DurationCrisis2023

Worried about duraiton risk in 2023

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I believe the yield curve is wrong and the price of long duration sovereign bonds is being artificially capped by BOJ monetary policy. The GFC was a credit crisis. We are in a duration crisis!

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@dampedspring @dampedspring what is going on with Japan duration. Seems like severe market dysfunction?

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@leadlagreport This 🎯

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Not only does your comment make sense as a plausible alternative in mid February, the recent Meta headlines strengthen it. When I made a market comment on $TLT that got under @leadlagreport skin 18 months ago he DM’d me a zoom link to talk about it. What a difference in character between the two of them. MANY will be right and wrong in their market views like all of us. The FEW who have the class to consider alternative views with a good counter point.
“There are no gurus, only cycles” - Confucius ~500 B.C, I think)

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@highyield6 Agree not sure the dust even needs to settle. Long 2s from these levels fantastic risk reward imo

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@dampedspring @dampedspring what about tail events in the bond market? My way otm $tlt puts are certainly starting to perk up

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@highyield6 Honestly you may not need to war to be over or the oil to start flowing. Just financial conditions to tighten enough from long end rising

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@highyield6 Respect your views a lot. I’m taking the other side on this one. I think it’s a massive short here. Eventually i suppose at some point it will be a neutral. I think 2s are big buy right here. Markets are though especially with war. You have been right way more than me.

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One of the more I would say non consensus views on term premium I would say is that it’s not about the budget deficit. Don’t get me wrong it certainly can be but we are so far from that currently. Term premium was above its long term average of 1.5% when Clinton ran a surplus. A surplus! So when pundits talk about 100 billion here or there on a 2 trillion annual deficit impacting term premium when it’s 0.58% it makes me want to pull my hair out. Like call me when term premium is 3%+ and we can have a conversation about our deficit. I think term premium is much more a function of western central bank balance sheets (USA, Japan). Its unhelpful association with irrelevant moves in the budget leads to unnecessary fear. It should be considered a form of monetary tightening for the top 10%! Not a tick by tick report card on fiscal policy.

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Also interest cost will be a lot lower because only 1% of the debt is financed at 30 years. The myopic focus on long term rates is very misguided and frustrating. Given the pace of recent trump tweet bombs ($fnma QE, 10% interest cap) they must see internal data that is showing a beat down in midterms. Somewhat paradoxically I think the best thing they could do for midterms would be allowing term premium to rise to closer to its long term average of 1.5% (currently 0.58%) and its associated drag asset prices. Rising asset prices used to be good for the incumbent. Something may have changed though. Bidens best year was actually 2022 when asset prices got smashed and the predictions about a midterm beat down were completely wrong.

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@GiveUsArms @dampedspring @dampedspring that’s a big knee jerk in the wrong direction

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@dampedspring @dampedspring How much do you think they have. This sounds like real QE this time. Last time we did real QE housing got less affordable …

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@dampedspring quick thought. We are seeing the hyperscalers really hit the market with debt supply causing spreads to widen. One narriative seems to be that market is pricing in credit risk from these hyperscalers compared to the risk free rate. Is it possible that what we are actually seeing is the market being forced to assign a more market based term premium based on the sheer supply. The treasury market in my opinion is highly controlled. Quarterly refundings are carefully choose so that supply seems to never exceed. Buybacks only seem to be increasing. It’s just a highly controlled market with what I believe to be a very artificially suppressed term premium. If the spread widening in hyperscalers is related to a real market based premium being priced in a more “free” market then what I am describing would be a pretty sizable market inefficiency. Smart money seems to have no problem taking small inefficiency and leveraging them up massively to make a return (consider the basis trade where a small difference between cash and futures treasury pricing can be leveraged 50-70x. Is there a scenario in your where smart money could go long hyper scaler duration and short sovereign duration with a large amount of leverage? If that were to happen happen in size could that force the sovereign duration to quickly price in a more realistic market based term premium? Would love to hear your thoughts

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@dampedspring @dampedspring thank you for the reply!

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@dampedspring My third question is in relation to your suggestion that if we see anything approaching the level of bond market dysfunction we saw in April then equity calls may be the right plan. Hard to argue with given how quickly the bond market got trump to change course in April. Probably most administrations would immediately change course no matter what with that level of bond market dysfunction. However I think there was another factor then that really forced him to TACO. Trump team knew that in the coming months they were gonna have to pass BBB which was very very important to them. The knee the votes were gonna be tough to come by with slim majority. Eventually they got there by a very slim margin. In my opinion there is zero chance they get those on the fence voters in an environment where the term premium is rising like it did in April. If what was happening in the bond market wasn’t quickly fixed then BBB was dead in my opinion. Do you think it’s possible with the BBB no longer an issue that the reaction function was saw in April from trump may be a little different? For any other administration I would say obviously they would pivot but this administration seems willing to entertain some pretty crazy ideas. I saw headline from before the market opened on Friday which I thought was very interesting: “Scott Bessent says US treasury willing to take immediate exceptional measures to ensure market stability” I thought it was really odd to be reading something like that with stocks basically at ATH and the bond market completely stable. What does he know that I don’t? Do you think it’s possible that the administration is willing to let the long end of the bond market dysfunction a lot more than people think?

Now I’m getting super conspiratorial but could there even be a counter intuitive benefit to the deficit in letting long end blow up as follows: 1) uncontrolled rise in long term yields with no TACO. 2) many more short term cuts priced as implications for a big hit to the wealth effect begin yo get priced. 3) The short term cuts getting priced bring down borrowing costs for government (my understanding is the vast majority of government debt is on the front end and belly and less than 2% is 30 year bonds) 4) long term bonds get destroyed with no TACO this time and Bessent steps in with those exceptional measures he felt the need to mention and does an emergency buy back program to buy back our crashing debt at a 20% discount and issues at what are now much more attractive short term rates. Could something like this theoretically work? I wouldn’t put anything past this administration. Probably I am missing something obvious why something would never happen.

Really appreciate you work and happy to see you back on X.

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@dampedspring I recently subscribed to dampedspring. I was initially hesitant despite you top notch macro threads as the subscription fee seemed high for a short weekly video, however I have to say I have absolutely no regrets and you nick have provided great weakly insight. I have couple questions about yesterday’s video. So for starters I want to say that your analysis on why trump pivoted in April is super important to remember and spot on. You discuss the potential impact of these new tariffs as being growth negative and inflation positive. I agree with both. You suggest that the long duration bonds could look through even a large but one time price level adjustment and trade more on the negative implications for the broad employment. I agree with that. You suggested based on the total of the growth and inflation impacts nominal duration may be a buy especially on weakness.

As you know there is another variable in the price of long term bonds which I know you are very well aware of and have educated me on: term premium. I am wondering what impact you think this latest trade war escalation might have on term premium? It is difficult for me know exactly what happened in April in the bond market. The term premium data I look at on the fed website is only updated every 5-7 days. However to me it looks look the move that really spooked the bond market was because the rapid rise in term premium.

As you have highlighted numerous times supply/demand, QT policy in treasury hands, and fed balance sheet composition have all contributed to suppressing term premium from being anything close to its historical average of 150 bps (currently 49 bps). I wonder if there is another element causing this structurally suppressed term premium which would be the status quo of the last several decades which is the USA runs large trade deficits. The trade surplus countries take that surplus and recycle it into US assets which suppressed term premium and equity risk premium. The administration has made it very clear that status quo is not acceptable to them. At a minimum they want foreign direct investment rather than asset recycling. Is it possible the spike in term premium we saw in April was the market pricing in what a decoupling might mean in terms of term premium? Some of the same drivers for growth and inflation which you suggest could make duration a buy now were also present in April but in my opinion that term premium shock dominated price action.

My second question is related to the Japan bond market. Any relation to what happened in April? Looking the chart of Japan 40 year bonds we see the sharp drop in yields in late March when thinks we’re going according to the administrations plan followed by a massive spike in early April when term premium spike. In your opinion how does that fit into the story?

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@dampedspring @dampedspring makes sense. The move in gold, yen, and sovereign duration just makes me very suspicious