Thursday, October 27, 2016

WSJ: "Inflation Fear Fuels Bond Rout"

Since July the 10 year yield has risen 50 bps.


Nathan said...

Thanks for continuing to write on this topic CP.

I still subscribe to the idea that rate increases are self-limiting. It may well be that rates are "too low" for a healthy economy but we don't have one of those. I would go so far as to say that anything other than a continued decline in rates will cause the tide to go out on this economy. So, I'm wagering that higher rates and a healthy economy live on the other side of lower rates and a wave of creative destruction.

With all due respect, bond bears don't have any sense of irony. Rates are still down significantly YTD and NGDP growth is still low. Real rates have perked up a bit lately (0.52% -> 0.72% on 30yr TIPS) but are still well below last year's levels (~1.30%).

We might see a few isolated quarters with unexpectedly-high inflation, but higher inflation, like higher rates, is fundamentally self-limiting. If we look at Japan, where Abenomics succeeded in generating sharp, but momentary spikes in inflation, the mechanism becomes more obvious - when 1/3rd of your population cost-push inflation results in lower spending. Mrs. Watanabe doesn't earn a wage and accommodates higher energy prices by spending less elsewhere.

An increasingly large fraction of the US population doesn't have a "wage" to speak of, and even among working-age Americans the number of full-time jobs is not growing. So, I just don't see how inflation today in predominately low-productivity sectors like health care can be construed as anything but future-growth-inhibiting. It's isomorphic to a massive make-work jobs program that might keep people busy, but doesn't generate wealth or additional debt-serving capacity.

BTW, I'd highly recommend following @GreekFire23 on Twitter if you're not already.

Anonymous said...

Credit Bubble Stocks: the only coverage of the new bond bear market?


CP said...

I agree that rate increases are self limiting - under certain circumstances. Recall that I have used that argument as a bullish thesis for bonds:

The feedback loop of rate increase -> economic slowdown -> rate decrease does exist, but it depends on investors reflexively buying bonds when the economy slows down. Note that this is a "negative feedback loop", meaning that the system is inherently stable.

Here's another scenario. Imagine that interest rates rise and the economy slows down. Tax collections will fall (capital gains, etc). Welfare transfer payments go up, so borrowing goes up as the deficit increases. Government interest payments as a % of the budget rise.

Fundamentally, we have a debtor which is looking shaky. And suppose that investors stop entertaining the delusion that the debt is ever going to be repaid in real terms?

The logical thing to do would be to be in cash or at least on the shortest end of the yield curve. Sell long term paper and buy short term paper. Long term yields rise further.

Now there is a different feedback loop. Rate increase -> economic slowdown -> increase in rates. This is a positive feedback loop. It is how companies with bad fundamentals go bankrupt.

It all depends on investors perception of the bonds, which is psychological and could change at any time.

This will be the bond bear market. Imagine a 10 handle on the 10 year bond. Has it started yet? I don't know. Will there be bond rallies - buying opportunities - inside of the bear market? Sure.

The market and investor psychology can alternate from feedback loop 1 (-) to feedback loop 2 (-).

CP said...

By the way, there are $1.6 trillion of Treasury bills and $8.6 trillion of Treasury notes now outstanding.

So, that suggests at least $3.3 trillion of U.S. government debt being rolled every year.

CP said...

One take:

The 30-year bull market in US bonds will eventually come to an end. But the end is going to be marked with an event worthy of this 30-year bull market.

The dollar rally will continue due to the hawkish Fed. China will continue to defend the Yuan by depleting FX reserves. The long bonds will rally due to a deflationary force unleashed by the devaluation of the Yuan. Eventually, either China will run out of FX reserves defending the Yuan or it will float the Yuan by ending the dollar peg. Both of these scenarios will result in rapid and disorderly decline in the CNYUSD. The sudden decline in CNY will result in a massive bid in US long bonds. This will be the moment when the great bull market in US bonds will end.

I have no problem with a view that U.S. bonds have one more rally.

Nathan said...

Thanks for the responses CP, I think we're more or less on the same page :)

I find it hard to reason about the stock of government debt and what it really signifies. If it were entirely up to me I'd rather suffer a painful recession than sleepwalk into >100% GDP in debt territory. However, at the same time I think there is some credence to the MMT view about deficits and taxes. I don't generally agree with MMT proponents - they seem like closet statists - but I think viewing taxes as a liquidity sink is useful.

After the GFC it seems like monetary and fiscal policy effectively chose a high debt stock / low rates combination when a lower debt stock / higher rates combination is probably more conducive to economic growth. From an aggregate perspective the two combinations are fairly similar since (debt stock * interest rate / GDP ~= constant) - the UST is paying out some fraction of GDP in interest payments every year. However, there's a major difference in *who* collects the interest payments in each scenario.

For example, if after a lifetime of savings grandma has $500k and can invest in CDs @ 5.0% she has a safe and accessible way to fund her retirement. When rates decline to 2.5% or 2.0% it effectively devalues grandma's previous labor and eliminates her safe / accessible options. Now, maybe grandma was lucky and split her savings between CDs and AMZN and came out ahead or at least even. But given that equities and other risk assets are held by wealthy people the net effect of "financial repression" was to widen wealth inequality in the US (as it did in China).

However, I think the Fed and perhaps others have realized that retroactively devaluing Boomer nest eggs did more harm than good since it has kept them from retiring and the "growth" that it inspired didn't increase the number of worthwhile jobs. It basically kept 55+ year old Boomers in jobs they wanted to leave, excluded Millennials from those very same positions, and dramatically increased the notional net worth of people like Jeff Bezos.

In the real economy it's completely irrelevant whether Jeff Bezos is worth $60B or $6B, but it does matter whether 30 years of middle-class savings can support a retirement using safe, accessible instruments. So one way or another I think we'll get higher CD rates at the expense of risk assets.

If that's true long (nominal) bonds could be a bad bet over a long time horizon. However, before we get there I think we'll see at least one more epic bond rally coincident with an annihilation of risk assets (loop 1).

Basically I expect household wealth / GDP to normalize at the expense of risk assets / real estate, after which point NGDP and RGDP growth may take off higher than is currently expected. In the former period cash ought to perform well and long bonds and TIPS may (or may not) perform better. After a significant correction / rebasing (e.g. AMZN -90%) stocks, bonds and cash should all be reasonable investments from that point forward.

Inflation and long nominal bonds are hard to estimate because even structural deficits of >5% don't necessarily imply significant inflation. Taking someone who earns $25/hour in manufacturing and putting them on SNAP / Medicaid directly increases the deficit but is disinflationary IMO. That may seem contrary to reason but think about credit growth and the total amount of (private + public) credit in each scenario.

So, my impression is that the role of the deficit in determining inflation is generally overstated. I think it matters, I would even say it matters a lot, but far more important is the NPV of the typical working-age American's discretionary income. From that perspective a percent change in hourly wages or the LFPR has a much bigger impact on inflation than the deficit.

Anyway, just my two cents :)

CP said...

Important to note: if feedback loop 2 (+) is in effect, then it won't be possible for the government to guarantee the trillion $ liabilities of insolvent financial firms.

Anonymous said...


Just under $4 trillion of the $10.2 US treasury securities are held by foreign investors ( Aside from Cayman Islands (hedge funds), the vast majority of these foreign-held securities are increasingly being sold by net creditor governments in order to fund longer-term deficit spending and fiscal stimulus plans (as, e.g., China, Japan, and petrostates, etc.). This does not brood well for holders of US treasury securities in the USA.

From the data I have collected on China's holdings, it seems like they are selling long duration USD treasuries and buying JPY (rather than RMB... perhaps to convert JPY back into a lower RMB in the future, but perhaps also to make investments with greater real yield than 10+ year US treasuries). In effect, by unwinding their massive holdings of US treasury securities, the Chinese government is calling an end to the 30-year bull market in US bonds (which they have benefited greatly from).

If US holders of US treasury securities also begin reducing duration in their portfolios, this will obviously roil many other markets. Duration risk is very under-priced. Feedback loop 2 (+) makes it much more likely that this will occur, whereas feedback loop 1 (-) only kicks this can down the road.

Anonymous said...

You are spot on:

"The situation becomes better understood when the Peoples Bank’s position is taken into account. The bank has been selling US Treasury stock in large quantities, stockpiling commodities and oil with the proceeds, though it has been diversifying into Japanese Government bonds as well. China’s dollars have been welcomed by markets, which are short of both quality collateral and raw currency. However, China’s supply of both has failed to stop the dollar rising against the yuan. Furthermore, China isn’t the only Asian and Middle Eastern state selling American paper, so the demand from other international players on the buy side has been immense, enough to determine the underlying direction of the dollar’s exchange rate."

CP said...

One of the anonymous made a good point that, for as long as feedback loop 1 (-) is kicking this can down the road, the sovereign debt load is quickly growing.

We might say that the longer FBL1 lasts, the more violent the positive feedback loop 2 will be.

whydibuy said...

Where is that clown low plains drifter or whoever who said the grand conspiracy to prop up stocks would end by Nov 8th with a dive in stocks.
Hows that bet working out for ya bears?
The clown said he was making a bet for that to happen. He had it all figured out like now with this silly post about feedback loops causing some apocalyptic end of the world move in bonds.
Don't you bears ever get tired of being wrong about financial end times? I mean, isn't that what you think is going to happen? Governmental collapse and the disintegration of civilized society? Whatever.....................

Hillary's Snatch said...

whydibuy is a Clinton supporter

Probably a fat worthless baby boomer

High Plateau Drifter said...

"the grand conspiracy to prop up stocks would end by Nov 8th with a dive in stocks.
Hows that bet working out for ya bears?"

Pretty well actually! The SPX has been losing altitude gradually since 08/23/16. And yes, I am betting that the markets will go down following the election. Following the election, the financial industry and the corporatocracy will no longer have an incentive to prop up the markets just to keep the stock holding segment of society happy and content to vote in favor of the "system."

All of my bets are on the system doing what is in its interest.

And BTW, it is "high plateau drifter", and I am still drifting along that high plateau with 80% in cash (actually over 100% if you count the cash behind my short positions).

CP said...

Speaking of plateau:

1L said...

whydibuy is a typical, fat, stupid baby boomer son of a bitch

look at the new lower low

CP said...


"S&P 500 closed the first trading day of November 2015 at 2,104. Index currently right at 2,104. $SPY"

Anonymous said...

I lol whenever I see Huma's Vedic mug; what else can you do? She's the type of craven creature that can only come to exist in a late-era, openly distressed bureaucracy. Nakedly power hungry, Machiavellian, completely indifferent to the struggles of the Historic American Nation. Just a wicked, black-eyed, soulless political climber who happens to be one of the most powerful advisors in the world. Do you think she has the interests of the farmer in Kansas foremost in her mind? Does she get a patriotic rush when poring over America's storied history or take pride upon hearing a a perfect pitch rendition of the Star-Spangled Banner? Is there any doubt that every thought that crosses her mind in relation to the American people is overtly hostile?

She is the portrait of a globalized, hostile elite, the modern arch-cosmopolitan. Unelected, unaccountable, and completely alien to the people of the nation she "represents". A doll-eyed technocrat married to a human penis who peddles influence at the expense of the American people. The ultimate betrayal of the white man's trusting nature by scheming middle managerial minorities distilled into a single HUMAn being. The fact she exists is enough to make a man believe in pure evil.

Anonymous said...

The alienation of the likes of Huma and Obama to Real America are indicative of the increasing political instability of the American Empire.

When you rule a foreign people, rule #1 is that you want to at least be perceived as fitting in with them. I've been reading Ancient Iraq by historian Georges Roux, and the most successful conquests of civilizations throughout Mesopotamia generally involved the usurpers moving in and then LARPing hard to look like Sumerian/Babylonian/etc royalty rather than what they really were. The people more readily accepted a foreign ruler so long as that ruler acted like one of them and kept their customs and worshiped their gods as higher than all others.

Our modern elite don't even try to do this and we have seen them make less and less effort in real time. Dubya was just as much of a globo-homo elitist as all the others, but he had to at least pretend to be a regular good old boy from Texas to get elected. Obama, by contrast, half-asses all associations with Real America and constantly undermines those half-hearted efforts by attacking the people and their traditions with both rhetoric and the law.

We're dealing with rulers who are so arrogant that they dismiss the past as evil and refuse to learn a lesson kings have known since before 2000 BC.

League of Women Voters said...

They can’t grasp why elite powerbrokers would want to transform functioning, stable countries into uninhabitable wastelands overrun by armed extremists, sectarian death squads and foreign-born terrorists. Nor can they understand what has been gained by Washington’s 15 year-long rampage across the Middle East and Central Asia that has turned a vast swathe of strategic territory into a terrorist breeding grounds? What is the purpose of all this?

First, we have to acknowledge that the decimation and de facto balkanization of these countries is part of a plan. If it wasn’t part of a plan, than the decision-makers would change the policy. But they haven’t changed the policy. The policy is the same.


Washington is erasing borders, liquidating states, and removing strong, secular leaders that can mount resistance to its machinations in order to impose an entirely new model on the region, a new world order. The people who run these elite institutions want to create an interconnected-global free trade zone overseen by the proconsuls of Big Capital, in other words, a global Eurozone that precludes the required state institutions (like a centralized treasury, mutual debt, federal transfers) that would allow the borderless entity to function properly.

League of Women Voters said...

Anonymous said...

1. No enemies to the right. No one gets denounced or disowned or read out of the movement for being too far right. Criticisms of other alt rightists should be friendly or brotherly, or should criticize them for being too far left (Milo is gay, nazis are socialist) If you criticize someone for excessive rightism, criticize him as you would criticize your brother in front of non family and police. No enemies to the left works great for leftists. No one asks President Obama to disown his terrorist mentor Bill Ayers. If someone twits you about a fellow alt rightist who is calling for alarmingly large categories of people to be given helicopter rides to the Pacific ocean, ask him what was the position of the New York Times during Mao’s Great Leap Forward.

Anonymous said...

Normally in an election, there is not much at stake, so peace is better than war. In this election, too much is at stake for anyone, left or right, to accept the decision of a majority of the voters. The election will not immediately lead to civil war, regardless of fraud or outcome, the time is not quite yet, but it will move us markedly closer to the time for war. The stakes get higher every election. The results of this election, and probably all future US elections, will not be quietly and routinely accepted by the losing side.

CP said...

S&P 500 close on 11/2/15: 2104.05

One year later? 2102.24

Anonymous said...

Today, most people in industrial societies don’t need to know much about the natural world in order to survive. What do you really need to know in order to get by as a computer engineer, an insurance agent, a history teacher or a factory worker? You need to know a lot about your own tiny field of expertise, but for the vast majority of life’s necessities you rely blindly on the help of other experts, whose own knowledge is also limited to a tiny field of expertise. The human collective knows far more today than did the ancient bands. But at the individual level, ancient foragers were the most knowledgeable and skilful people in history. There is some evidence that the size of the average Sapiens brain has actually decreased since the age of foraging. Survival in that era required superb mental abilities from everyone. When agriculture and industry came along people could increasingly rely on the skills of others for survival, and new ‘niches for imbeciles’ were opened up. You could survive and pass your unremarkable genes to the next generation by working as a water carrier or an assembly-line worker.

CP said...

Look at the plateau:

Anonymous said...

"The risk is that interest rates will go up or down by more than 20 basis points over a three-month period. But my premise is that central bankers will do anything possible to contain interest-rate fluctuations."