private investors. Those private investors may either be domestic or foreign. Again, the issue is whether the marginal buyer needs to hold safe assets regardless of valuation or whether these buyers focus on valuation. I place less emphasis on Treasury arbitrage and basis traders, which is a different problem. If the perception is that bonds are expensive, or, more importantly, that rates are trending higher, yields will clearly be higher. 

Nominal yield will fall only if inflation expectations fall, term premiums fall because risk is perceived as lower, and real rates move lower because growth slows. Pension funds and insurance accounts will drive the US bond market. These buyers do not have to be vigilantes; they can just price-sensitive investors.

The diesel fuel shock - the driver of concern

The real energy shock is not with the price of crude but with the price of refined products. There is no question that crude oil prices have spiked and remained elevated since the beginning of the Iran War, but higher crude is just one component of a more complex energy price shock. Ukraine's war strategy to destroy Russian refining capacity is affecting refined product prices worldwide. Houthi attacks on Saudi refining are also disrupting the production of refined products. Finally, refining utilization is running above 96% in the US. There is no room for more production. 

So we have the following set of problems:

1. Refined product cannot move out of the Middle East 

2. Refinery capacity destroyed in Russia (approximately 40%)

3. Refining capacity impacted in Saudi Arabia

4. US refining is running above 96%, with refined product exports to Europe. 

The problem is not with crude but with refined product prices.

How to go broke from Bill Eckhardt

“Amateurs go broke taking large losses; professionals go broke taking small profits.”

Bill Eckhardt

Bill Eckhardt is one of Chicago’s true trading legends. He may not be as well-known as others, but through the turtle bet, he helped launch an industry called managed futures. 

His short phrase is packed with information and rivals the classic phrase “you never go broke taking a profit,” an old financial proverb with an unknown exact origin, though often attributed to the legendary financier Bernard Baruch. It is also included in the book Reminiscences of a Stock Operator about the speculator Jesse Livermore.

Eckhardt is from the trend school, and if you don’t know when a trend will end, it is best to just hold your positions and not take profits early. Of course, you have to take losses quickly.

World Order drives currency dominance

When we discuss currency dominance, we also need to think about the world order. Politics and economics intersect. The exorbitant privilege the US receives through the dollar and Treasury rates is financial compensation for serving as the world’s dominant hegemon. The US has played a special role in creating and maintaining the world order, and in exchange for providing this order, it receives gains in capital markets and financial flows. 

If the US either does not want to play that special role or is usurped in controlling the world order, it will lose some of its special financial privileges. This is a slow process of world control, given that no one country or group of countries wants to impose a world order not driven completely by self-interest. 

As put by some market observers, the US has moved from Magnanimous to Mercantilist, from global interest to self-interest. This world of self-interest is inherently unstable.