Weekly Good Reads: 5-1-1
Far from over (central banks), duration extension, carry trade, naps
Welcome to another issue of 5-1-1! I am Marianne O, an investment professional and author of The Learner’s Mind on investing, economy, and wellness ideas. For this Weekly, I include 5 links to relevant economic and investment news, finance, and wellness/idea pursuit based on what I read. I also include 1 important chart and 1 investment term to know. You can easily subscribe to my newsletter by clicking below.
Market and Data Comments
The S&P 500 Index and the Nasdaq declined 1.4% this week while the 10-year U.S. Treasury yield rose 3bp. The yield curve (10y minus 2y) has steepened further to just beyond -100bp.
Central Bank policies can be summarized as far from over, whether it is more interest rate hikes from the Fed, ECB, and the BoE (U.K.) or more interest rate cuts from China.
Bank of England shocked the market with a 50bp rate hike, completely erasing the investors’ hope that rates will soon peak.
Fed chair Powell was evident this week in his testimony to Congress that further rate hikes are needed to get inflation back to 2%, especially since the core inflation rate (CPI less food and energy was at 5.3% in May) is more than double the Fed’s target. The shelter component is about a third of CPI. As John Mauldin explained (see link below on “Funny Recession”), structural changes have led to a qualitative mismatch between home demand and home inventory, which pushes prices higher for longer. A recession is needed to get to the Fed’s inflation target of 2%.
This caused several investment houses to call for extending the duration of bond holdings from 1 to 2 years to no more than 5 years, especially in the investment grade credit where the spread is at about 135bp over government bonds (note the lowest interest rate spread reached during the Pandemic was about 80bp).
The chart below shows the MOVE Index, which denotes the market-implied measure of U.S. Treasury bond volatility (a greed and fear index for bonds). The index at 105 is halved from the peak (worst) seen in March 2023, signaling the market expects future bond prices will be more stable, which means more comfortable holding bonds.
Next week, we will watch the ECB Central Bank forum (Fed, ECB, BoE, BoJ) and the Fed’s annual bank street test with a new market shock evaluation expected (higher capital requirement vs. unexpected stress (no change in stress requirement for community banks.)
Economy and Investments (Links):
US Inflation’s Minsky Moment Will Last Even as Rates Stall (Bloomberg or click here.)
Top Credit Investors Again Bet on Peak in Rates and US Recession (Bloomberg or click here)
A Funny Kind of Recession (Mauldin Economics)
Finance/Wealth (Link):
The Berkshire Beat: June 23, 2023 (@Kingswell on substack)
Kingswell’s newsletter talks about his favourite reads and news on Berkshire Hathaway (Warren Buffett’s company). This week he highlighted Buffett’s additional investments in 5 Japanese companies (“sogo shosha” or trading houses) were financed brilliantly. In investment, we call them a carry trade (see more below.)
In Buffett’s case, he borrows in Yen at about a 1 % coupon and invests in his Japanese stocks, which provide him a much higher dividend yield of 3 to 5%. Since these are all denominated in Japanese Yen, Buffett does not have to worry about foreign exchange rate fluctuations. And he locked in this Yen debt for over 10 years.
Wellness/Idea (Link):
Do Naps Boost Brain Health? Keep Dreaming (Robert Roy Britt on Medium) - The verdict on whether this is good for us is still out. Robert argued: Trying to improve daytime activity and light exposure will likely provide more benefits to health rather than frequent napping.
One Chart You Should Not Miss: The World’s Most Liveable Cities (ranked by living conditions in 2023 with 100=ideal), Statista based on Economist Intelligence Unit Global Liveability Index
The head of Economist EIU highlighted Vienna had earned the top spot for 2023 (also 2018, 2019, 2022) owing to its winning combination of stability, good culture and entertainment, reliable infrastructure, and exemplary education and health services. The resurgence of education and a lower burden on healthcare systems as COVID-19 restrictions ease has caused several developing economies in Asia and the Middle East to increase in ranking. The world’s political and economic axis continues to shift eastward.
One Term to Know: Carry Trade
This refers to a trading strategy where the investor borrows at a lower-interest rate (in one currency) and then converts the proceeds to another currency where the interest rate yields higher. It can be in the same currency involving two different financial products. Investors, therefore, enjoy a positive spread in the interest returns.
This can be risky in several situations: (1) deterioration in the fundamentals of the currency/economy where the interest rate is higher causing asset prices there to fall (2) when there is a fixed exchange rate, investors take advantage of the stability of the exchange rate and borrow heavily in foreign currency (say USD which the local currency is pegged to), but when the local currency fundamentals deteriorate, there is pressure for the currency to unpeg, causing a blowup in the debt level and interest payments when converted back to local currency.
The carry trade is for investors with higher risk tolerance and sophistication or institutions with deeper pockets.
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