You are giving the "brain dead" too much credit here in your analysis. Their logic is simply U.S. recession = lower rates -> buy duration. Obvious flaws to this logic aside, this is precisely what people are doing - particularly the RIA and retail heavy TLT holders.
my observation is increasing government spending makes recession unlikely. But I understand the financial logic. I just think the political logic has changed completely... both republican and democrats will spend what it takes to stay in power
Russell, how are you thinking about the governments’ refinancing cycles and the level of interest rates they will need at the time of new issuance? Will that require CBs to bring rates down again or is it feasible for governments to refi at current (or higher) rates?
Weirdly looking back at the 1970s, rising wages meant tax collection was very good. Certainly chimes we what I see - that more power to corporates makes tax collection harder. The current system lets the richest pay the lowest taxes - so I suspect we will see efforts to make tax far more progressive. I suspect a buyback tax to make dividend and buyback pay equal tax will be in the offing. SO higher corporate taxes, higher wages and general inflation should help government balance budgets
Russell what do you think about long alternatives like US TIPS paying high real rates ? James Aiken has been pointing these out recently. Is there a trap as government can manipulate inflation adjustments ?
Yes in theory they should be good... but they have not traded well so far... and yes, the risk of governments not honouring their commitments looms large...
With inflation cooling, global growth anemic, and the tremendous amount of existing debt it seems like the powers that be would want lower rates to fund spending. How high can they go/hold before they can’t afford it. Scratching my dead brain....
As far as I can tell people who buy TLT are preparing for the inevitable yield curve control. Sounds like a reasonable next step towards nationalization of financial markets.
How will the USA handle interest on the national debt being $1 trillon a year? I think once the lag effects catch up to consumers & businesses on these higher rates something will crack in the economy. Only reason it hasn't cracked yet is many homeonwers and corporations locked in low rates back in 2020/2021. But that can't hold out forever. Commercial real estate, businesses borrowing, consumer credit cards, auto loans, home buyers, etc.......will eventually get hit by these rates.
And once the interest rate lag effects catch up to consumers and businesses the economy will contract. And TLT may get a bid at that point or before. I don't see how Russell sees the developed world economies operating with higher rates for an extended period of time. It just can't afford those higher rates.
When governments are driving growth, GDP growth tends to be strong. One thing we definitely learnt from Covid is that when government transfers cash to workers, the spending multiplier is huge. And I think that is policy for the forseeable future - hence growth and inflation will keep surprising to the upside...
Again, agree. This is the new world we seem to live in. Nothing my Econ degree can help with! Now, it makes me wonder what dutiful students are taught in college today!
In spite of my agreeing with everything on this post (it all makes sense in some universe!) I’m making a call: Sept/Oct is when the rate disruption explodes into the economy. What’s my logic? See 1987, 2008, 2019. It seems to take from March to Sept for a market accounting.
How do you see Australia fitting into this story? Cash budget heading back to surplus and government spending as a % of GDP is back around historical averages (mid to low 20%)
Thought I'd found other EFTs as well as leveraged short ETFs both spread bet and CFD but now the short side of them is all closed now too. Just 10 year T and UK Long Gilts.
Russell, can you clarify? How can deficits not matter, but spending does? I'm confused because I see them as highly correlated (unless you are raising taxes).
Typically governments are the largest single employer - so if government policy is to keep wage growth low and cut taxes - you are going to see deficits, but not much inflation. On the other hand, if govermnets are increasing wages by 10% a year, and raising taxes as well, you will likely see limited deficits buy high inflation. US government debt to GDP was only 20% in the 1970s....
Thanks for the reply, Russell. I'm not sure it see your logic yet, probably because of my priors. First, I tend to think of the inflation of the 1970s as a demographic driven phenomenon -- we had a huge swath of Boomers coming of age, globally. Supply chains couldn't meet the demand. Second, I believe the change in debt to GDP is, at least, as important as the static number *at low debt-to-GDP values.
I think we're seeing that today. Debt-to-GDP is high, interest rates are, relative to history, high and, therefore, debt servicing costs are high *while* we continue to run war-time level annual fiscal deficits >5% of GDP. All of this is conspiring to expand the money supply (aka inflation) regardless of monetary policy -- The federal government doesn't care about interest rates and debt servicing costs (for now, anyway).
Last point... I read your employment comment *as if* the government attempted to set wages, like it was an input. It seems to me that employment and wage level is result of the large fiscal deficits. Again, I'm jaded by my prior conclusions on the topic.
Big picture... I agree with all of your conclusions. I can't wrap my head around owning duration at such low risk premiums in the face of enormous, and rapidly growing, federal fiscal deficits.
A theory... I think the low term premium on long bonds *may* be a result of entities that need to ALM, like pensions and insurance companies. I could see them making large, levered bets on long duration assets because they must. We know pensions are woefully underfunded, but everyone needs to pretend that 7% returns are achievable - which requires leverage. Someone has to buyer of the long bonds here... I can't think of anyone else. Can you?
Pensions and life insurers will be forced buyers of duration - all the way down. Fortunately for accounting purposes they can hide the losses... unlike regional banks!
You are giving the "brain dead" too much credit here in your analysis. Their logic is simply U.S. recession = lower rates -> buy duration. Obvious flaws to this logic aside, this is precisely what people are doing - particularly the RIA and retail heavy TLT holders.
my observation is increasing government spending makes recession unlikely. But I understand the financial logic. I just think the political logic has changed completely... both republican and democrats will spend what it takes to stay in power
Looks like Jan agrees with you:
-Goldman Sachs Says This Yield Curve Inversion Is ‘Different'
-Economist Jan Hatzius says term premium is lower than normal
-Consensus is too pessimistic, pressuring long-term rates
Russell, how are you thinking about the governments’ refinancing cycles and the level of interest rates they will need at the time of new issuance? Will that require CBs to bring rates down again or is it feasible for governments to refi at current (or higher) rates?
Weirdly looking back at the 1970s, rising wages meant tax collection was very good. Certainly chimes we what I see - that more power to corporates makes tax collection harder. The current system lets the richest pay the lowest taxes - so I suspect we will see efforts to make tax far more progressive. I suspect a buyback tax to make dividend and buyback pay equal tax will be in the offing. SO higher corporate taxes, higher wages and general inflation should help government balance budgets
Russell what do you think about long alternatives like US TIPS paying high real rates ? James Aiken has been pointing these out recently. Is there a trap as government can manipulate inflation adjustments ?
Yes in theory they should be good... but they have not traded well so far... and yes, the risk of governments not honouring their commitments looms large...
With inflation cooling, global growth anemic, and the tremendous amount of existing debt it seems like the powers that be would want lower rates to fund spending. How high can they go/hold before they can’t afford it. Scratching my dead brain....
Russell, newbie here. what are your thought about TBT as a proxy for short TLT ?
For a short fund (which means higher costs) it is actually not too bad. Directly short TLT is best, but I know that is not available to everyone
As far as I can tell people who buy TLT are preparing for the inevitable yield curve control. Sounds like a reasonable next step towards nationalization of financial markets.
That is a reasonable view... although short dollar seems a better trade for YCC in my view
Or buying gold
Or TIP Bonds
How will the USA handle interest on the national debt being $1 trillon a year? I think once the lag effects catch up to consumers & businesses on these higher rates something will crack in the economy. Only reason it hasn't cracked yet is many homeonwers and corporations locked in low rates back in 2020/2021. But that can't hold out forever. Commercial real estate, businesses borrowing, consumer credit cards, auto loans, home buyers, etc.......will eventually get hit by these rates.
Agree. This is the big adjustment pending beneath the surface of an otherwise calm market façade
And once the interest rate lag effects catch up to consumers and businesses the economy will contract. And TLT may get a bid at that point or before. I don't see how Russell sees the developed world economies operating with higher rates for an extended period of time. It just can't afford those higher rates.
When governments are driving growth, GDP growth tends to be strong. One thing we definitely learnt from Covid is that when government transfers cash to workers, the spending multiplier is huge. And I think that is policy for the forseeable future - hence growth and inflation will keep surprising to the upside...
Again, agree. This is the new world we seem to live in. Nothing my Econ degree can help with! Now, it makes me wonder what dutiful students are taught in college today!
In spite of my agreeing with everything on this post (it all makes sense in some universe!) I’m making a call: Sept/Oct is when the rate disruption explodes into the economy. What’s my logic? See 1987, 2008, 2019. It seems to take from March to Sept for a market accounting.
How do you see Australia fitting into this story? Cash budget heading back to surplus and government spending as a % of GDP is back around historical averages (mid to low 20%)
Totally - house to income ratios imply government forcing wages higher and getting interest rate policy restrictive
What pisses me off is I cannot sell the TLT market to open on IG spread bet.
I can short it as CFD with by broker. I don't use IG spread... there are probably other ways to do it. Maybe ask about the underlying treasury?
Thought I'd found other EFTs as well as leveraged short ETFs both spread bet and CFD but now the short side of them is all closed now too. Just 10 year T and UK Long Gilts.
I’m thinking some complacency on a Biden/Trump outcome. Not that it affects your overall thesis. Dr. Pippa M. who saw Trump now sees outside the two.
I don't think it matters really - all roads to political power now lead though robust fiscal policy
What would Hugh Hendry say? 🫢
buy bonds wear diamonds?
Short bonds wear diamonds?
this is the way
Not sure I see the mandalorian connection - but I like it!
Japan shows you can can run large deficits and still keep rates and inflation at low levels. maybe the Fed will just have to start buying again?
Japanese government did not raise spending... its not the deficits that matter. It whether spending is rising or not
Russell, can you clarify? How can deficits not matter, but spending does? I'm confused because I see them as highly correlated (unless you are raising taxes).
Typically governments are the largest single employer - so if government policy is to keep wage growth low and cut taxes - you are going to see deficits, but not much inflation. On the other hand, if govermnets are increasing wages by 10% a year, and raising taxes as well, you will likely see limited deficits buy high inflation. US government debt to GDP was only 20% in the 1970s....
Thanks for the reply, Russell. I'm not sure it see your logic yet, probably because of my priors. First, I tend to think of the inflation of the 1970s as a demographic driven phenomenon -- we had a huge swath of Boomers coming of age, globally. Supply chains couldn't meet the demand. Second, I believe the change in debt to GDP is, at least, as important as the static number *at low debt-to-GDP values.
I think we're seeing that today. Debt-to-GDP is high, interest rates are, relative to history, high and, therefore, debt servicing costs are high *while* we continue to run war-time level annual fiscal deficits >5% of GDP. All of this is conspiring to expand the money supply (aka inflation) regardless of monetary policy -- The federal government doesn't care about interest rates and debt servicing costs (for now, anyway).
Last point... I read your employment comment *as if* the government attempted to set wages, like it was an input. It seems to me that employment and wage level is result of the large fiscal deficits. Again, I'm jaded by my prior conclusions on the topic.
Big picture... I agree with all of your conclusions. I can't wrap my head around owning duration at such low risk premiums in the face of enormous, and rapidly growing, federal fiscal deficits.
A theory... I think the low term premium on long bonds *may* be a result of entities that need to ALM, like pensions and insurance companies. I could see them making large, levered bets on long duration assets because they must. We know pensions are woefully underfunded, but everyone needs to pretend that 7% returns are achievable - which requires leverage. Someone has to buyer of the long bonds here... I can't think of anyone else. Can you?
Pensions and life insurers will be forced buyers of duration - all the way down. Fortunately for accounting purposes they can hide the losses... unlike regional banks!