When domestic politics, geopolitics, and central bank policy align in a single direction, we take note

My co-head Dan Dees and I co-author a weekly client message on things we’re seeing in our business that inform our worldview.? Periodically, we will post these missives here to connect and engage with a broader community. Here’s a snippet from this week’s message:

Most current market participants have spent the majority of their careers living through a one-way bull market in bonds. There were multiple causes, but central to this trend was low and stable inflation catalyzed by globalization and credible targeting of inflation by central banks. US long bond yields spent the first half of the 1980s in double digits before trending down for four decades to reach a pandemic low of <1%. Anecdotes abound from the unprecedented QE era – with trillions of negative debt perhaps best illustrated by the Republic of Austria issuing 100-year paper in 2020 with a paltry yield of 0.88%.

We’re now witnessing a defining paradigm shift playing out from QE to QT, deglobalization, and ballooning fiscal deficits. The long end of government bond curves have been battered, with US long bond yields flirting with 5%. As we walk the trading floors, the chatter is all about the changing supply and demand dynamics in long end fixed income. This transition is reshaping the demand dynamics for banks, reserve managers, insurers, and pension funds alike. You don’t have to search far for yield. Safety and security are available in the short end of the rates curve with short-dated UST yields well above 5% in the current yield curve inverted environment.

This week was all about a lack of end-user demand for long duration paper. We haven’t a clue which direction the next 50 bps will be, but it’s not a stretch to imagine a world of structurally higher long-term bond yields. We are a mere headline away from the next growth scare and a changed backdrop for bonds – but the world of negative interest rates seems a distant prospect. When domestic politics, geopolitics, and central bank policy align in a single direction, we take note.