In January’s monthly letter, I noted that rates strategists are on board with the notion that bond yields in developed economies, and particularly US Treasury yields, might’ve reset durably higher last year and could drift up in 2023, especially relative to local lows.

What most market observers and participants aren’t fully on board with, though, are grandiose tales of new world orders, characterized by stochastic inflation, rolling bouts of explosive rates volatility and the generalized demise of developed market bonds as a reliable asset. That outcome would threaten the very foundation of a system built atop G7 inside money, which in turn would mean the end of the world as we know it. Little wonder there’s not a lot of buy-in.

That said, it’s notable that softer versions of the same general idea are pervasive in tales of tail risk. Zoltan Pozsar may be largely alone when it comes to preemptively penning a macro history of the next 50 years, but allusions to a new, inflationary reality and all that might mean for bonds aren’t especially hard to come by, even if they aren’t included in anyone’s base case.

Consider, for example, that although Credit Suisse’s house view sees US 10-year yields receding to 3.3% by year-end, Pozsar’s employer included a “risk” scenario in which benchmark US yields hit 5%. In itself, that’s not especially eye-catching, but the color the bank included when explaining how the risk case might unfold was worth a mention.

Analysts including Andrew Garthwaite cited a “bottom-up push,” including from Japan, where a potential end to yield-curve control could reverberate through global fixed-income. I discussed that at some length last week here. Although the BoJ declined to deliver a second straight shock at its January meeting, another YCC adjustment is almost surely forthcoming, and I consider it very likely that the policy will be jettisoned at some point this year.

Credit Suisse expects no change to YCC in their central scenario, but if the BoJ were to abandon it, there’d be three reasons. “Wage growth is at a 25-year high, YCC is becoming logistically impractical [and] a weak yen is politically unpopular,” the bank said. Although Japanese investors sold G7 (plus Aussie) bonds in 2022, potentially leaving less to sell in a BoJ pivot scenario, higher yields at home and a stronger yen would, at the least, make domestic assets more attractive.

Last week, BofA’s Michael Hartnett included a prospective end to BoJ YCC when discussing the “heretical” idea that US yields might rise even in the event of a domestic recession. He called the BoJ’s policy stance over the past three decades “folly.”

“Japan’s nominal GDP has averaged 0.1% annual[ly] since 1997, when the BoJ adopted zero rate policies, yet the BoJ bought ¥76 trillion in JGBs over the past seven months, or 14% of Japan’s GDP,” Hartnett wrote. “That’s $3.6 billion every trading day [in a] heroic attempt to defend its failed YCC policy… bless.”

Markets, he went on, “know better.” Going forward, “peak liquidity” and higher bond yields will be the story in Japan, and that would mean spillover effects for other locales, including and especially the US.

In addition to a potential shove from a BoJ shift, US yields could be biased higher if European rates rise alongside wage growth and higher eurozone core inflation. Europe’s rapidly improving economic prospects amid collapsing natural gas prices increase the chances of higher EGB yields.

But the real kicker from Credit Suisse’s discussion of how the risk view to US yields might unfold came when the bank suggested investors might “realize that bonds do not diversify and thus 60/40 is dead, lead[ing] to a huge fall in diversification demand for bonds.”

As Hartnett might put it, that’s a “heretical thought” and a rather blunt nod to the “losing our religion” discussion. It also makes for a stark contrast with the idea that bonds now offer significant value versus stocks, thereby making the case for a reverse 60/40. “I recommend not a 60/40 portfolio, but more like a 40/60 portfolio, or even a 60/25/15 portfolio,” Jeff Gundlach said this month. “Bonds [before] stocks and then other things in the 15%.”

In the same list of “how” factors that could lead to sharply higher US yields in defiance of the bank’s house view, Credit Suisse mentioned one more tail risk: “The Fed changes its inflation target to 3-4% owing to the cost of on-shoring and a wish to boost real wage growth and avoid the risk of deflation and QE in the future.”