Five Narratives for the Bond Beatdown

1. Oil shock – Markets could be discounting that the recent move higher in oil may be the beginning of a new era of higher geopolitical risk characterized by an inflection in refined product supply disruptions due to the proliferation of cheap and effective offensive military capability.

2. High nominal growth – Nominal GDP (real growth plus inflation) is running somewhere north of 7. There is a fair case to be made that yields should actually be higher, given the persistence of growth running well above potential.

3. A new long-term regime of higher inflation and rates – From the mid-1980’s until the pandemic, rates and inflation trended consistently lower. The period is known as “The Great Moderation of Inflation.” That era of falling commodity prices and the productivity benefits of globalization and growing labor supply is definitively over. That, of course, does not guarantee that the current regime of persistent inflation and higher rates will last more than three decades, but it is hard to ignore that historically, these rate regimes have been long.

4. The Japanese bond market anchor has been lifted – The liquidity fountain of the Yen carry trade has been turned off, and the global ballast to rates globally has been removed. As rates rise in Japan, more Japanese savings are repatriating home.

5. Fiscal deficits and accumulated debt – Is it possible that the long last bond vigilantes have finally arrived and will serve the noble purpose of shaming policymakers globally into fiscal prudence? Maybe. The vigilantes likely have more work to do in the US.

6. AI infrastructure crowding out – A trillion dollars of capital expenditures here and a trillion dollars of capital expenditure there, and it starts to add up to a real crowding out issue. Additionally, the investment boom is driving demand growth for commodities and myriad components, further stoking inflation.

In our view, each narrative is valid but incomplete; together, these forces contribute to higher inflation and interest rates. How much higher could rates go? At what point do these higher rates slow growth? Unfortunately, none of the narratives provide us with the answers to those questions. Our only advice is don’t try to call the bottom.

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