Examining possible reasons for rising yields the WSJ notes "The Fed isn't a buyer, banks historically are a fraction of buying and now the banking system is shrinking. Put those together, Treasurys have to clear at a different price. That means higher yields—it's pretty simple."

Naturally, yields are connected to a number of things. Let's start by examining the US Government debt crisis. Just over the last 4 months, the US Government Total Public debt increased by over $2 Trillion or 6.5%, starting from already historically high levels.

Debt levels are rising because the Government is spending more than it receives in revenue. Visualizing the 2022 Federal Budget puts the yearly deficit in perspective. However, interestingly defense expenditure remains at historically low levels. 

In its June 2023 Budget Outlook the CBO projects "that federal debt held by the public relative to the size of the economy will nearly double within three decades" and that "spending will continuously outpace revenue".

Rising yields are of course devastating for serving the interest payments on the national debt. Brian Riedl recently wrote an important piece explaining the dynamics that are driving a potential debt crisis.
He notes that between 1990 and 2021, the average interest rate that the federal government paid on its debt gradually declined from 8.4% to 1.7%. However, Washington never locked in those low interest rates. The average maturity of the federal debt remains at just 76 months, so nearly all of it must be replaced with new bonds within a decade. Brian calculates that each additional percentage point in interest would cost Washington $2.8 trillion over the decade, and $30 trillion over three decades. He concludes that Washington’s interest rate may settle around 4% to 5%, which would gradually push the debt well past 200% of GDP.

As Charlie Bilello shows, the interest expense on US public debt is rising rapidly and will soon cross $1 trillion per year.

In the words of Paul Tudor Jones "You get in this vicious circle, where higher interest rates cause higher funding cost, cause higher debt issuance, which cause further bond liquidation, which cause higher rates, which put us in an untenable fiscal position."

Legendary investor Ray Dalio said "We're going to have a debt crisis in this country. How fast it transpires, I think, is going to be a function of that supply-demand issue, so I'm watching that very closely." Ray has written extensively about the issue. To end the topic on an optimistic note, Ray writes: "The best way for policy makers to reduce debt burdens without causing a big economic crisis is to engineer what I call a “beautiful deleveraging,” which is when policy makers both 1) restructure the debts so debt service payments are spread out over more time or disposed of (which is deflationary and depressing) and 2) have central banks print money and buy debt (which is inflationary and stimulating). Doing these two things in balanced amounts spreads out and reduces debt burdens and produces nominal economic growth (inflation plus real growth) that is greater than nominal interest rates, so debt burdens fall relative to incomes."

Let's examine yields in more detail. Since the last newsletter in June, yields rose across all maturities, with the long-end rising faster than the short-end, causing the Yield Curve to steepen. 

The Yield Curve is often considered to be a predictor of an economic recession. According to the Daily Shot (via Jesse Felder) and Game of Trades the unemployment rate has systematically spiked following Yield Curve inversions and subsequent steepening.

Rising yields have of course been devastating for bond prices, especially high duration ones, which are more sensitive to interest rate hikes. As an extreme example, the 100-Year Austrian Government Bond experienced a 75% crash since December 2020. 

According to Charlie Bilello, at 38 months, the Bloomberg US Aggregate Bond Index has experienced its longest bear market in history.

Looking at the 1-year rolling correlation between Stocks and Bonds, during the latest recession, bonds have not served as the diversifying asset that they're known for in the 60/40 portfolio. Instead they stayed relatively correlated with stocks and thus they fell in tandem.

So how have stocks been impacted by rising yields? The answer is "it depends". For example, Microsoft locked in low interest rates on their debt in 2020-21 and are now earning much higher yields on their cash.

However, as Charlie Bilello explains, many companies are not in the same position as the behemoth that is Microsoft. In terms of borrowing cost, rising interest rates have hit smaller companies much harder than larger ones. Interest expenses for the small-cap S&P 600 Index hit a record high in the second quarter.

Accordingly, we see that over the last few months, large-cap stocks have been outperforming small-cap stocks.

With this rise in large-cap stocks, the top 10 holdings in the S&P 500 now make up 30.5% of the index, the highest concentration we’ve seen with data going back to 1980.

In fact, Apple, Microsoft, Alphabet, Amazon, NVIDIA, Tesla, and Meta now represent over 28% of the S&P 500 Index.

The situation among small-cap stocks is dire, around 1/3 of Russell 2000 companies aren't profitable - near the highest level in data going back to 1985.

Let's take a closer look at stock market sectors. Year-to-date, 3 sectors drove the market higher: Communication Services (incl. Google and Meta), Information Technology (incl. Apple, Microsoft, Nvidia) and Consumer Discretionary (incl. Amazon).
Consumer Staples (incl. Walmart and Procter & Gamble) and Utilities (incl. NextEra Energy, Southern Company and Duke Energy) underperformed the most.

According to Richard Bowman from simplywall.st, dividend stocks (most common in the Utilities sector) are sensitive to rates for the following reasons: Firstly, these companies use a lot of debt so higher rates means their cost of capital goes up. And secondly, why should you buy a “risky” stock yielding 4% when a “risk-free” government bond earns you 4.5%?

Internationally, US stocks have been outperforming the rest of the world since 2008.

As of September 29, US stocks now make up 62.25% of the MSCI All Country World Index, which includes developed as well as emerging markets.

Similarly, Emerging Markets have been underperforming developed markets since 2010.

Examining emerging markets in a bit more detail, India has been outperforming China by a huge margin  over the last 3 years. This has been driven by Indian companies in the Industrials, Utilities and Real Estate sectors.

Amidst global geopolitical tensions, Gold, a traditional safe harbor, has been shrugging off rising real yields.

The Gold/Silver Ratio has been rising along with the strength of the US dollar.

The Oil/Gold Ratio has been falling along with US Stock Market Volatility.

Commodities, as measured by the Producer Price Index, peaked in May 2022 and have only started to rise again in recent months.

Similarly, Home Prices are on the rise again.

Mortgage rates have been rising faster than other yields with long maturities. The average 30-Year Fixed Rate Mortgage Rate is back at 7.57%, which is the highest reading in 23 years! 

Credit spreads between Mortgages and US Treasury Bonds are as high as during the 2008 housing crisis.

The average house in the US now cost 7.4 times the US median annual household income, which is higher than during the Housing Bubble.

Contrary to what home prices might imply, the US housing market is frozen. Pending home sales in the US have moved down to their lowest level since April 2020, Apartment construction is down and vacancy rates are up.

Meanwhile, affordability is at record lows. The median American household would need to spend 43.8% of their income to afford the median priced home. That’s the highest percentage in history, worse than the peak of the last housing bubble.

Let's finish by looking at Crypto. Year-to-date, Bitcoin has outperformed Ethereum, causing Bitcoin/Ether ratio to fall.

Relative to the entire crypto market, Bitcoin Dominance has been holding its position after it broke out above 47% in June 2023.

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