A running joke during the four-decade bond bull market was analysts’ penchant for suggesting yields might soon break modestly higher due to this or that macro catalyst, only to be frustrated again and again.

As Morgan Stanley’s Matthew Hornbach put it in February of 2018, “history has shown consensus estimates for Treasury yields are usually wrong [and] everyone understands that accurate point forecasts rarely occur.”

When predictions for higher yields were finally borne out, scarcely anyone could claim prescience. “Pandemic” and “European ground war” weren’t popular on strategist bingo cards, even if they probably should’ve been. Another pandemic was a foregone conclusion, after all, and you didn’t have to be any sort of geopolitical “expert” to know that Europe’s dependence on Russian energy could one day become a liability.

In fairness, the following probably wouldn’t have made it past compliance if it were included in the preamble to a year-ahead rates strategy piece:

Although we’re unsure of the timing, scientists generally believe the odds of another pandemic are high, and while such an event could be deflationary in its initial stages, the ramifications of supply chain disruptions could be highly inflationary, particularly when paired with an overzealous policy response in developed markets, where monetary authorities and lawmakers may resort to central bank-financed fiscal stimulus. In addition, the president of the Russian Federation seems increasingly prone to historiography which, when considered with the conflict in the Donbas and the annexation of Crimea, skews energy and food price risks to the upside. In consideration of those and other factors, inflation is likely to quadruple over the next 24 months, in our view, with far-reaching implications for G10 bonds and rates.

Instead, predictions for higher yields typically revolved around forecasts for marginally better growth outcomes, or some other mundane thesis which, if it didn’t pan out by June, could always be jettisoned in favor of an acknowledgment that just like the prior year and the year before that, bond yields in developed markets weren’t likely to move materially higher.

There were intermittent selloffs, of course. But notwithstanding innumerable false dawns, the bond rally became a fixture — a fact of market life.

Structural disinflation went a long way towards explaining the inexorable decline in yields, and that disinflation had its own structural enablers, most of which were eventually taken for granted by economists.

In 2020, the pandemic sowed the seeds for a macro regime shift, and by the end of last year, the game had changed entirely. The mighty bond bull finally perished, struck down by the highest inflation since the bull run began in the 80s.

The war-driven surge in commodity prices served as the coup de grâce for a beast mortally wounded by the inflationary read-through of supply chain frictions and the threat of additional de-globalization.

When the curtain closed on 2022, US Treasurys were down nearly 13%. It was the second consecutive annual loss, an exceedingly rare event. As one PM put it while speaking to Bloomberg last week, “In bonds our kryptonite is inflation.”

Positive returns for Treasurys so far in 2023 are in no small part a reflection of the hope that inflation has peaked, and will surely recede from here. Regardless of your position on that (still contentious) point, the relevant math all but precludes harrowing near-term spikes in some inflation aggregates, or at least it does barring additional energy and food price shocks. Relatedly, goods inflation will continue to fade in 2023 absent another round of very bad luck for humanity.

Fading inflation and recessionary vibes from the world’s largest economy should be conducive to lower yields going forward, and readers are reminded that 10-year US government bonds have never logged negative returns for three consecutive years.

To be sure, analysts and strategists are on board with an argument that says the reset higher in yields could prove a semblance of durable given the macro environment and policy realities. They’ll also readily concede that yields might yet drift higher, certainly relative to local lows which, in 10s, means ~90bps below last year’s peaks.

“Much of the year-to-date decline in US yields is coming from perceptions of weakening growth and easing of monetary policy relative to expectations,” Goldman’s Praveen Korapaty said in a January 20 note, on the way to suggesting markets might be overreacting.

“Growth news outside the US has been positive [and] while US growth data are admittedly weak… much of this is in ‘soft data,'” Korapaty went on, adding that “although several Fed speakers have voiced their preference for another downshift in the pace of hikes, we do not see this as translating to a lower terminal rate [even as] markets appear to be trading the change that way.”

Goldman thinks expectations for a US recession and a commensurately softer Fed tone should reverse, even if it takes markets a few months to come around to the reality of a sturdy economy and a Committee that means what it says vis-à-vis getting Fed funds to 5% and holding terminal in what’ll seem like perpetuity relative to market pricing for outright easing in the back half of the year.

“The upward momentum in CPI has moderated in recent months, but the moderation has been driven by goods inflation. Shelter inflation can decline as the housing market slows, but core services inflation ex-shelter is likely to be sticky on the way down,” TD’s Priya Misra remarked, in a recent note. “Labor market tightness is likely to maintain upward pressure on wages, keeping services inflation high [which could] slow the pace of moderation in inflationary pressures,” she added, on the way to suggesting that China’s re-opening could give global growth “a significant boost, keeping inflationary pressures elevated.”

According to most, the outlook for rates in 2023 hinges to a large extent on whether monetary policy’s famous lags are in fact “long and variable” or, more precisely, whether some market participants are misinterpreting Milton Friedman. Recall that Goldman’s relatively upbeat view on the economy is predicated in part on the idea that the rate of change impact from last year’s tightening on growth is likely playing out right now, even if the peak cumulative impact on the level of GDP won’t come until later.

That should be juxtaposed with the more conventional view, which was captured succinctly by the same PM who spoke to Bloomberg for the linked article above. “A lot of tightening is still set to hit the economy at a time when it is already slowing,” he said. That’d argue for a more bullish outlook on bonds, and against the idea that the rally from last year’s yield peak has run too far, too fast.

One way or another (i.e., regardless of where everyone falls on the near-term outlook for rates), I think it’s fair to say market observers are almost universally skeptical about the idea of a new secular trend tied to an epochal macro regime shift. Accepting the reality of a new world order is almost as hard as predicting the end of the old one.

To some extent, any reluctance to countenance histrionic narratives about the future of bonds in a changing world is just a reflection of the (mostly uncontroversial) contention that yields are highly unlikely to trend higher for 40 years in the same fashion they trended lower for a generation. While acknowledging that the notion of developed market government bonds yielding 15% (for example) is far-fetched, we shouldn’t rule out the possibility that the newly established bond bear proves to be a formidable creature, if not as terrifically imposing as the bull that preceded it.

One contrarian take says that the onset of recession in advanced economies (and particularly in the US) could ultimately catalyze higher yields if it means more fiscal “indiscipline” set against central banks reluctant to finance government spending.

If that’s a bit too prosaic for the dedicated contrarians among you, a more ambitious bearish rates narrative says it’s the end of the world as we know it — even if inflation traders feel fine.

“Inflation traders should be paranoid, not complacent… but when I asked a small group of [them] over dinner in London about how they come up with five-year forward, five-year breakevens, I did not sense any degree of paranoia in their answer,” Zoltan Pozsar said late last month. And then, with breathless gusto:

For two generations of investors, geopolitics did not matter. This time is different: It’s time to get real and it’s time to start pricing the secular end of ‘lowflation.’ When you look at the yield curve and think about the five-year section and then the forward five-year section, by the time the forward five-year section starts, President Xi may have accomplished his ‘next three- to five-year’ goal of paying for China’s oil and gas imports exclusively in renminbi and may have advanced commodity encumbrance by developing downstream petrochemical industries in the Middle East ‘region’ of Belt and Road and also the rollout of ‘BRICS coin.’ I don’t think five-year forward, five-year rates are pricing the future correctly: Breakevens appear to be blind to geopolitical risks.

In 1992, Michael Stipe said, of the deliberately disjointed, rapid-fire lyrics to R.E.M.’s classic calamity ode, “The words come from everywhere. I’m extremely aware of everything around me, whether I am in a sleeping state, awake, dream state or just in day-to-day life.”

Stipe went on: “So, that ended up in the song. Along with a lot of stuff I’d seen when I was flipping TV channels.”

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