The term premium’s almost positive again.

Stop press, I know.

The term premium’s like The Masters: Hugely important, but highly conducive to drowsiness if you engage with it from a comfortable chair in the afternoon. R-star’s in the same category.

I bring it up because some strategists are drawing a parallel between April of 2024 and August of 2023, where that means equities are suddenly aware of a re-pricing in rates which threatens to push bond yields to cycle highs.

Back then (i.e., last summer) the re-pricing was primarily a function of a rapid increase in the term premium, which stormed out of negative territory amid oversupply concerns and generalized angst around America’s fiscal trajectory.

Long story short, the US was ramping up issuance just as the buyer base for Treasurys was shifting in favor of price-sensitive investors and at a time when, notwithstanding the debt ceiling deal, the fractious political environment in Washington offered little in the way of hope for a bipartisan solution to the country’s “debt problem.” In essence, that was the rationale for the Fitch downgrade, and also for a three-month selloff at the long-end of the curve.

The term premium re-priced ~125bps over that stretch, a harrowing development that manifested as an unfriendly bear steepener to the deep chagrin of risk assets and particularly stocks.

Ultimately, Janet Yellen stepped in when, at the November refunding, Treasury tipped smaller-than-expected coupon increases two days after cutting the borrowing estimate. That arrested the bond selloff and set the stage for the November-December “everything rally.”

In 2024, the rates rally stalled and then reversed amid US economic outperformance and a succession of CPI overshoots, prompting a rethink of the likely Fed funds trajectory. That all fed into (no pun intended) long-end pricing. The figure above shows the roundtrip(s) in the term premium: From deeply negative to positive to deeply negative to now on the brink of positive again.

I’d argue April 2024 isn’t comparable to August 2023. The rates re-pricing early this year was a function of a expectations for monetary policy, not concerns around fiscal profligacy. I’m certainly not suggesting those concerns have gone away. They haven’t. In many respects, they’re worse now. “Fiscal dominance” is a fixture of the daily discourse, for example. All I’m saying is that when it comes to rates in 2024, it’s more about the swing from ~175bps of “priced in” easing in January to now less than 50bps than it is about the read-through of fiscal largesse for the long-end.

That said, there’s a connection between last summer’s long-end rout, the Treasury-Fed tag team effort to turn things around (in November and December) and the situation the Fed finds itself in today.

In a Monday note, Morgan Stanley’s Mike Wilson spelled out that connection. To wit, from Wilson:

A topic that’s coming up more in discussions with clients is whether a policy error may be in the making. First, it’s clear that aggressive fiscal stimulus aided economic growth last year with nominal GDP growth reaching ~8% in Q3 and ~6% for the full year. Second, this stimulus led to a significant budget deficit that resulted in a challenging funding environment and a higher term premium last summer/fall. In the midst of this fiscal backdrop and a rising term premium, Treasury reduced its expected coupon issuance which created sizeable demand for duration into the end of last year. Shortly thereafter, the Fed announced a surprisingly dovish policy shift which also aided this demand. By letting the bond market run with a very dovish narrative, we ended up with ~7 rate cuts for this year priced by early January and a 10-year yield of ~3.8%. In short, the squeeze from lower coupon issuance and dovish commentary from the Fed resulted in a dramatic fall in rates. This drop in rates fueled a massive rally in risk assets, a subsequent wealth effect, and a significant easing of financial conditions. It’s hard not to conclude that this asset inflation was a contributor to the better growth and higher than expected inflation data that is now preventing the Fed from following up on its prior dovish guidance. As a result, the bond market has run with this hotter than anticipated data and is now pricing just 1.5 cuts this year. In a worst case scenario, some are wondering whether the Fed may even have to hike rates again. Time will tell, but the recent reversal in data has put the Fed back in hawkish mode, and that presents a headwind for equity valuations.

That excerpt is a testament to the fact that the macro-policy-markets nexus isn’t a series of discontinuous vignettes. Rather, it’s a running narrative.

A word of caution in that regard to Treasury and the Fed: Today’s expediency can easily become tomorrow’s policy dilemma.