Hello my friends. Today is September 12th and this is Markets Weekly. All right guys, so last week was a super interesting week in markets. Looking at the bond market, you can see that we had a huge huge sell-off with a 10-year yield rising to almost 5%. So today, first let's talk about the huge carnage in the bond market. Talk a little bit about Secretary Bessent's buyback program and how it disappointed the market. And lastly, let's talk about how the Fed is set to not just hike rates next week, but to begin a proper hiking cycle with the market pricing in as many as four hikes in the next 12 months.

All right, starting with the bond market. So, just look at this chart of the 10-year yield. It looks like it's going parabolic in just a few days. It's basically surged to almost 5% and maybe it will get there and beyond in the coming weeks. So again, the sell-off was across the curve. 30-year yield rise to about 5.35%.

So what is driving this? Well, let's think back to our episode last week when we were going over some popular stories trying to explain what's driving yields higher. Popular story number one, huge fiscal deficit, large amount of sovereign debt. So is it going from 40 trillion to 40.1 trillion in a couple weeks that the market, you know, just can't handle it? It's the straw that broke the camel's back and it's revolting. Or is it crowding out by AI hyperscalers? Did many hyperscalers come to the market the last week and suddenly issue a whole bunch of debt? Or is it the surging oil prices due to escalation on the geopolitical front?

Guys, this is such an easy easy question. Anyone who has been following markets the past few months can say war on, yields up; war off, yields down. Honestly, the people who are selling these other alternative stories, I'm getting the sense that these guys are actually propagandists for the war cuz what they're saying is just so ridiculous.

All right, so last week we did have significant geopolitical developments. So the Houthis, a militant group in Yemen, have made some very successful offensives and taken over the city of Mocha. Now rewind the past few months again. Iran mostly shutting the Strait of Hormuz. Some barrels are still getting through with the escort of the US Navy, but it is disrupting shipping in the Strait of Hormuz. So in order to counteract that, nations like Saudi Arabia have been going to their plan B, which is shipping oil from the Red Sea, maybe through the Suez Canal or through the Bab-el-Mandeb Strait. So despite the complications in the Strait of Hormuz, some Middle Eastern oil is still getting through. Now after taking control of Mocha, the Houthis now have power to disrupt shipping through the Bab-el-Mandeb Strait and so that could potentially shut down this release valve where Saudi oil has been getting out.

Now in addition to that, we also had news that the Saudi East-West Pipeline has been temporarily shut down due to drone attacks that originated from Iraq. So it looks like again Team Iran is tightening its control over Middle Eastern oil. So not just trying to double down to control the Strait of Hormuz, but also having its friends shut down other potential exit points. And that additional pressure is pushing oil prices higher. Looking at this chart of spot Brent, you can see that oil prices have surged. They're not quite at the level of the panic earlier in the year, but they're definitely getting there.

Now what's been buffering the oil shock has been the SPR that we have in the US and many other countries have, and notice that they've been steadily dwindling. Now nobody knows what is the exact operational floor of the US SPR, but many people think that it could be any moment now. So we are definitely going into a phase where less oil is getting out of the Middle East, our stocks are running down, and also news suggests that the Chinese are back in the market buying so there's more demand. All that is squeezing oil prices higher, and not just crude oil, but looking at prices like diesel, gasoline, basically the refined products, those prices are rising as well.

This suggests higher inflation not just in the US but globally, and as inflation concerns percolate, the central banks are going to be forced to react. This past week, we had the ECB hike the second time this year and it's forecast to hike again this year. So it looks like the ECB is reacting to it, and as we'll talk about later, it looks like the Fed will have to react to this as well. So, as the market begins to price in more rate hikes, that is sending global yields higher. Again, such an easy and obvious story, it's unbelievable that anyone is saying anything else.

All right, the second thing I want to talk about is this Bessent buybacks. So, a couple weeks ago, Secretary Bessent looking at the 30-year yield passing 5.3% was upset. Basically told people that he is going to greatly expand Treasury buybacks as a way to cap yields.

So, the 30-year again trades in part due to the expected path of Fed policy, but no one really knows what the path of policy is 30 years into the future. So, there's a stronger supply and demand component. The theory is that you go out and you buy 30-year bonds, more demand, private sector has less supply, so the price goes up, which is to say the yield goes down. And on the announcement of the expanded buybacks, originally there were 2 billion buybacks scheduled, the Secretary expanded it saying that he would do, you know, at least 6. So that could potentially be a big source of additional demand, reducing the float of 30-year bonds, pushing yields lower. At the announcement, you did have a pretty notable reaction where the 30-year yield declined.

Now, in the following days, the market got more clarity about this plan. The market was hoping, hey, maybe the Secretary would say 10 billion in buybacks just to really surprise the market, show that we have a big bazooka, really show the market that he's serious about getting 30-year yields lower. But the market was very disappointed to see that he didn't actually offer a big bazooka. He just offered 6 billion in buybacks, which is higher than the 2 billion initially, but did fall short of the market's expectations, and at that time the 30-year yield went higher showing the disappointment.

Now this past week we finally have the actual execution of the first expanded buyback operations and it was also a disappointment. Looking at the results, you can see that although the Treasury was willing to buy back 6 billion, it actually only bought back 5.1. So, not only did the maximum sizing of the operation disappoint, the actual execution disappointed the Street as well. And so, that could be part of the reason why you have the 30-year bond note not just rising past Secretary Bessent's 5.3% panic point, but now trading about 5.35%.

Now one reason for this could be that Bessent hasn't actually executed this correctly. So at the trading desk of the New York Fed we used to do QE, and I think this is probably still done through the trading desk as well, is that when the official sector, so the Federal Treasury, buys stuff from the Street, it's done through primary dealers in a reverse auction format. What happens is that the primary dealers offer to sell the Fed securities and the Fed decides whether or not to buy it. The Fed decides whether or not to buy it basically based on some valuation metrics, you know, spline and cheapness of market and so forth. So they will only buy things that they think are cheap.

And that's the whole point too, I mean that's to provide liquidity, clean up things in the markets that are trading too illiquidly. So I think the way that Bessent would need to tweak this is to change that and to make sure that when they buy stuff they're buying stuff that is expensive, right? They're basically overpaying. That's the whole point, right? If you overpay, then you're going to buy more stuff and you're going to jack the prices up, which is another way of saying push yields lower. So expanding the size of the buybacks is not going to do anything. What he really needs is to tweak the buyback algorithm so that they're buying expensive things. So hopefully he'll do that. He's a smart guy, I'm sure he'll figure it out. I mean, the yields are really not going his way.

All right, the last thing we want to talk about is what is basically all but certain to be a Fed hike next week and a hiking cycle to come. Now, as I talked about two weeks ago, Chair Walsh basically promised a September hike and now the market is on board as well with the market now pricing in basically a 90% chance of a September hike.

Now, last week we did have some dovish commentary from let's say Governor Powell and so forth. These are influential people and they were not really on board for a rate hike unless they saw a hot CPI print. So, Governor Waller was pretty clear his line in the sand as to what he expected to see. He wanted to see a hot core CPI that would translate into a hot enough core PCE, then he would be for a September hike, even though in that speech, as we discussed, was quite dovish.

So, the August CPI really was for the most part on point. But when you look at it, you can see that core CPI was hotter than expected and it was just hot enough to be above the threshold delineated by Governor Waller. So there's a reaction function now, right? Told you what his reaction function is, data met his reaction function, and now he's for a hike. And we know that Walsh is for a hike, and so the market saw the CPI print and all but fully priced in a September hike next week.

And I know there are people who are in denial about this, but these people are very obviously not specialists in this area. People who complain about the August CPI will say, well, you know, this is just a one-off driven by cell phone services and so forth. And they're right, but I think the trajectory as we look at it is that there are just one-offs all the time. One-off here, one-off there. If you keep having one-offs and you just ignore them, then you're not really doing anything and inflation keeps going higher.

So, what is though a much more interesting story is that the market is not just pricing in a rate hike next week, but it is now pricing in four hikes. So, the entire trajectory of Fed policy has shifted significantly in just one week. For the past month, I'd say the market was basically just pricing in say two hikes, a mini hiking cycle. On Friday, priced in four hikes. That is a huge sea change in how the market is thinking about this.

Now what could have happened is that the market is beginning to see that this inflation from energy prices could be a persistent thing. You have the President talking about suggesting that maybe this will go on, you have news reports suggesting that it may go on through the President's term, and so if that's the case I think the market is also becoming more comfortable with an extended hiking cycle.

Now I will say that the market reaction to the August CPI was very surprising to me. CPI hotter than expected, you would expect the equities to sell off, right? But actually equities jumped, gold surged a little, sold off throughout the day. That was really weird to me. I don't know, it could be for example people taking off hedges, you got that V crush sending things higher. I'm not sure, but it was a weird reaction. But the bond market reaction, I think, was much more understandable.

So, you had basically the front end and the belly sell off. So, yields rising in the front end and the belly, but you had just the long end coming down a little bit more. And that is the market saying that the Fed is going to hike, it's going to be a hiking cycle that gets inflation under control. And so you have the long end not so worried about inflation becoming unglued. So this is actually a positive reaction.

If the Fed doesn't hike next week, I'm thinking the bond market would really implode. Because that's the Fed basically being under control of the Trump administration, right? The test of whether or not you have an independent Fed is whether or not you can hike rates. And with the market fully expecting this and with the inflation data and oil prices and all that stuff trending higher, if you don't hike rates next week, I think you will have a total implosion in the bond market next week in the long end. The short end of course has to follow the Fed policy expectations, and it's not even clear it would be positive for risk if you had say the long end go up 20 basis points in a day.

So, in any case, next week looks like it's going to be a very interesting week. Fed meeting, we'll get the dot plots and all that stuff. And I'm getting to think that it will be quite hawkish. And even though many people scoff at even the idea of the Fed hiking in September, I think a hiking cycle of let's say three hikes is not unreasonable. You're basically undoing the cuts you did last year.

And I guess a lot would depend upon what happens in the Middle East and of course the equity markets. So this Middle East situation has the potential to be quite severe. It seems like the Iranians really want to ruin the Republicans' midterm election chances and they certainly have the tools to do that.

I think the war will end immediately after the election because they can't hold out any longer. They're desperate to try and affect the election so that we can get a nice weak group of people in there.

All right, I'll be back next week to talk about my thoughts on the Fed meeting. Talk to you all then.