Back in August, the global stock of negative-yielding debt ballooned to a cartoonish $17 trillion amid one of the more voracious bond rallies in recent memory.
At the time, tensions between the world’s two largest economies had escalated anew, raising the specter of another leg lower for global growth. Recession fears proliferated, and long-end yields plunged, inverting the US 2s10s curve, much to the chagrin of risk assets and a certain US president.
Since then, yields have bounced, and so has the macro data. Global PMIs have rebounded, the US economy (sans ISM manufacturing) has inflected for the better, there’s more clarity (or what counts as “clarity”, anyway) on Brexit and an interim deal between the US and China has allayed fears of another escalation in the 20-month-old trade war.
And yet, it’s hard to conjure a scenario in which yields are able to rocket to the upside based purely on economic optimism. As SocGen’s Albert Edwards will be more than happy to remind you, bonds have been in a bull market for the better part of four decades.
It’s not so surprising that equity strategists are congenitally bullish, but why are bond strategists always bearish, despite being consistently wrong in the face of a 35 year secular bull market! – https://t.co/r274sIJKL1 via @heisenbergrpt
— Albert Edwards (@albertedwards99) December 18, 2019
“This unbelievable bond bull market is now 38 years old”, Kevin Muir, of Macro Tourist fame, exclaimed over the summer. “That’s almost four decades of bond yields going only one way – DOWN!”
“It’s been an un-friggin’-believable trade and every time it looks like the bull is over (see last fall’s two-closes-above 3.25% sucker play), the bond market run continues”, he went on to pseudo-fume. “On a risk-adjusted basis, this has been one of the greatest trades of our lifetime”.
G-10 yield forecasts for 2020 may be too high for Albert Edwards’s liking, but they hardly reflect expectations of blockbuster growth let alone runaway inflation. In other words, Kevin would probably like for the projections to be higher, at least to the extent they turn out to be some semblance of prescient (Muir is a bond bear). Here, for example, are Goldman’s forecasts:
And here are BofA’s projections:
As you can see, BofA expects 30-year yields in Germany to be stuck at 0 (that’s zero) for the duration (get it?) of 2020. You might argue that the bank is taking a “once burned, twice shy” approach after their “marking to misery” call (which correctly projected lower yields) was insufficiently bullish on bonds despite getting the direction right over the summer, but the point is that the rush to play the nascent reflation narrative in December notwithstanding, forecasts simply do not reflect expectations of sharply higher yields.
What could change the game? Well, fiscal stimulus, that’s what.
Bond bears have been patiently (and, in some cases, not-so-patiently) waiting for a coordinated global fiscal push for quite a while, and the rumblings are there. In fact, on Sunday, Bloomberg ran a piece dedicated to the idea that “the bedrock of ultra-low yields is at risk” from a growing fiscal impulse.
“The risk of a reversal in the last decade’s trend of falling yields is palpable”, the article reads. “The governments of the two largest economies are spending more, and relying on debt to plug much of their revenue shortfall”.
To be clear, the drum beat of fiscal stimulus is getting louder. Japan is set to roll out new measures in a bid to ward off a recession, for example. India unveiled corporate tax cuts in September, South Korea is opening the taps, Christine Lagarde is pleading with Germany to loosen the purse strings and then there’s Donald Trump, who, despite being an ostensible “Republican”, has demonstrated that when it comes to ushering in the domestic growth renaissance he promised on the campaign trail, there is no deficit too large to deter the administration. As far as China is concerned, Beijing intends to lean on local governments and infrastructure spending to bolster growth in the new year.
Remember, the larger the fiscal deficit, the better the growth outcomes, generally speaking. In the absence of inflation, and considering the dormant Phillips curve, the arguments for governments that print reserve currencies not spending to bolster employment and growth are dwindling fast, in what many claim is a new economic paradigm.
Part of the argument for more fiscal stimulus revolves around the notion that monetary policy has reached the limits, with rates at or near the lower bound in many locales and G3 balance sheets still bloated.
Ultimately, some manner of coordination between monetary and fiscal policy (“public-private partnerships“, if you will) is inevitable.
“Greater coordination between fiscal and monetary authorities is almost certainly the wave of the future”, MMT patron saint Stephanie Kelton told Bloomberg, in a July interview from (appropriately) Tokyo. While Kelton said central banks won’t admit to having lost their independence, the bottom line is that “you’re going to see central banks responding in more accommodative, coordinating ways”.
“I don’t think explicit fiscal and monetary policy coordination is necessary as long as central banks do their job appropriately in pursuing their mandates”, Goldman’s Jan Hatzius told the bank’s Allison Nathan, in an interview. “If that’s the case, then in a situation that requires fiscal stimulus, the central bank will effectively cooperate and be patient in responding to the inflationary pressures that emerge [but the] bottom line [is that] you don’t need explicit coordination unless the central bank is pursuing an overly-restrictive policy, and if that’s the case, it will probably be difficult for fiscal and monetary authorities to agree on a coordinated policy anyway”.
Central banks have certainly been accommodating. Colloquially speaking, Germany can borrow for free, and so can Japan, a state of affairs Trump has bemoaned on Twitter in the course of demanding that Jerome Powell get America’s rates to zero or below.
“The reality… is that central banks can’t step away from supporting the market”, BofA’s Barnaby Martin recently remarked. “They will need to be present for a long time, in our view, laying the groundwork for potentially higher debt levels in the future…à la Japan”.
Of course, the more support central banks lend, the easier it will be to ensure that fiscal stimulus doesn’t lead to sharply higher rates. “It still looks way riskier to trade against haven flows and central bank purchases while the global economic outlook remains fragile”, Bloomberg remarked on Sunday.
Remember, “peak QT” is behind us, and while the Fed can plausibly equivocate around what is and isn’t “QE” as long as its monthly purchases are still confined to bills, a switch to coupon purchases in 2020 will make obfuscation next to impossible.
And yet, assessments of the fiscal impulse hardly suggest that a major turning point is at hand. “Based on current information, the fiscal policy stance in the median OECD economy is expected to be broadly neutral over 2020-21, following an estimated median stimulus in 2019 of around 0.3% of potential GDP”, the OECD says. “The future fiscal policy stance should depend, among other things, on the need to boost short-term demand and longer-term potential growth, taking into account debt sustainability considerations”.
In other words, betting that a fiscal tsunami is going to swamp the structural factors weighing on inflation and suppressing bond yields will probably remain a fool’s errand in the near- to medium-term.
Over the longer-haul, though, it could be a different story.
“Be prepared for MMT to be implemented since it balms so many short-term problems. While it may take the election of a progressive Democrat for MMT to become policy in 2020, I can assure you both parties will support MMT by 2029 when the entire Baby Boom generation finally reaches age 65 and demands their Social Security and Medicare benefits”, Harley Bassman wrote back in May.
As for whether the inevitable institution of MMT (or some form of MMT) will lead us all to ruin, Bassman says yes, but warns that trying to trade that eventual reckoning could kill you. Literally.
“For the record, I do not believe that MMT is viable over the long-term; although as stated prior, it is unlikely my personal horizon will overlap its eventual denouement”, he wrote.