Robert Swift takes a look at the shift in language coming from central bankers and finance ministers and, more importantly, the implications for equities and bonds.
Confirmation bias is a common problem for portfolio managers. You have a thesis and then look only for news flow and data that confirms that thesis.
Since there always lots of news and data available, this bias is commonplace. However sometimes, you’re right and the news flow is supportive because it is meaningful.
One such example now is a subtle shift in language coming from central bankers and finance ministers, representative of a shift in macro policy from monetary to fiscal. For a number of reasons they will never say the last twenty + years of continued monetary incontinence has a) been a mistake and b) a mistake that has gone on too long in the face of evidence that illustrated its shortcomings, but at least we are seeing a shift? We think so at least and have positioned the portfolios accordingly. This has implications for the kind of risks that should be in your portfolios.
Here’s where we think the language has shifted and how it points to more fiscal; and the flip side, a continued steepening of the US yield curve with that of certain other countries to follow.
This is the start of a global paradigm shift or pivot.
See the chart below from our colleagues at GCIO in Singapore, with whom we run an Asset Allocation service.
See the chart below for the spread between US and German backed Euro bonds.
Powell is a genius tight rope walker here. He can’t abuse the notion of fiat money much more than it has been in the last 20+ years. Greenspan, Bernanke and Yellen did that to excess during their tenures, leaving with him with a nasty condrum – the markets need the opium of easy money and a free put option; this dependency is not good for their long term health; weaning them off it may cause a tantrum.
However at 100% debt to GDP he can’t really let rates get too high as he administers ‘cold turkey’ since debt service costs will be usurious as a drain on the budget. By using calming language now and talking UP the economy, he is tempering the inflation threat early; calming the markets about his attitude to fiat money and their elevated prices, and yet letting some element of doubt or risk back in. If you are calmed by his thoughts on inflation and how it isn’t present (oh yeah?), then remember that NO asset price crash has occurred without the CPI or PCE being ‘under control’. Essentially they have to deflate this bubble WHILE stating that the economy is on a sound footing AND prepare us for a shift in macro policy away from what has clearly not worked. We hope we can be talked down calmly.
(If you want an apology about the horrible policy errors conferred on us all, forget it).
(The inflation statistic is a horror show once you try to understand what is in there and frankly horribly adulterated. So if you don’t look out for ASSET bubbles then you will miss the danger signs. I think it was Bismarck who said that the 2 things you should never see being made are sausages and the law. I think we can add ‘inflation statistics” to that?)
So how much higher do rates go?
We are nearer the end of the long rate rise vs short rates than the beginning but they ain’t going down below 1.5% again.
Charts from ‘FRED’ or the St Louis Federal Reserve Bank, show the average 10s vs 2s spread is about 1.2% over the last 50 years…we are just above average now.
Now maybe we should be using the ratio rather than the arithmetic difference since the steepness is relevant, and if so then we are certainly closer to the above average point.
So, while fully cognisant of the difficulty in predicting long rates, we guess at 2.5% as the new average on the 10 year with maybe an overshoot if the recently announced additional $3 trillion package is passed. Yes $3 TRILLION. It was only about 20 years ago, by the way, that government debt to GDP was at about 50%. And to think that doubling that debt while having nothing to show for it; except more wealth inequality and a fail grade in Infrastructure, is not deserving of an apology!!
Implications for equities and bonds are (we think) clear:
See: Thematic: Global Infrastructure Spending Emerging As The Focus
See: Nextera Energy – Having your Cake and Eating it?
Markets & Commentary
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.