Goldman Sachs latest Top of Mind publication is about the bond bear market, and there are a number of opposing views on whether yields are going to continue climbing, or if inflation is going to accelerate or stay under control.
One of the most bearish views on bonds came from Paul Tudor Jones, the founder, CIO and principal of Tudor Investment Corporation, which has c$11 bn of assets under management according to Pitchbook.
Here are some of the most interesting quotes in the interview.
« The bear market in bonds is the natural upshot of the bull market in monetary and fiscal laxity. »
Key reasons why Jones is bearish on bonds is threefold:
- there’s going to be a « huge flow of funds imbalance » between supply overwhelming demand: Fed’s going to get out of the market while the US government is going to step in looking for buyers of its bonds. The Trump administration will have to finance huge deficits and the trade war they are starting is going to drive significant trade imbalance.
The US is committing an economic policy error by cutting taxes and spending while the cycle is at peak. A 5% public deficit « is unprecedented in peacetime outside of recessions », says Jones. « We are setting the stage for accelerating inflation, just as we did in the late ’60s » he adds. So fundamentals are not good.
Finally valuation. « Bonds are the most expensive they’ve ever been by virtually any metric ». Most important point here is the following: « Valuations haven’t been that relevant in recent years because of central bank manipulation outside of the US, but with the Fed in motion and the US economy in fifth gear, they start to matter a lot. »
And now the most to the point quotes for the famed hedge fund manager:
« I think we’re experiencing a hysteresis effect in global groupthink, led by the Fed, believing that we can depress term and risk premia without consequences for inflation or financial stability. »
« Central banks love to look in the rearview mirror. They typically operate in waiting for the most obvious moment they can to make a decision to fight yesterday’s battles. »
« The elephant in the room is the level of real interest rates. (…) in 2018, with the economy operating at full employment, our real 10-year rate is 0.64%, well below historical averages. Why? It seems the reason is the Fed is trying to bring core inflation from a smidge below 2% to a smidge above it. But since 1970, US inflation has averaged 1.3% in peacetime. And yet somehow we have this magical 2% inflation target. It’s a unicorn we keep chasing at the expense of everything else. »
What should central bankers do? Reverse course.
« Policy-wise, that means moving as quickly as possible to raise rates and restore appropriate risk premia so as to promote the long-term, efficient allocation of capital. While this will hurt a bit in the short run, it is better than the intergenerational theft that is being perpetrated now with the combination of low rates and high deficits. »
« I think the recent tax cut and spending increases are something we will all look back on and regret. »
Where does he see opportunities?
« I want to own commodities, real assets and cash. When would I want to buy stocks? When the deficit is 2%, not 5%, and when real short-term rates are 100bp, not negative. With rates so low, you can’t trust asset prices today. »
« If and when the Fed raises rates enough to stop and reverse the stock market rise, that virtuous circle predicated on increasing capital gains will reverse, and bonds and stocks will decline together like they did in the 1970s. »