A Famous Deflationist On What’s Next For Bonds
Remember when US Treasurys were on track for an unprecedented third consecutive annual decline?
I do. I remember that. It was just two months ago.
On October 19, when Jerome Powell told David Westin that US monetary policy wasn't too tight, US government bonds were staring at a ~3% loss for 2023. That was atop 2022's history-making 13% decline, which was itself a wholly unfortunate encore to 2021's 2.5% loss.
We were that close to history. Two and a half months from a third year of losses f
I took a nice quick profit myself, but am biting at the chomp to reason my way back in with a dip of my toe. Glad I read this post.
I just renew my CD and the term is 20 bps better than one year ago this time. It is a blackbox guess until one masters THE math.
A 150 bp decline from current 10Y yield would be 2.3%. A 150 bp spread would have mortgages under 4%.
Housing bears claim unwanted AirBnB and second homes will boost house supply when mortgage rates drop – having supposedly been held off the market awaiting higher prices.
A near-halving of mortgage rates will increase homebuyers’ “buying power” by half – if you could borrow $400K at 8%, you can borrow $614K at 4%.
How much additional supply is needed to soak up a ~50% increase in buying power?
In the very long run, I anticipate a return to disinflation, an Ice Age 2.0.
Consider the three major trends that drove the last 30 years of disinflation (discussed in these pages frequently):
1) Aging demographics in developed markets
2) Technology
3) Globalization.
1) & 2) seem almost certain to continue for the foreseeable future. It’s 3) that’s likely to undergo a huge reset, which will be inflationary. Re-shoring/near-shoring have been a big inflation driver since the pandemic (though it started during the Tariff Man’s trade war), but when China invades Taiwan, it’ll start happening in earnest. Just look at what Western conglomerates with operations in Russia went through in 2022, and know what to expect, just add a couple orders of magnitude.
Still, that will sort itself out over the course of 5-10 years, after which things will shift back to globalization trends which were well underway during the original mid-90s Cold War.
This is all assuming we don’t bomb ourselves back into the stone age, of course, but if that happens, who gives a $#!+ about inflation?
There is one major inflationary counter-trend (I mean, apart from the random potential for outbreaks of war and pestilence) which will become increasingly salient over the next few decades: environmental degradation. That’s a catch-all, but water use and global warming are the two biggest factors. Much of the developed world is pumping its aquifers dry faster than nature can replenish them (looking at you Arizona). Eventually water will become too expensive for most people to live in such areas. The need to relocate major populations is inflationary.
Higher temperatures will lead to increased crop failures and decreased yields when crops hold up. Ag tech can offset this somewhat (and because of that, it’s a significant overweight in my personal portfolio), but at a certain point, you just can’t grow things in areas where you used to. That’s inflationary too.
Finally, higher temperatures makes for more natural disasters. Hurricanes will be more powerful, and the polar vortex will more frequently come unmoored from its proper place at the North Pole. Natural disasters have always been a sort of “Every once in a while a random amount of stuff gets destroyed and we have to replace it,” factor, only now it will be more frequent, and the amount of destruction per incident will be greater. That’s inflationary.
Still, that’s probably not enough to overwhelm the disinflationary impact of points 1-3 above.