Bond Bulls And Banana Republics
As regular readers know all too well, I harbor something that looks (and feels) quite a lot like cognitive dissonance when it comes to inflation fault-finding.
Who gets the blame for inflation in these pages depends in part on what kind of mood I'm in on any given day. Please don't misconstrue that. It's not as capricious as it sounds.
There's no one "truth" when it comes to assigning blame for this generation's inflation crisis. Anyone who claims it's possible to identify the one proximate ca
Could’ve had an inflationary depression on our hands.
Broken clocks broken clocks broken clocks
Not you Mr. H you’re very timely
Excellent takedown (my word, not yours) of Hosington and all the hard-money Austrian types who yearn for a return to the gold standard. The fact that inflation spiked globally over the past twelve months should be argument enough that the Fed’s accommodative posture was only partly responsible.
Yep, it’s easy to say a coach should’ve called a different play upon seeing the failed 4th down conversion, but yelling “run the ball!” from the comfort of your couch doesn’t make you qualified to coach the Rams (maybe the Lions). It’s one thing to comment on what you would do, but it’s a whole different ball game when your decisions have actual consequences.
Who the heck is “Hosington”? I found and briefly browsed the WordPerfect documents on their blog.
Their 1Q21 piece, probably posted in April 2021, pronounced:
“Contrary to the conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year end and will undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation”.
Okay then!
I also took a look at WHOSX (the Treasury fund they run, at 66 bp), in which the strategy is to “invest in long-dated securities during a multi-year disinflationary environment and short-dated securities during a multi-year period of rising inflation.” As far as can be discerned from performance, they must own ultra long dated Treasurys essentially all the time, since over twenty years WHOSX has basically acted like TLT – but worse, at 4 times the fee.
As may be guessed from their 1Q21 note, they did not in fact shift to short-dated securities during the current period of rising inflation, because WHOSX is down about -25% YTD, -400bp worse than TLT and -2200bp worse than SHY. Maybe they eased duration down to the current 20+ years, but I guess a period of rising inflation needs to literally be “multi-year” before they will meaningfully shift over to “short-dated securities”.
And why should they have shifted? Their 3Q21 piece, probably posted July 2021, asserted:
“The current economic growth and inflation rates of 2021 will be the highest for a very long time to come”
Well, I can understand why the past year would have made them mad at “the poor results of the Fed’s stewardship” (2Q22 note). I mean, if the Fed had been better stewards, they wouldn’t have needed to actually execute on their advertised strategy, which would have been good, because they didn’t.
Lacy Hunt is a kinda/sorta big deal. I wouldn’t spend this much time on a nobody.
Hunt is a former Fed economist. He made the same mistake that the Fed did (transitory, etc). As late as the 3Q21 note (probably posted Oct 2021, not July as I said above), he said that inflation would peak in 2021 i.e. would be declining in 2022.
WHOSX fund can have duration from 1Y to 25Y, per website. It’s core strategy is to be short [long] duration when inflation is rising [falling], per website. In Dec 2021 fund’s duration was 23Y, at top end of fund’s D range over the past decade, per Morningstar. So Hosington really leaned into their economist’s view. As of now, fund’s duration is still >20Y, per website.
A Treasury bond fund whose central strategy is to predict inflation completely miscalls the biggest inflation event in generations. Six month drawdown cancels out a decade of yield.
The markets are humbling and humiliating. We (investors) make mistakes daily, our hit rate would get us cut from any decent MLB team, and once a decade or so, things get so confusing that a whole bunch of us make career-ending mistakes. Powell may have made one. People in this business should be humble. Blowing the biggest call in a fund’s history should beget humility.
” . . . to say nothing of core.”
These asides are worth the cost even outside the content itself.
The Federal Reserve (via QE) has been able to not only provide more liquidity to the US financial system, ensuring that it can function without “glitches”, but has also allowed Congress to spend more money than they collected in taxes or could readily borrow from third parties (other than the Federal Reserve). For the most part, over the last 15 years, the Fed has been able to manage all of this without causing the global financial markets to freak out and demand higher interest rates- which would have had a significant, damaging impact on the US economy (our engine).
The Federal Reserve seemed to have hit the “sweet spot” of not too much/not too little money printing, as evidenced by the US economy running pretty smoothly and the longer term stability of US debt/interest rates.
However, beginning in May, 2021, the delicate balance of “not too much and not too little” appears to have started cracking – as evidenced by the rapid and dramatic increase in the ON RRP program. The current Fed balance sheet is $9T, however, the ONRRP balance is $2.3T- meaning that instead of banks directly purchasing UST’s from the open market – they purchase/borrow them overnight (repeatedly, day after day) from the Fed.
https://fred.stlouisfed.org/series/RRPONTSYD
If I am reading this “signal” correctly, the US banks were willing to purchase the last $2.3T of UST’s that the Fed purchased- had the Fed not stepped in front of the US banks. However, since the Fed was a little bit “too piggy” with buying too many UST’s; the Fed is compensating, by offering to lend (for a negligible fee) to the US banks.
Being forced to somehow come up with another $2.3T in UST’s, US banks decided that for a nominal overnight fee, they could have maximum flexibility by borrowing the needed UST’s.
However, now that the overnight fees are increasing, it seems that US banks will try to, as soon as possible, optimize the point in time (when banks think UST’s have bottomed?) when they collectively switch from borrowing the $2.3T in UST’s ( and stop paying interest expense) to purchasing the UST’s outright (and start earning interest income).
What happens when the US banks stop borrowing via ONRRP and purchase those UST’s instead? Will this be a non-event or chaotic?
It’s overly simplistic, if not a tad bitter and juvenile to pin 100% of the blame / responsibility on Powell and FOMC…I, though, will never forget Chair Plain English’s semi recent testimony to Congress where he incriminated himself and committee by acknowledging that they realized inflation was more ingrained than transitory in August 2021, yet they took no action until early 2022…not good at all imho…
This is the rambling of an old mind, so don’t kick me too hard. With all the talk about inflation, I’ve spent too much time thinking about it. If the price of milk goes up it’s inflation, at least in simple dictionary terms. We all know that doesn’t mean inflation across an economy. This leads me to think that inflation in a global sense is a reflection of an economy’s underfunding of societal costs. By example, I propose that our current high inflation from a big picture and longer time frame is the underfunding of infrastructure, addressing global warming, and the unequal distribution of wealth all exacerbated by a pandemic. In other words we haven’t been paying the full price for what we’ve been taking and eventually the bill comes due. We can tamp it done in the short run (probably years) but in the long run (decades) we can’t escape paying the full price.