Alright so the madness of the past month or so clearly needs explaining. If you want the tl;dr version, it's not actually the bond market directly, it's just pure market irrationality and a bond run triggered by the texas snowstorm/not a long term thing. But here's the full (long) post of just what has sent everyone's heads spinning over the last three weeks:
The last week looks like this (all triple levered):
The last month looks like this:
And the year to date looks like this:
As you can see, everything except the dow topped out on the 16th of feb and then commenced a run of absolute madness (plummets, spikes, and everything in between) from there on out. There's been both a downtrend on average and a massive increase in volatility.
If you were to believe the talking heads on the news, there's been a huge run in the bond market and this is smashing risk stocks. Whilst this is correct, it's like usual, only half the story. What we need to understand is WHY this is going on and to put it into context.
If you were to only look at 10 year treasuries over the past month, you'd be forgiven for thinking "oh yep, big spike, classic inverse correlation with stocks as the risk premium and p/e both get whacked, exactly what you'd expect":
I've marked 1.3 for a reason, and I'll explain why in a moment.
But look at the 10 year yield over over the past year:
Didn't exactly start on the 16th of feb, did it?
So in a classic case of post-hoc analysis, all the talking heads are pointing to previous articles like the following and being all "yeah see people were concerned about this ages ago":
And then followed this up with the previous carryon about the 1.3% point. I mean, everything went mental and flipped at the nice round 1.3% point so that must have been it, right?
Well, no.
Remember that inflation fears play a huge part in bond markets. You're not going to loan money out if inflation will eat away any returns you make, are you? So if inflation is high, you're going to want your return to be above the inflation rate in order for your investment to actually be worth something by its expiry. I mean, that all makes pretty obvious sense I would have thought.
Now, there was something that triggered massive inflation fears on the 16th but it wasn't any kind of actual inflation data like CPI numbers getting released or something like that, oh no.
What happened was that a once-in-a-century weather event, a massive snowstorm (because we haven't had enough once-in-a-century events lately) absolutely smashed an enormous part of the united states' power grid in its
south, where power-producing assets are not built for cold weather endurance because, well, it never snows there. Until it did:
It was so bad that it even got its own wikipedia pages:
Of particular note is this one, all the political BS about renewable energy began virtually immediately but reality was that even the fossil-fuel derived power generation was smashed on account of not being built to handle the cold:
And so that all went very quiet very quickly.
But what couldn't be swept under the rug was what this did to power prices. Remember, as it shows in the wiki entry above, in texas they couldn't even import their power from other states, so power prices went stratospheric. Remember, pay close attention to the dates of everything in this post:
And
this is what triggered the massive inflation fears. This was so bad that even
hospitals, perhaps the only buildings actually outfitted with any kind of redundant power system (all hospitals have onsite generators precisely to keep them going in the event of a power outage) had to be evacuate.
And to be fair, can you really blame markets for getting worried about this? Texas actually has a massive and growing tech sector and is well on its way to becoming the USA's #1 tech state as companies are bailing out of california like mad so you can imagine just how concerned an awful lot of companies and investors (and therefore money) became about this.
However, like all market reactions, it was an overreaction.
Texas is the country's energy capital, both in terms of greentech and conventional power. It's by far the top U.S. state in terms of wind power generation, it is rapidly moving up the ranks for solar power, and everyone understands' that it reigns supreme in oil and natural gas.
The storm front seized up
everything. It coated wind turbines with ice, forcing 7GW—approximately 10% of Texas’s available grid--offline. It turned associated water that often occurs as part of natural gas production to ice, shutting in half of the state's production. Oil was similarly impacted, stopping some two-thirds of Texas’s output. Between these direct issues and follow-on ones – water coolant at nuclear power plants froze, forcing shutdowns; insufficient natural gas led to fuel shortages shutting down nearly 17GW--approximately 25% of Texas’s available grid; oil and power curtailments necessitated shut-downs of the bulk of Texas's refineries leading to mass gas station closures – some seven million Texans lost power. Some for days.
Anti-Green voices were quick to condemn the wind turbine issues as proof that greentech will never work. Anti-fossil fuel voices were quick to condemn conventional fossil-fuel thermal-power generation as broken beyond repair. Both are wrong. Deliberately, stupidly, hilariously wrong. What happened is a lot more basic:
Texas doesn't normally get winter, and so isn't winterized.
But the good news is that this is actually going to be absurdly,
comically easy to fix. Peter Zeihan explains below:
"The technologies and equipment required to operate energy systems at temperatures below 20 degrees are not new. They have been used regularly for decades in places as far removed as Ohio, Oregon, West Virginia, Peru, Tajikistan, Chechnya, and Bosnia. They aren't technically difficult. They aren't overly expensive. What they are is usually unnecessary in areas that never have winters. You're just not going to see things like heating elements embedded in the blades of wind turbines or insulation on natural gas pipes in places like Brazil, Sicily, Vietnam…or Texas.
The entire incident has dented Texas' reputation (for now) as a low-regulation, low-risk and above all else low-cost place to do business. Winterizing isn't difficult or overly expensive, but it cannot be done overnight, and it is not free. Those costs must be passed on to anyone who uses fuel or electricity, which is, well, everyone. I still believe Texas will be the U.S. state that will do the best in this rapidly deglobalizing world we are entering, but some of the shine has undoubtedly come off.
A post-mortem of the recovery process will make it very obvious which pieces of infrastructure will recover more quickly. Burst pipes must be repaired or replaced. Homes that require natural gas for heating will have to have everything inspected to prevent catastrophic follow-on fires and explosions. Coal piles that have frozen through all the way to the ground will take several days to fully thaw. But wind turbines? A little sun on the blades and they can start spinning again.
We've all assumed that the intermittent nature of greentech generation is a negative, necessitating it being backed-up and balanced-out by more reliable conventional electricity sources like natural gas burning power plants. For the most part that remains true, but this coming week Texas will demonstrate that in some circumstances wind is actually more reliable than supposedly rock-solid, non-intermittent, fully-dispatchable fossil-fuel driven power. That unexpected lesson will lodge itself into Texans' collective subconscious and color infrastructure decisions for years.
That lesson will find itself reinforced by the issue of longer-term costs.
Safeguarding wind turbines so the events of this past week can never happen again only requires some built-in heating elements or a few drone ports to manually de-ice. Once (or maybe twice) and done. But safeguarding more conventional power generation? Insulating every above-ground oil, natural gas, and water pipe in a state that's bigger than France? Building out internal storage for coal piles at coal plans? Developing natural gas storage depots rather than relying upon just-in-time fuel deliveries? Insulating the country's largest concentration of petroleum refineries? Each incremental improvement might be easy, but Texas will need to upgrade everything. The cost will easily run into the tens of billions.
But Oklahoma does this as a matter of course".
So in summary?
It's not nearly as bad as everyone think it is. Expensive to fix yes, but not overly
difficult, and that's the key takeaway here: Winterising everything will be expensive and annoying, but not
difficult.
So long term, it's a speed bump. Nothing more. But our headache in the short term is that
the markets haven't figured this out yet.
In fact, the fears are so bad that a run has effectively been triggered on bonds and risk stocks, with 10 year treasuries continuing to scream and risk stocks (like tech) continuing to be smashed day after day after day.
We had a brief respite on thursday when the CPI data was released and inflation was actually
below expectations and so everything flipped immediately: