Is the world's most watched bond yield signalling an economic implosion?

David Berthon-Jones

Aequitas Investment Partners

I would have thought the economics field (which was so confident in secular stagnation) would be more vocal about the eventual return to 2% for US 10s, from rates currently near-to-north of 4%, and higher for other developed economies. Slow-moving, long-running phenomena such as demographics, deleveraging, and the other horsemen of the near ZIRP era were the leading explanation for decades of declining rates.

Instead, economists are spending most of their time tweeting out what daily fluctuations in rates are, in quite some alarm, and reiterating that policy needs to be even tighter, seemingly abandoning their prior narrative. You can insert your favourite stripe-shifting hyperbolic punter here. 

30 years of fundamentals (living longer, lower fertility rates, lower productivity) didn't just suddenly go away overnight. Long and variable lags (the famous quote from Milton Friedman, that characterises the time frame and speed with which monetary policy is meant to impact the economy) are doing exactly that

In other words, monetary and fiscal policy decisions, from the past 2 years, are still washing through. Presently, the policy is now set in the complete reverse, tight by way of stance, from easy then, and it will take time to wash through too. You can see the change in the money supply below (top row, middle) and the stance of the budget (bottom right). 

Reading most of today's commentary, you'd think we'd just dropped L&V as a catchphrase, one without meaning. And that's just the policy side and the demographics side.

The pandemic restructure of the global labour market is unlikely to be a decade-long phenomenon. Work from home and hybrid arrangements are metrics that are stabilising at new levels, which suggests in turn that household formation rates settle, which suggests rental dynamics settle down, meaning OER (owners equivalent rent) settles down.

If that sentence seems unclear, the prevailing wisdom is that much (if not most) of the increase in dwelling price and the increase in rent since the pandemic has been a function of new households formed as a shift in consumer preferences to working from home (needing a bigger space, an extra bedroom, not spending all one's time with flatmates who are also trying to have Zoom calls).

That impact was massively inflationary to direct and indirect housing costs. They are part of what has driven inflation, to surprise on the upside, in turn causing policymakers to (in our view) overreact to a one-time readjustment. 

EPOP (employment to population, middle column, third row) and other measures show we are not eschewing work in some meaningful new way, even if the exact jobs sought, and the conditions they come with, have. So there's no reason to think that the labour market is impaired in some profound way. We are not a nation of "quiet quitters", a phrasing you might have heard elsewhere.

A period of adjustment to match new preferences, is, I think, the root cause of most of the mystery here. Also if it is an empirical fact that the Beveridge curve has shifted out, well, it is a perfectly fair hypothesis to think it might shift back, particularly if the poaching dynamics hypothesis turns out to be true.

If we add this to all we know about the direction of MP + FP, and the other things you can point to (COVID case rates, or supply chains measures like those shown below) surely it is cause to rethink that r* is somehow now at 2.5% from -1%.

In our view, it is likely that we settle back down to something far more akin to the 2019 range for the 10yr, oscillating between 2-3%, but unlikely to be much above 4% for long, without wrecking great damage to underlying economies with lots of leverage.

As such, yields above that range, in our view, are very attractive for an asset class that should give some low to negative correlation to equity market risk, at that level of carrying, in a diversified portfolio. 

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David Berthon-Jones
Co-Chief Investment Officer
Aequitas Investment Partners

David is Co-CIO of Aequitas Investment Partners with Dr Rowan Stewart. David and Rowan are responsible for investment strategy and the delivery of reliable, cost-effective multi-asset, and direct equity portfolio solutions to Advisers, Dealer...

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