BRAINard on capping curve, BARRONS on bad bonds and a MINORITY REPORT (Rosie's view)
They say the more things change they more they stay the same …
Just a couple of years ago (so, pre pandemic) I offered THIS:
Yesterday was the anniversary of THIS SPEECH delivered by the BRAINard who is clear #2 and w politicians FAN FAV choice to help KEEP RATES LOW … p11 onto 12 (of 15)
… For these reasons, I have been interested in exploring approaches that expand the space for targeting interest rates in a more continuous fashion as an extension of our conventional policy space and in a way that reinforces forward guidance on the policy rate. In particular, there may be advantages to an approach that caps interest rates on Treasury securities at the short-to-medium range of the maturity spectrum—yield curve caps—in tandem with forward guidance that conditions liftoff from the ELB on employment and inflation outcomes.
EMPHASIS mine. These are words that should NOT be taken lightly or forgotten…
Now, cycle forward to this morning’s (NOT directly related virus) news and you’ll note
China’s industrial profits growth ACCELERATES in October (RTRS and TRADING ECONOMICS for somewhat more).
Want MORE?
…Industrial revenue growth accelerated to 11.8% yoy in October from 9.5% yoy in September. Sequentially, revenue rose 0.9% mom in October (vs. -1.0% in September). Overall profit margin (total profits divided by revenues) edged up in October (Exhibit 2). Upstream profit margin rose further while downstream profit margin fell. Policy measures to ensure energy supply boosted coal production volume, contributing to further increase in upstream industrial profits in October. As coal prices fell meaningfully since late October upon government efforts, the significant pressure on downstream profit margin may ease going forward.
Everything’s FIXED? Hardly but HOPE springs eternally.
YET … haters gonna hate and bonds are NOT to be considered part of the 60/40 mix. Barrons just LAST WEEK, “Bonds Look Like a Bad Bet Now. Here’s Why.”
… Paulsen took a more expansive look at history, going back to 1926, when much of modern financial record-keeping began. What he found was a sharp difference in the stock-bond return relationship when the benchmark 10-year Treasury yield was above 3% versus when it was lower. Call it the Mendoza Line for bonds.
Looking over that near-century of data, the 10-year yield was below 3% about one-third of the time, he found. When it was above that line, bonds did a good job as portfolio diversifiers, with little reduction in return but a significant cut in volatility. Conversely, when yields were under 3%, shifting from stocks to bonds in order to dampen volatility exacted a heavy penalty in returns.
When the 10-year Treasury was under 3% (as it is now, at 1.53%), stocks averaged a monthly return that generated a blazing 16.9% per annum while bonds averaged just 2.8% (which now seems princely). Shifting to the classic 60/40 balanced portfolio cut the return to 11.1%, or by about two-fifths, in exchange for about a one-third reduction in volatility …
… So, taking refuge in bonds whenever stocks have an inevitable correction may not offer safety. That would likely come to pass if the Federal Reserve acts more forcefully to rein in inflation, now running at 6%.
Please evidence what happened this past week … and advise? It would seem that main stream (Barrons)media has caught on and this morning, the hard copy hitting the newstands offers a correction of sorts. The other side of the coin, if you will, so that in weeks and months ahead, no matter WHAT happened, they will have an issue with a story all about how they told us so.
Fine.
This weekend’s update, “Don’t Bet on Rates Rising in 2022. Here’s Why.” clearly caught my attention.
…Under the less likely scenario, Powell’s second term will become Volcker 2.0, says Ed Yardeni, president of Yardeni Research. That’s a reference, of course, to former Fed Chairman Paul Volcker, who effectively hit the economy over the head with a two-by-four in the late 1980s as he raised interest rates to an unprecedented 20% to curb inflation. Yardeni pegs the odds of Powell channeling Volcker at 25%. It isn’t his base case, but he calls it a risk scenario that investors shouldn’t dismiss.
“They have created a mess they need to clean up,” Yardeni says of the Fed in reference to inflation, adding that the groundwork exists for the kind of wage-price spiral that would require much more aggressive policy action than the two to three rate increases investors expect next year …
Yardeni claiming the Fed is to blame for ‘the mess’ and needs to clean it up — seems to me a bit off the mark (with all due respect). The VIRUS and our politicized macro economic and geopolitical backdrop created the mess and likely will NOT clean it up until / unless the masses of voters take TO the ballot box.
But I digress. The story ALSO then goes on to cite Rosie who simply flat out disagrees and is perhaps one of the most well recognized (despised, disagreed with) card carrying members of Team Transitorian.
… the longtime bear and ardent defender of the inflation-is-transitory argument also thinks interest rates won’t rise much, if at all, for a different reason. Rosenberg says the fragility of the U.S. economy is underappreciated. “The inflationistas who have been calling for inflation over the past decade are like dogs with a bone and they just won’t let go,” he says. “The risk runs the other way.”
Rosenberg rejects the growing consensus view that inflation has spread to stickier places, like rents, and is being underpinned by troublingly low workforce participation. His forecast? Zero rate increases next year and beyond.
“This may be the biggest bet against market pricing I’ve ever had on the books,” says Rosenberg, arguing that the supply response to booming demand, such as in new housing construction, is totally underestimated.
These views stem from his recently unlocked MINORITY REPORT — A Thanksgiving Special which I’ll LINK TO and highlight the following BECAUSE I could NOT agree more if I tried.
… I have to say that in my 35 years in the business, I have never seen such a widespread consensus convinced that it’s smarter than those “dumb” central bankers and that inflation is here to stay indefinitely. Who knew that the first global health crisis in over a century was going to create the conditions for such prosperity, a revolution for workers with no skills or formal education, run-away economic growth, massive public debts that nobody ever has to be worried about, unprecedented asset inflation, corporate credit that no longer needs to be priced off of default rate projections, meme stocks, NFTs and cryptocurrencies making millionaires out of 20-somethings and massive inflation that doesn’t include a corporate margin squeeze? Not to mention taking the crisis and moving the whole world towards a “social contract” rewrite where the likes of Bernie Sanders are carrying the baton for a new left-leaning experiment. This is really incredible material for future historians …
Um, ok … hard to disagree there. Continues,
… It has become commonplace to compare today’s backdrop to the 1970s, but what we know about the 1970s is that when the economy was not in recession (we had four from 1970 to 1982), real GDP growth averaged 5% at an annual rate. We just saw in Q3’s GDP report — and remember that GDP is aggregate demand — that growth falters to 2% when fiscal stimulus fades as it did last quarter (a much bigger impact than the delta variant exerted). So in the 1970s we had tremendous demand pressures for two-thirds of that so-called “stagflation” era. The demand curve, for the most part, did not shift to the left (it only did when the Fed induced a recession) — but that’s the key right now since we know what the supply curve is doing …
Goes on to utter the most hated words in all of finance. It’s DIFFERENT this time (referring initially TO demographics). He goes on to discuss WAGE FLATION a bit, too. In singularity, increasing wages are great (especially if they were for enough people who then could keep up with high and rising prices of other things) BUT,
… The other issue is whether one can talk about wage inflation without taking productivity into account. Productivity growth in the year to the second quarter in the non-financial corporate sector was +4.4%, considerably higher than it was in the 1970s. Unit labor costs, as a result, are running at -3.0%, which compares to an 8.0% annual rate during the 1970s. Yes, we have a huge run-up in energy prices, but this only affects 3% of spending today versus 10% back in that hotinflation era of the 1970s. And remember — during that inflationary period, we endured 16 separate oil price shocks which took the price up an incredible 11-fold.
Everyone is entitled to their view. And inflation may well become more entrenched than I think, as I too am formulating my conclusions based on my own assumptions. But this is nothing like the 1970s, no matter your forecast …
AND a few words on RATES for good measure,
… Interest rates cannot back up much without inducing a destabilizing run-up in debt-servicing costs, and that is why Powell got stopped out at 2.5% on the funds rate at the peak of the last cycle, falling more than 50 basis points short from where he wanted policy to go, and the next thing you know there is a 20% drawdown in equities and the credit market froze up, creating the conditions for the famous “Powell Pivot.” The tightest labor market in 50 years, the most protective President since Herbert Hoover, a massive tax reduction, a recordhigh (at the time) fiscal shortfall, a quintupling in the stock market and the longest economic expansion in recorded history, and even with all that, what we saw was the lowest peak in the policy rate since the 1930s.
So yes, the Treasury market is now pricing in quite a bit of Fed hikes (more than the central bank says it intends to do) and inflation (breakevens are up to multi-year highs), but we have seen this before. Shoot first, ask questions later. As I said, nothing moves in a straight line. Go back to those Bernanke “green shoots,” the huge Obama infrastructure package ($1 trillion in current dollars — maybe in today’s environment that isn’t so huge, after all), endless QE and negative real rates, and guess what? We had the 10-year T-note yield ratchet up from 2.51% on March 18th, 2009, to 4.01% on April 5th, 2010. Look it up. As painful as that move was, patient fixed income investors were ultimately rewarded. From May 2nd, 2013, to December 31st of that year, the 10-year yield soared from 1.66% to 3.04%. And the 10-year yield also went from 1.37% on July 5th, 2016, to 3.24% as of November 8th, 2018 …
For MORE on rates backing up becoming destabilizing, SEE BRAINards views and ideas and in as far as Rosie’s conclusion regarding ‘flation is that it’s more price DISTORTION caused by acute supply imbalances which WILL right itself even though it’s taking longer than widely anticipated.
This debate is far from settled and we’ve all got a right to an opinion (not our own set of FACTS). We’ve also got a right to vote and that is something ELSE we should all continue to be thankful for, regardless of which side you take….As always, any / all thoughts / comments welcome.
-Feiss