The ‘Ultimate Fear’

The "view" from where BofA's Michael Hartnett is sitting goes something like this. "Still bearish risk assets on the price of money and higher-for-longer = hard landing." That's verbatim from the latest installment of his popular weekly "Flow Show" series. In the past, Hartnett has described himself as a "patient bear," but this week, he used the word "impatiently" in the context of the long wait for "capitulation selling," a recession or a "credit event" with the potential to "trigger bullish

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2 thoughts on “The ‘Ultimate Fear’”

The main possible reasons for why bonds may not rally in a recession are, I think:

1) the recession will feature high inflation (stagflation),

2) Treasury supply during the recession will be too high relative to demand,

3) uncertainty and thus term premium will be high.

#1 might happen, if inflation’s sensitivity to rates is much lower than economic growth’s sensitivity to rates. Which is related to the “soft or hard landing” debate, so if the assumption is a recession aka hard landing, I think the risk of #1 has to be at least significant.

#2 is hard to assess, while supply will likely increase in a recession (until, perhaps, the 2025 expiration of the TCJA tax cuts which may increase revenue by $300-400BN), I don’t understand the demand side well. It is easy to say QT, AOCI, FX depress demand, but the Fed, banks, and foreign govts are only some of the buyers. It is also easy to say discretionary investors will “fly to safety” but does that mean fly to duration? And how big are those different buyer groups, and what are their motivations?

#3 means predicting an unobservable future thing – dicey! – but in general, uncertainty of all sort, including term premia, tend to be higher in recessions. I’ll post a link in a sec.

So if #1 is “definite maybe”, #2 is “no idea”, and #3 is “probably yes”, then seems the “bonds don’t rally” scenario is at least a substantial risk?