Of course you do. Because you are a person who reads everything Heisenberg writes, aren’t you? Heisenberg is like Frederick Douglass: “an example of somebody who’s done an amazing job and is getting recognized more and more.”
No but, self-deprecating humor and obligatory Trump jokes aside, that Dimon piece was actually pretty funny because it underscored the extent to which, when it comes to 10Y yields, everyone is probably thinking a little too hard about “magic” numbers, arbitrary “lines in the sand” and “pain thresholds”, and not hard enough about the “how” and the “why” behind rate rise. The latter considerations are far more important when it comes to assessing stocks’ ability to digest higher yields. Why are yields rising (is it “good” yield rise tied to growth expectations or something else)? How fast are they rising (the rapidity matters more than the level when it comes to flipping the stock-bond return correlation)? And on and on.
But hey, when the topic du jour is “magic numbers” and Jamie Dimon tosses one out (4%), it makes for great stories, even if his point was actually to say that 4% is something folks should generally be able to handle.
Well joining Jamie in the 4% camp is Macquarie, whose strategists were out on Wednesday with a sweeping new piece called “The End Of The Great Bond Bull Market: Breaking Through To The Other Side.”
They begin by splitting the bond bull market into 3 phases and I’ll just run through these quickly via some brief excerpts from the note which, in its entirety is nearly two dozen pages long.
“Phase 1” is The Volker Disinflation. Here’s Macquarie:
The first 17 years of the bond bull market were mainly about unwinding inflation. 10-year bond yields fell by around 10 percentage points between their 1981 peak and 1998, as observed inflation fell by around 7.5 percentage points on a 5-year moving-average basis. Inflation expectations fell commensurately over this period, and stabilised alongside the flattening in headline inflation. While actual inflation fell a little further in the most recent 20 years (largely post-GFC), it is notable that 10-year ahead CPI inflation expectations have remained remarkably stable over this period at a little over 2%.
And then came the fabled EM savings glut:
In response to the Asian financial crisis experienced in the late 1990s, many developing economies sought to reduce the potential for future crises by pursuing policies that encouraged domestic saving (to build up foreign exchange reserves and reduce external debt). As we would expect, this manifested itself in higher current account surpluses among EMDEs. Between 1998 and 2006, EMDEs as a whole shifted from an aggregate current account deficit of 1.5% of GDP to a surplus of 4.8% – a dramatic 6.3% of GDP (or 1.6% of global GDP) addition to annual global savings. While this indicates observed (as opposed to desired) savings-investment outcomes, it occurred without any apparent change in preferences among advanced economies, suggesting a causal link to growing global imbalances and falling interest rates.
And then of course there’s the post-crisis era defined as it was (or maybe “defined as it is” is still better although you know how that goes – “it depends on what the definition of ‘is’ is“) by the secular stagnation meme and QE, with the latter serving to depress the term premium and the former contributing, supposedly, to the endemic suppression of growth outcomes in advanced economies.
So what’s changing? What informs Macquarie’s “end of the great bond bull thesis” and accompanying 4% call?
Well, for one thing, they write that “over time US 10-year yields have tended to move broadly with nominal GDP growth, which is currently tracking between 4 and 5 per cent per year.”
But beyond that, they flag signs of nascent inflation pressures, the wage growth story and of course, the expectation that late-cycle fiscal stimulus in the U.S. is likely to prolong what is already the second-longest expansion in history.
Finally, they note that some of the structural impediments to higher rates are fading. Specifically, they write the following (and again, these are just short excerpts from a longer discussion):
- The increase will be driven by the slow withdrawal of central bank financial repression (boosting the term premium).
- Across the EM economies, the large current account surpluses ended with the great recession, with the block in aggregate now in deficit — their savings are more than being deployed on their own investment.
- In terms of demographics, after a period where the bulk of the population in many countries was “middle aged” and therefore saving for retirement, we note that dependency ratios look set to increase as the population over 60 (the dissavers) grows rapidly.
Oh, and they of course state the obvious which is that it’s possible Trump has set the U.S. on a path to fiscal ruin. They don’t couch it in those terms, but you get the idea.
This is something of a tedious subject for a lot of the doomsday blogger crowd, as those folks (the doomsday bloggers) are predisposed to defending Trump while simultaneously bemoaning a lack of fiscal discipline in Washington.
Well amusingly (and predictably because it’s exactly how he ran his businesses and because, you know, populism), he’s turned out to be someone who is more than willing to throw caution to the wind when it comes to the timing of stimulus. As a reminder, what he’s doing is completely anomalous. Recall this chart from Goldman:
See that yawning gap over there on the right-hand side? And see that arrow pointing to the Vietnam War?
Yeah, well as Macquarie writes in their conclusion, “while many still doubt the sustainability of higher US yields, it is possible that by enacting a major fiscal stimulus at a time of full employment, the US government is repeating the mistakes of the mid-1960s when the spending on the Vietnam war and good society programs (at a time of low unemployment) saw inflation unexpectedly pick up after a long period of stability.”
Nothing further.
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