A tweet exploded US bonds. What did Bill Ackman, who closed his short position, really see?

Tweet sparks explosion in US bonds. What did Bill Ackman, who closed his short position, truly witness?

Author: Ge Jiaming, Wall Street News

Did hedge fund Pershing Square’s founder and legendary investor Bill Ackman hit the bond market again?

On October 23rd, the hedge fund giant Bill Ackman, who accurately shorted long-term US bonds in this round, announced on X (formerly Twitter) that he has closed his short position on long-term US bonds considering factors such as the slowdown in the US economic growth.

Almost at the same time Ackman made the above statement, the US bond yields quickly dropped during the intraday trading. The 30-year US bond yield plummeted by about 21 basis points, while the 10-year US bond yield, after surpassing 5% for the first time in sixteen years, dropped more than 10 basis points to 4.88%.

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After Fitch’s downgrade of US credit rating, Ackman previously stated in early August that he was shorting US 30-year treasuries, anticipating a surge in US budget deficit and various factors that would push US inflation far above the Fed’s 2% target. He mentioned that it would not be surprising if the 30-year yield climbed to 5.5% in the near future.

In late September, Ackman stated that they were still firmly shorting the Treasury bonds and expected long-term interest rates to rise further. “The combination of long-term inflation rates and real interest rates, plus term premiums, indicates that 5.5% is an appropriate level for the 30-year bond yield.”

Since the end of August, the 30-year US Treasury bond yield has risen by more than 80 basis points, and Ackman has made a fortune.

Why has Ackman’s attitude towards US bonds undergone a 180-degree shift now?

As a member of the Investor Advisory Committee (IAC) under the US Securities and Exchange Commission (SEC), Ackman attended a group discussion on October 19th, and the contents of a speech report published during the discussion provide some insights.

Ackman believes that the US economic growth may unexpectedly slow down, and the Fed should not raise interest rates further. As inflation continues to slow, maintaining high interest rates by the Fed is equivalent to further tightening monetary policy, which would make real interest rates more restrictive. He believes that the Fed’s current policy outlook seems to have not fully taken into account the downside risks facing economic growth, and he suggests that the Fed should gradually begin to cut interest rates.

01 Real interest rates are at an apparent restrictive level

Ackman believes that based on the current level of real interest rates in the US, the current rates are already close enough to the restrictive level. The most important variable that drove the nominal interest rates of US bonds up so far this year is the substantial increase in the US real interest rates (nominal rates minus inflation expectations).

The current real interest rate for the 10-year US bond has risen to around 2.5%, which is less than 0.2% before the outbreak of the pandemic (as of December 31, 2019, it was 0.15%). During the period from 2013 to 2018, the average level was only 0.42%. If we do not consider the extreme case of the US dollar liquidity crisis in 2008, the current US bond real interest rate has returned to the level before the 2008 financial crisis.

Ackman believes that since the 1990s, the real interest rate has only been able to briefly maintain this level at 2.5%.

Powell also pointed out that the current real interest rate is positive, which is conducive to pushing inflation down. According to recent inflation data, the restrictive policies of the past have also been effective in controlling core inflation.

In September, the US core CPI increased by 4.1% year-on-year, showing a downward trend for three consecutive months, with a month-on-month increase of 3.1%. Core CPI is still in a downward channel. Although short-term oil prices face some uncertainty, their impact on inflation expectations is relatively limited.

According to the average inflation rate for three months, Ackman said that the data shows that core PCE is about 2%, and core CPI inflation is about 3%, lower than the inflation rate of 4% to 5% at the beginning of the year.

02 Labor market imbalances are improving, wage growth is slowing

Ackman points out in the report that as of August this year, the number of job openings has dropped from a peak of over 12 million in March 2022 to 9.6 million, a decline of 20%. This means that the phenomenon of labor market imbalances is improving and job vacancies are decreasing.

At the same time, the proportion of resignations and layoffs to non-farm employment has returned to pre-pandemic levels. The Atlanta Fed’s “Wage Tracker” measures the year-on-year wage growth, and the results show a significant slowdown in wage growth.

In September, the average hourly wage for all private nonfarm employees rose by 7 cents to $33.88, with a month-on-month growth of 0.2% and a year-on-year growth of 4.15%, lower than the market expectation of 4.3%. The slowdown in average hourly wage growth indicates a gradual easing of wage inflation pressure, which has a positive effect on alleviating overall economic inflation.

Due to the current resilient growth of the service industry, which mainly relies on residents’ income support, the slowing wage growth will also put pressure on the growth rate of the service industry.

Ackman concludes that the improvement in labor market imbalances and the slowdown in wage growth both indicate that core service inflation will further slow down, reducing the need for the Federal Reserve to raise interest rates.

03 Future US economic growth may slow down more than expected

Ackman pointed out that under the continuous strong boost of personal consumption and government expenditure, the real GDP growth rate of the United States in the past few quarters has remained stable above 2%. However, as the tailwind factors of personal consumption (which accounts for about 70% of GDP) gradually fade away, and downside risks emerge, economic growth will exceed the expectations of the Federal Reserve and slow down:

1. Slowing income growth; 2. Excessive household savings being depleted; 3. Weakening supply and demand for consumer loans, deteriorating credit quality; 4. Lower-income consumers have the highest propensity to drive incremental consumption but also face pressure; 5. Resumption of student loan payments; 6. Early signs of a slowdown in consumer spending; 7. Long-term interest rates rising to further tighten financial conditions; 8. Geopolitical and financial stability risks

Ackman said that the latest transaction data from Bank of America (covering approximately $4 trillion in annual spending) shows that the growth rate of payment amounts has dropped from 12% in 2022 to 4% now. Large investment banks and retailers, as observers of economic activities, have also begun to emphasize the slowdown in consumer spending:

Therefore, Ackman believes that as inflation continues to ease and economic uncertainty increases, the Federal Reserve should gradually begin to cut interest rates: excessive tightening at a time of slowing economic growth may inadvertently catalyze a “hard landing”.

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