Hold the line! I thought of Toto's 1978 hit when watching the markets Thursday afternoon and Friday morning. The stock markets are clearly dancing to the tune of the global bond markets this week not to any 1970s classic rock hits.
Thursday afternoon at about 2:30pm, as the yield on the 30-year U.S. Treasury bond hit an all-time low by crashing through 2%, a more pitched battle was taking place. At that moment, the 10-year U.S Treasury note -- the benchmark for pricing basically every fixed income security in this country -- saw its yield fall below 1.50%. That was not an all-time low, as the 10-year yield hit an almost incomprehensibly low yield of 1.37% in July 2016, but clearly it had the stock markets spooked. The DJIA was showing a drop of 140 points and Thursday looked to be a continuation of Wednesday's massive plunge.
At that time, though, the line held. The yield on the 10-year rose -- or "backed up" in bond desk parlance -- above 1.50% and is quoted at 1.58% as of this writing. I believe a move closer to 1.4% would have confirmed Wednesday's slide and taken us back closer to 2,700 on the S&P 500. As the line held, however, we are seeing a marked rally in global equities now and the S&P 500 is threatening 2,900 in Friday's action.
So, I guess you can breathe a sigh of relief as a market bull, but it might be helpful to know who it was that was holding the line for you. The first thing you must know -- and never forget -- is that the U.S. bond market is much larger than the U.S stock market. I went to SIFMA's website to get the exact figures and uttered an audible "holy moley" when I saw the latest figure for debt outstanding in the U.S.: $43.170 trillion. I knew it was at least $40 trillion, but $43 trillion blew my mind and let's hope we are not so jaded as to think that an extra $3 trillion in debt outstanding is not a significant sum.
Of that debt figure, the U.S. Treasury market comprises the largest portion, or $15.959 trillion as of the end of July 2019. In contrast, according to yCharts data, the market capitalization of the S&P 500 was $24.74 trillion at the end of July. The market for Treasuries alone is not as large as the stock market, but the market for all bonds that are priced based on Treasuries is nearly double. Also, SIFMA's figures include only U.S.-issued bonds. If one were to include all global fixed-income securities whose pricing is based on the pricing of U.S. Treasuries, that figure would easily double the S&P's market cap.
About $6.8 trillion, or 42% of U.S. Treasuries outstanding, are held by foreign entities. Japan recently surpassed China as the largest holder, with both countries holding $1.1 trillion of USTs. That re-ranking represents an increase in the rate of Japanese purchases of USTs, though, not a meaningful reduction of holdings by the Chnese, whose UST portfolio was roughly the same in June 2019 as it was in June 2018.
So, there's no wall of worry in the bond market. The idea that the Xi administration would dump U.S. Treasuries to spike our interest rates and hit back at the Trump Administration just has not occurred. The 30-year is a few basis points away from an all-time low for goodness' sake. There is no overhang here.
The U.S. Treasury will keep issuing bills, bonds and notes at ridiculously low rates to finance the ever-increasing deficit and both private and sovereign holders will keep snapping them up. For sovereign holders, holding USTs allows them to hold dollars, as that currency exerts its supremacy over the rest of world's paper money, especially that issued by emerging market central banks.
For private holders of Treasuries, though, this move downward in rates is not a good thing. Insurance companies, for instance, are hammered by lower coupon yields on the fixed income securities they must use to fund long-term liabilities. Banks are hurt as the inverted yield curve makes loan pricing less lucrative than money paid to attract deposits. Savers, often the elderly, are hurt by much lower rates paid on their time deposits.
Those entities have been able to offset the pain of lower rates with the amazing capital gains that bonds have generated thus far this year. But there's a point at which that calculus no longer makes sense and lower coupon yields just can't support raising liabilities for the Western world's aging populace.
The U.S. stock market is telling us that pain point is a 1.50% yield on the 10-year U.S. Treasury note. I try not to argue with the bond market, so I will keep watching Bloomberg's U.S. bond rates page, and will keep taking bearish positions on stocks when the yield on the 10-year approaches 1.50%.