Ahead Of The Fed: Bessent, Bullion, Bans, & Hawkish Bias

Authored by Peter Tchir via Academy Securities,

Before jumping into the Fed, let’s just spend another minute on diesel, and Bessent’s “Performance” which along with Warsh’s Difficult Task, were formed the bulk of last weekend’s Never Forgotten! And Some Work Stuff…

Bessent’s “Performance” & Bullion

On the Treasury buyback, we didn’t even get to the full $6 billion. The buyback focused on off the run treasuries, deemed as “cheap”, but not cheap enough that the Treasury Department would “overpay”. If you really want to move bond yields lower, because they are “too high”, using the full amount you said you could use (which is still far too little to make a dent), and ripping through offers would be a good start. Bessent is nowhere close to a “whatever it takes moment” on Treasury yields.

More chatter about “marking gold to market”. I’m incredibly comfortable with selling gold to raise money. I’m comfortable with marking to market the gold holdings (and even other assets the U.S. government owns or has rights to). We never look at just the debt side of a corporate balance sheet. We examine both the asset and liability side, so why not spend more time on the asset side of the U.S. government balance sheet? I’m less comfortable with using those mark to market gains to “create” value that can be used to buy back debt. I can see some of this, but it gets a bit weird.

Hearing more chatter about marking gold to some fictitious price that generates far more than the current value of just over $1.1 trillion. Not sure if there is an basis for this, but it has come up in some conversations.

• Selling some gold and using proceeds. A++ (I don’t buy into the importance of gold holdings for reserve current status). I’d prefer proceeds to start a sovereign wealth fund, but that is probably a stretch given the admin’s current focus on bond yields.

• Marking all gold higher and using the gain to reduce this year’s deficit. Let’s call that a B+/A-. Using the mark to market gains to fund bond buybacks? Down to a C in my book.

• Marking gold to some random number, not supported by anything, other than to generate a huge gain? D- or F.

Something to keep an eye on.

Diesel Export Bans

We harped on the fact that shortly after the initial attacks on Iran, China put export restrictions on a variety of refined products. That played havoc with global markets, with Asia particularly hard hit. While not every declaration of “force majeure” (I love that word), in the region was directly tied to China’s actions, it didn’t help.

It did help Global ProSec™. It is bad enough to expose yourself to “cheap” energy products from an unstable/risky Middle East, but depending on China has its own set of problems. Just like the U.S. felt the pressure on processed and refined rare earths and critical minerals (and is doing more about it), Asia felt China’s hand on the scales of their economy in a bad way, that they could do little about.

Hence, Australia announcing first new refinery in 60 years and spending more on oil exploration than they have in at least a decade.

The U.S. banning diesel exports should help drop prices in the U.S. (I will give the benefit of the doubt to the admin on this one). Though how quickly prices would drop, would depend on how quickly the ban took effect and what it encompassed. Full suspension of the Jones Act would be required (again) – currently it is on a shipment by shipment basis.

Having said that, it should “energize” (pun intended) every country’s efforts to secure their own domestic energy resources better.

It may do more harm than good over the long term. There was a lot done in the name of COVID, that fell into a “let bygones be bygones” bucket. It was a global shock and one that the world had little experience in dealing with. It was no country’s fault (other than maybe China, but I’m not going to put my tin hat on today).

Cutting diesel exports now might hit differently. It is high, but “shockingly” high? Probably not. Is the price action directly linked to the attacks in Iran? Incredibly difficult to argue with. Has Ukraine’s increased attacks on Russian refiners also added to the price problems with diesel? Yes, to a degree. China’s ongoing restrictions are also hurting. So is there a strong case to disrupt trade deals between companies (or countries) right now? A case so strong that it would not cause a shift in long term behavior regarding the status of these deals going forward?

If the U.S. seriously proceeds with this, expect foreign energy stocks to do very well. U.S. energy companies should continue to do well as they are global in nature and will in many cases benefit from increased global tolerance to harness and use the resources at their disposal.

To The Fed – Finally!

Sorry, that took a bit, but kind of more excited about highlighting some other things that might not be getting any attention with all eyes focused on the Fed.

Rate Decision:

• I don’t think they should hike, for all the reasons we’ve been arguing about for the past few weeks, but let’s assess what is likely.

• 5% chance of a 50 bp hike. Seems unlikely, but if you want to set the stage for a “one and done” or better yet (in my opinion) a hike that can be undone the moment a deal with Iran is reached and oil prices do come down, there is a certain appeal to this approach. Long end of the yield curve should respond very well. Stocks would likely bounce around trying to get more direction from the press conference.

• 80% chance of a 25 bp hike. Largely priced in. Bond yields and stocks will need to focus on details, the vote count/dissents and the press conference to get real direction.

• 15% chance of no hike. Long end of the yield curve would see yields move higher almost instantly. Stocks probably rally initially.

Language, Press Conference, Dissents:

• Ongoing hawkish bias and inflation vigilance. Flatter yield curves with front end yields rising and longer end yields going lower. Stocks would sell off into the close. Low probability.

• A maintenance/pre-emptive hike well explained. If they can include some arguments from the T-Report, on why they took this step, but push towards being able to unwind it, rather than cementing it as a first step in a hiking cycle, longer dated bonds start fading (maybe not today, but in the coming days), but stocks can rally. Medium probability.

• Confusing, poorly explained thought process. Bonds and stocks sell off. Medium probability.

Wild Cards:

• Warsh seems comfortable with existing balance sheet size. His desire to shrink the balance sheet over time is well known. It adds an “edge” to the market. If he argues along the lines that “now is not the time” or “it is at an appropriate size for current market conditions” or something that should help bond yields a bit. Pushing off the risk of declining liquidity from the Fed would be good for stocks and bonds. Low/Medium probability.

• Opening the door to a Fed Operation Twist. Powerful for bonds and stocks – nearing a “whatever it takes moment”. Very low probability 

Bottom Line

As much as the market is looking forward to clarity, and getting “what is priced in”, I suspect that by tomorrow there will be more questions than answers and the push to higher yields, across the globe will resume.

We need a breakthrough in the war(s), or a slowdown in compute spend (all of which could occur) to take some pressure off of global bond yields which remain more about supply, than inflation, but the two are linked via the global reconstruction of energy supply chains (a big part of Global ProSec™).

It would be refreshing to see Warsh dissent, but for a hike to go through. Seems unlikely, but would be cool, and probably good for markets.

Good luck as we all spend the time until 2pm, second and third guessing our positioning ahead of the Fed. They should really do this announcement and presser in the morning!