I hope Scott Bessent’s paying attention.
The US long end’s on track for its worst month since the height of 2023’s late-summer/early-autumn term premium scare.
A gauge of Treasurys maturing in 20 or more years is down nearly 7% in December, the most for any month since September of 2023, when Bill Ackman was still hawking his long-bond short on social media and Hamas was still on their side of the fence.
As the figure shows, it’s been another tough year. Consider this: The popular long-bond ETF (which tracks a similarly-constructed index) is barely off the October 2023 lows (i.e., the cycle-high for yields), and remains down some 49% from records seen in August of 2020.
What’s the problem? What’s keeping investors so down on longer-term US debt? Fiscal concerns, for one thing. The same debt trajectory worries and deficit alarmism which prompted last year’s term premium scare are back in focus, this time in the context of “Trump 2.0” which, as a policy platform, promises unfunded tax cuts, protectionism, the deportation of cheap labor and possible encroachments on Fed independence.
Just as importantly, Trump’s adversarial style points to more D.C. dysfunction, suggesting slim odds for bipartisan “solutions” to what sound-money types swear is a ticking time bomb. All of that rankles ratings agencies.
10-year US yields are up 40bps in December. Nearly all of that’s the term premium. As the figure shows, we’re now back to the October 2023 wides, according to the New York Fed’s estimate.
All of that has to be considered with the broader macro backdrop, which many (myself included) are inclined to suspect will evidence elevated inflation going forward or, at the least, more inflation volatility than investors were accustomed to during the so-called “Great Moderation” years.
Indeed, an ongoing theme in these pages says “The Great Moderation” is probably better conceptualized as a great aberration. As I put it years ago in “Normal Is War,”
It’s imperative we consider the possibility, as disconcerting as it most assuredly is, that in fact, nothing has changed [in the 2020s]. That “The Great Moderation” was no epoch. Perhaps the great macro peace was merely an interlude. It’s possible — likely, even — that we forgot what normal actually is. Normal is volatility. Normal is rancor. Normal is war.
Since I penned those lines in September of 2022, we’ve seen more volatility, more rancor, and (a lot) more war.
The biggest takeaway from December’s FOMC meeting wasn’t the rate cut, but rather materially higher core inflation forecasts and an attendant rethink on the part of policymakers as to how much easing they’ll be able to explain away in 2025 (not as much as previously expected).
Most of the “Trump 2.0” agenda’s assumed to be inflationary one way or another. I’m (more than) open to contrarian takes (e.g., that offered by Wells Fargo’s Chris Harvey, who last week suggested a variety of ways inflation could moderate and Treasury vol could recede in the new year), but the point here is to explain the consensus, which Nouriel Roubini (I’m not generally a fan) summarized in remarks to Bloomberg last month. “In a world in which average inflation might be 5% rather than 2%, bond yields may be closer to 7% to 8% rather than the current 4%-plus,” he said, pitching steepeners and adding that Treasurys are exposed to “massive price risks.”
Note from the figure on the left, above, that in the November installment of BofA’s Global Fund Manager survey (a majority, but not all, of the responses for which were collected prior to the US election), nearly 15% of professional fund managers thought government bonds would be 2025’s best-performing asset. Fast forward a month and that share was just 2%.
The December poll also showed inflation expectations among pros are the highest since March of 2022, and as the figure on the right, above, shows, the net share expecting bond yields to fall was the lowest in two years.
Coming full circle, I hope Scott Bessent’s paying attention.
Bitcoin
I believe it may have taken the shine off of what was touted as a Trump bump and a lot of Q4 statements are gonna have people asking
“ where is it?”
“et tu Bitcoin?”
I agree with more volatility. Yields are impossible to forecast, but if I had to guess I would say most of the chattering classes are overstating inflation risks worldwide. Good article thanks.
Trump 2.0 inflationary? Maybe not if his handler manages to suck $2trillion out of the budget. That said, I wouldn’t buy the long bonds because pumpkinfuhrer is proposing to pay them off in bitcoin.
There is an overlooked timing issue at play as well. Further tax cuts or even an extension must be approved by Congress and then are unlikely to take effect until 2026, no? As well, won’t any massive DOGE also require Congressional approval?
Miller, meanwhile, is promising that immigratrant roundups followed by mass deportations will commence on day one as will the imposition of substantial tariffs. Both will be challenged by woke do-gooders but the courts are mostly in the GOP’s pocket, so good luck on that.
So some early inflation fuel perhaps followed by deflationary government job cuts offsetting the impact of any tax cuts. So the chatterers may be proven right at first.
Most of his agenda will get tied up in the courts for at least a while. For example, tariffs are a power explicitly reserved in the Constitution to Congress. Congress has passed a few laws giving the president the power to unilaterally impose tariffs in specific cases (e.g. national security), blanket tariffs on everything is the opposite of a specific case.
He’ll likely get what he wants in the end, it’ll just take longer than a lot of people seem to be thinking.
This will be where the GOP genius in packing the lower courts with “conservative” justices will reward Mitch McConnel & Co. for their efforts. ExpWe can expect expedited referrals to the Supreme Court to be common. That’s reassuring, eh?
Biden has successfully appointed one more federal judge than Trump I did (235 vs 235), and there are relatively few vacancies left (43, plus 100 potential retirements). The Senate Dems may squeeze through some more in January. The Supreme Court, though, is way skewed.
I think the DOGE theory is that Elon/Vivek can force mass quitting of the Federal workforce by RTO mandates not requiring Congressional approval, and/or that the courts will approve “impounding” i.e. Executive branch refusing to spend what Legislative branch appropriates, also i.e. a “pocket veto”.
From a legal article I found: *”Nothing in the Constitution explicitly describes either the roles of the legislative and executive branches in the appropriation process or the power of the President to spend the money appropriated. Impoundment is unmentioned. Perhaps this lack of coverage informed President Nixon’s attempt to limit by impoundment federal appropriations that supported state sewage systems and sewage treatment. He acted to impound a significant portion of an allocation of funds after his veto of an appropriation was overridden by Congress. The city of New York challenged the impoundment.
During the course of the impoundment controversy, Congress passed the Impoundment Act of 1974, which reinforced Congressional control, but gave the President authority to impose a 45-day delay in spending money appropriated. The Supreme Court later implied that the President had no general authority of impoundment, but did so only as a matter of statutory construction of the appropriations legislation.[5] The Constitution went unmentioned in that case. And the constitutional validity of the Impoundment Act was not at issue. So, the constitutional issue regarding impoundment remains open. I leave it to the reader to address that issue.”*
But isn’t Bessent just a toothless DEI ornament?
Trump won’t stomach 7% yields.
Cash is best in 2025 as term premium is going up – so funding costs go up – even if Powell cuts rates before he is fired. A tax cut, deporting the cheap labor pressure relief valve, and tariff are not enough to offset the strong dollar deflationary push. Oh what a mess – stag deflation anyone? Trump is not a Republican but those Senators sure are and the House will be lucky to keep the government funded as DOGE cuts services while the Democrats get mad, but have the only power there is. I don’t believe it is possible to predict a positive outcome.
This seems as good a place as any to link Sahm’s blog post on the defects of the SEP and how those detract from the Fed’s communications. If Dr H will permit https://stayathomemacro.substack.com/p/the-feds-summary-of-economic-projections
I don’t know that I agree with Sahm. About the problem, sure: the market is uncertain what the Fed expects to happen and how it plans to act. Hence, perhaps, the rising term premium. But before calling for a solution, ask can there be a solution?
The FOMC members have a lot of experience and data and analytics available to them, but sometimes things happen that are beyond their experience, and then they don’t know what they think will happen or what they think they will do.
Parenthetically, we already know the FOMC aren’t actually great forecasters, but I say who cares, the job of the FOMC is to act, not to forecast. They are protagonists not pundits.
Covid was an example – a hundred year pandemic, things happened that no living person had seen and no model was built for, the FOMC had to play by ear, and probably should have started doing so earlier.
Right now, with Trump promising tariffs not seen for almost a hundred years and other things not preciously seen by any living market participant – we’re way past Watergate, folks – the FOMC again has to play by ear. Worse, the promised things haven’t happened yet so there is as yet nothing “concrete” to react to.
So some of the FOMC are starting to factor possible Trump actions into their dots and thinking, others are resolutely not, and the SEP has no hope of representing the “consensus Fed forecast” that Sahm wishes for. Naturally the market is uncertain, and pouting about it.
Tough, but that’s the way it is. The FOMC is uncertain, and expresses that in diverging dots and rising rate expectations. Powell is uncertain, and tells you so as fortrightly as any Fed Chair can. The future is uncertain. So term premia rise – as they should.
Uncertainty up -> risk up -> rates up -> valuations down. Expected growth up -> multiples up -> valuations up. We get to ping pong between these two dynamics, until they meet or one falls away.
Also liquidity up (down) -> prices up (down), of course, but money flow seems able to turn on a dime, in the short-medium term.