Market participants witnessed enough remarkable developments over the past fours years to burn retinas. November brought another such development: One of the best months for US bonds in four decades.
The list of superlatives employed by the mainstream financial media to describe bonds’ abrupt about-face is long indeed. Any synonym of “excellent” will work.
Suffice to say that regardless of how you care to define “US bonds” (i.e., whether you’re just talking about the long bond, or you want to include the entire constellation of IG fixed-rate taxable bonds), last month was outstanding.
10-year US yields fell more than 50bps in November, among the largest monthly rallies since the 80s. Do note: Benchmark yields were more than 60bps lower on the month as of Wednesday.
The rationale behind the reversal centers around the idea that the US economy is cooling and the Fed will have reason and scope to cut rates in 2024.
One person betting on those rate cuts is Bill Ackman, who was short the long bond until late-October, when he took profits ($200 million worth, reportedly). As I reminded readers this week, nothing has actually changed in terms of the factors Ackman cited for his long-end short over the summer.
Sure, the outlook for the economy in the near-term arguably shifted last month. And yes, Treasury dialed back coupon increases at the refunding to placate nervous markets. And also yes, the Fed probably will endeavor to lower rates as inflation falls in 2024 in order to prevent passive tightening through the real policy rate channel.
But the bigger-picture concerns behind various bearish bond narratives are unresolved. Here’s a list, adapted from Ackman’s original short thesis:
- The long-term deflationary effects of outsourcing production to China are no more
- Workers and unions’ bargaining power continues to rise
- Strikes abound, with more likely to come as successful walkouts achieve substantial wage gains
- Energy prices, while lower of late, could surge anew in a world of scarcity
- The green transition is and will remain incalculably expensive
- There is no sign of fiscal discipline by either party
- The government is selling a lot of debt
- Major infrastructure spending is beginning to contribute to economic growth and the supply of additional debt
- Recession predictions have been continually pushed out
- The long-term inflation rate may not settle back at 2% sustainably
If you ask BofA’s Michael Hartnett, the persistence of bond-bearish domestic- and geo- political realities may mean any break in what some have dubbed a new, secular bond bear market is destined to be relatively short-lived.
“Markets always test the new secular thesis,” Hartnett wrote, in his latest.
The annotations on the figure below narrate the birth of the four-decade bond bull. Hartnett sees a kind of mirror-image dynamic with 2023/2024.
“1981 = 16% all-time yield high = start of 40-year Great Bond Bull; 2020 = 0.5% all-time yield low = start of Great Bond Bear,” he wrote, adding that US twin deficits prompted a cyclical yield reversal in 1984, before the secular bull resumed.
It’ll be “the same thing” in 2024, Hartnett suggested. In the near-term, macro developments can push yields lower (to 4% in a soft landing or even 3% in a hard landing), but over the medium- to long-term, politics and geopolitics “guarantee it will be a cyclical bond bull within a secular bond bear,” Hartnett said.
That may well turn out to be a semblance of accurate, but I’d say two things. First, missing a rally from 5% down to a hypothetical 3% would be quite painful, particularly given how well-telegraphed America’s fashionably late recession is. Second, the odds of US yields increasing steadily for 40 years on the way to 16.5% are quite low. At some point, the Fed would cap them.
In the same note, Hartnett captured the zeitgeist: “Our parachute in 2024 is the politics — elections mean stimulus, and that means the landing will be soft not hard.”