"Are Rock-Bottom Bond Yields 'Irrational'? -Gavekal
Supply, data and a few observations from the sellside...
Good morning and happy Monday (said nobody, ever). The beginning of the end of the year is upon us and looking at 30yy weekly, I’m hard-pressed to see anything definitive
How do YOU read global markets ink-blot test?
Since it’s going to be one of those weeks where you wish you weren’t here but then, with year-end position squaring and increased CHANCE for volatility, you may wish you were. Whatever the case may/may NOT be, I thought I’d add a couple things from the inbox over the weekend as well as refresh/remind what I sent along over the holiday weekend in the case you missed.
First, in as far as DATA goes overnight, Chinese Industrial profits fell sequentially in Nov (GS)
Bottom line: China's industrial profit growth moderated to 9.0% yoy in November. In sequential terms, industrial profits contracted 16.8% mom non-annualized sa in November after a sharp rebound of +19.7% mom in October. Industrial revenue rose 2.3% mom sa in November. The gap between upstream and downstream profit margins remained wide.
Also from Goldilocks over the weekend, the latest econ analyst production with
10 Questions for 2022
…We expect Congress to raise spending only modestly in 2022. While Congress is likely to approve some new spending on manufacturing and supply chain-related incentives, we no longer expect the Senate to pass the Build Back Better bill and the near-term spending it includes on extension of the expanded child tax credit. This implies that fiscal support will drop off more sharply, from a nearly 6% boost to the level of GDP now to 1.5-2% by 2022Q4.
Largely for this reason, we expect GDP growth to slow to a below-consensus 2.4% on a Q4/Q4 basis (or 3.5% on a full-year basis). Further reopening of the service sector, a boost to consumer spending from pent-up savings and wealth effects, and inventory restocking should all support growth next year, at least once Omicron risks diminish. But we think that consensus underestimates the size of the fiscal headwind.
With labor demand red hot and enhanced unemployment benefits now expired, we expect the unemployment rate to return to the pre-pandemic 50-year low of 3.5% by the end of 2022. Labor force participation is likely to remain below the pre-pandemic trend, though this looks largely voluntary or structural.
The current inflation surge is likely to get worse before it gets better, but by the end of next year we expect core PCE inflation to fall to 2.5%. Admittedly, the key driver of our forecast—the partial resolution of supply-demand imbalances in the durable goods sector—is hard to time. But we do not see underlying wage growth or inflation expectations as inconsistent with the Fed’s 2% inflation goal, and therefore expect inflation to begin to come down meaningfully.
High inflation is likely to keep the Fed on a quarterly tightening path next year. We expect the FOMC to raise rates three times starting in March and to announce the start of balance sheet runoff, which is likely to proceed more quickly than last cycle. Our forecast calls for three additional hikes per year in 2023 and 2024 and a terminal rate of 2.5-2.75%. Market pricing is much lower than this, and we expect it to move up over the course of next year.
Seen this chart before and seems like nothings changed. They are, then, more confident than ever before and thats great.
They say that all opinions are created equally (and we all know how some opinions are MORE equal than others). Here’s another view of WHY low USTs rates may not be irrationally exuberant, from Evergreen Virtual Advisor guys (GaveKal), Anatole Kaletsky asking
Are Rock-Bottom Bond Yields 'Irrational'?
What has been the most surprising financial event of 2021? The 20% gain in equity prices, the 40% jump in oil prices and even the fivefold leap in US inflation may all have been bigger than expected, but they were at least directionally understandable consequences of the fastest growth in the world economy for 40 years. That explosive growth, in turn, was a predictable response to last year’s unprecedented monetary and fiscal stimuli, magnified by the end of Covid lockdowns. A more surprising event than the performance of equities or energy, or even inflation, was also arguably more important, not only for financial markets but for global economic prospects.
The 10-year US treasury yield, which was almost universally expected to rise back into the 2-3% range that it had inhabited before Covid, is ending 2021 well below 1.5%. And the 30-year bond yield, which had never in history plumbed levels below 2% prior to Covid, is trading today at 1.8%. That is exactly where it was back in January, when US inflation was running at 1.4% instead of 6.8% and when much of the world economy was still in lockdown.
…If we accept that bond markets are inhabited by reasonably intelligent people who make rational decisions within their investment mandates, then two explanations of “surprisingly” low bond yields are possible, with diametrically opposite implications for equities and other assets.
The most common rationalization of bond market behavior, for which there has never been much evidence, is that bonds are “smarter” than equities— and that at present bond investors “know something” about the dismal long[1]term prospects for global growth and inflation that is not apparent to lesser mortals. Bond investors are therefore happy to buy low-yielding securities because these yields will move even lower, as they have in Japan.
The second explanation, which I find much more plausible, is that bond yields tell us almost nothing about the long-term prospects for growth or inflation. This is because the majority of investors who now dominate bond markets do not really care about what may happen to the US or world economies in 10 or even five years’ time. The marginal players who determine market pricing in bond markets today do not buy 10-year or 30-year bonds in the hope of making a modest real return by holding them to maturity. Instead of the traditional buy-and-hold investors still assumed in economics and finance textbooks, bond markets today are dominated by four very different groups of market players…
… there is nothing irrational about buying long-term bonds at negative real yields that are far below the “natural” or “equilibrium” levels assumed in textbooks of economics and finance. Since hedge funds, reserve managers and regulated investment institutions now far outweigh traditional buy-and-hold bond investors, governments and central banks should be able to keep long-term interest rates at very low levels for many years ahead, as long as inflation does not get completely out of hand.
And from recent sellside observations (and Goldilocks, specifically), 10yy back TO 1790
… AND finally, in the case you missed these updates from the holiday weekend and are looking for something(s) to read as you prepare to cope with hours of boredom and moments of panic, see Observations from global Wall Street’s inbox … and Weekly economic indicators … They may help ease the pain of having to be here this week.
That’s it for now. Off to the day job!