I think Private Equity will be a big beneficiary here just as every one and their mother is calling for the death of the industry. High nominal growth with low financing costs tends to work pretty well for levered equities
The market doesn't always set the price for long term Treasuries:
"Operation Twist is a monetary policy tool where a central bank sells short-term government bonds and uses the proceeds to buy longer-term bonds, aiming to flatten the yield curve. The Federal Reserve used this strategy in the past, including in 1961 and again in 2011, to lower long-term interest rates and stimulate the economy without increasing the overall size of its balance sheet, according to the Federal Reserve Bank of New York. The goal is to encourage borrowing and investment by making long-term debt less expensive."
And, "in 1947, the Federal Reserve (Fed) purchased long-term Treasury bonds and had effectively capped long-term Treasury yields at 2.5 percent. While the specific yield might have fluctuated slightly, the 2.5 percent level served as a ceiling during this period. "
I am presently being eviscerated by inflation. I own beach house rentals, and my city and county property taxes are going up close to 300%, as I get taxed for unrealized, inflationary gains. Additionally, both my homeowners insurance and FEMA flood insurance are heading decisively North, even as FEMA is running out of money for storm damage payouts.
The flip side is that 62% of US counties are seeing year over year sale price reductions. So as property tax payments and insurance premium costs move higher, property prices move lower. People are being driven out of their homes by PITI payments and HOA dues moving higher, their home values move further under water.
"It is most well know from Emerging Markets where the government has given up on budget discipline and just prints the money it needs to finance the deficit, ignoring price stability risks"
DMs have mostly given up on Budget Discipline a while ago. EMs were forced by markets to have more discipline while DMs haven't. No?
Thx for sharing your thoughts. I'd like to outline 2 points and would appreciate an elaboration/feedback if possible.
1: I understand that the move towards the front-end of the curve has a clear impact on the supply of long-end, hence it makes sense to expect lower yields. Additionally the administration has long signaled intentional demand creation for the long-end, of which the SLR relief is already in the process of being "unleashed". Nevertheless, we can observe a very sticky bias towards higher, more specifically sticky yields for the 30y duration area. This could be due to some sort of "political risk premium" that ends up in the term premium, or also higher inflation (or growth, but imo unlikely) expectations. Another thing is that the SLR relief has been already signaled ealry this year, and recently with Bowman nomination already set in motion, however 30y asset swap spreads are not really moving.
Now this leads me to the question of (sorry for the long intro into the Q) why do you expect the tilt towards Bills so change the already not very strong demand (despite measure being undertaken/tried) for long duration?
2: The described negative situation for equities is a textbook scenario for emerging markets. However, the capital flight from US (arguably steering clearly towards an EM politically) equities is kind of hard to imagine as it has correlated with business risk for asset managers for the last 1.5 decades. On top of that, you could make the argument that specific sectors that export a lot of (intangible) products to the world are currently experiencing elevated earnings due to weak USD. I find it hard that foreigners sell their US equities. I find it more likely that they'll hedge their USD exposures more than before, and potentially on the margin buy less US equities.
What are the repercussions of this ever expanding fiscal system and government debt / deficit way beyond levels the US can ever repay. Can we make unlimited debt? What will happen in the long term? Bankruptcy is inevitable in 30...40...100 years?
Thanks for the very eye-opening and educational essay.
When Yellen pivoted to short-term issuance, I presumed this was a ploy to saddle whoever came next with record large refinancing problems following the inflationary excessive (wasteful) spending ,which accelerated when they were sure it was the incoming Trump Administration they were burdening.
Given your essay and the actual BEHAVIOR you outlined (as opposed to a presumed/voiced long-term intent) I cannot help but conclude that, once in office the typical Administration is interested ACTING mostly in short-term expediency. Their efforts somehow find a way to kick the can down the road as a way to (hopefully) "solve" the long-term problem, when all that is most certain is that it will help solve their short-term problem of kicking the can far enough and not injuring their most important constituencies in the process.
My more jaundiced view of the the short-term thinking doesn't indicate any flaws with your investment strategy, except possibly in the future when you imply that the day will come when the problem of over-indebtedness and excessive spending above tax receipts comes to an end or slows down (at least temporarily).
Of course, those who are selling "short-term can-kicking" as a clever low-pain solution to long--term issues, have tricks up their sleeve: like gross devaluation of USD against gold and magically making Cryptocurrency into virtually-tangible reserves, along with the Resources of Greenland and Alberta.
On the other hand, I was impressed by DOGE in that, any success in cutting unnecessary spending and personnel was a certainty to increase unemployment and reduce GDP: a double negative whammy. True and continuing success would trigger a technical recessions and a rising trend of unemployment that would have (perhaps) led to a quicker FED rate cut, without adding Jay Powell onto the unemployment rolls.
But DOGE didn't last. Why? Because it caused too much of an uproar by implementing quickly to deter the organization of effective protests?
And the money saved freed up cash to purchase more pork to by Congressional votes.
Bottom line is that reducing an insanely large deficit to a crazy-large deficit will not fix anything. It is a Value-Signal. I am pointing out that "saving" money by paying less interest is just going to just free more "found money" to spend on boondoggles like the technically impossible and super expensive Golden Dome or some bridges to nowhere. Has Japan fixed anything in the decades of the carry trade and the consequent US Panic of 2008 and the associated crash?
Nevertheless, the play on rates and devaluation makes a lot of sense...just not cause these plans will work.
Thank you for writing this essay! I had been struggling with understanding the implications of going to short duration for several days. Your clearly expressed view both re-affirmed and challenged my own thoughts.
Do I understand this correctly when I say this sounds like a Nikkei scenario for equities? We get a last leg to this multi year bull market, but then when the budget deficit needs to be addressed in a few year we get a deflationary bust?
The deficit is being addressed with high GDP growth (or at least that's the goal here) and as far as the debt-to-GDP ratio is concerned whether or not that growth is nominal or real doesn't really matter especially if you control the yield curve
My point was stocks go up under the expectation of GDP growth due to massive stimulus, but when this is not realised but the debt has become unsustainable we get a deflationary bust. Just a scenario ofcourse.
Glad you’re writing again!
I think Private Equity will be a big beneficiary here just as every one and their mother is calling for the death of the industry. High nominal growth with low financing costs tends to work pretty well for levered equities
The market doesn't always set the price for long term Treasuries:
"Operation Twist is a monetary policy tool where a central bank sells short-term government bonds and uses the proceeds to buy longer-term bonds, aiming to flatten the yield curve. The Federal Reserve used this strategy in the past, including in 1961 and again in 2011, to lower long-term interest rates and stimulate the economy without increasing the overall size of its balance sheet, according to the Federal Reserve Bank of New York. The goal is to encourage borrowing and investment by making long-term debt less expensive."
And, "in 1947, the Federal Reserve (Fed) purchased long-term Treasury bonds and had effectively capped long-term Treasury yields at 2.5 percent. While the specific yield might have fluctuated slightly, the 2.5 percent level served as a ceiling during this period. "
I am presently being eviscerated by inflation. I own beach house rentals, and my city and county property taxes are going up close to 300%, as I get taxed for unrealized, inflationary gains. Additionally, both my homeowners insurance and FEMA flood insurance are heading decisively North, even as FEMA is running out of money for storm damage payouts.
The flip side is that 62% of US counties are seeing year over year sale price reductions. So as property tax payments and insurance premium costs move higher, property prices move lower. People are being driven out of their homes by PITI payments and HOA dues moving higher, their home values move further under water.
so beautifully and clearly written.. Thank you for sharing
"It is most well know from Emerging Markets where the government has given up on budget discipline and just prints the money it needs to finance the deficit, ignoring price stability risks"
DMs have mostly given up on Budget Discipline a while ago. EMs were forced by markets to have more discipline while DMs haven't. No?
Thx for sharing your thoughts. I'd like to outline 2 points and would appreciate an elaboration/feedback if possible.
1: I understand that the move towards the front-end of the curve has a clear impact on the supply of long-end, hence it makes sense to expect lower yields. Additionally the administration has long signaled intentional demand creation for the long-end, of which the SLR relief is already in the process of being "unleashed". Nevertheless, we can observe a very sticky bias towards higher, more specifically sticky yields for the 30y duration area. This could be due to some sort of "political risk premium" that ends up in the term premium, or also higher inflation (or growth, but imo unlikely) expectations. Another thing is that the SLR relief has been already signaled ealry this year, and recently with Bowman nomination already set in motion, however 30y asset swap spreads are not really moving.
Now this leads me to the question of (sorry for the long intro into the Q) why do you expect the tilt towards Bills so change the already not very strong demand (despite measure being undertaken/tried) for long duration?
2: The described negative situation for equities is a textbook scenario for emerging markets. However, the capital flight from US (arguably steering clearly towards an EM politically) equities is kind of hard to imagine as it has correlated with business risk for asset managers for the last 1.5 decades. On top of that, you could make the argument that specific sectors that export a lot of (intangible) products to the world are currently experiencing elevated earnings due to weak USD. I find it hard that foreigners sell their US equities. I find it more likely that they'll hedge their USD exposures more than before, and potentially on the margin buy less US equities.
There is still time to avoid that outcome!
How exactly can we avoid that outcome?
What are the repercussions of this ever expanding fiscal system and government debt / deficit way beyond levels the US can ever repay. Can we make unlimited debt? What will happen in the long term? Bankruptcy is inevitable in 30...40...100 years?
Thanks for the very eye-opening and educational essay.
When Yellen pivoted to short-term issuance, I presumed this was a ploy to saddle whoever came next with record large refinancing problems following the inflationary excessive (wasteful) spending ,which accelerated when they were sure it was the incoming Trump Administration they were burdening.
Given your essay and the actual BEHAVIOR you outlined (as opposed to a presumed/voiced long-term intent) I cannot help but conclude that, once in office the typical Administration is interested ACTING mostly in short-term expediency. Their efforts somehow find a way to kick the can down the road as a way to (hopefully) "solve" the long-term problem, when all that is most certain is that it will help solve their short-term problem of kicking the can far enough and not injuring their most important constituencies in the process.
My more jaundiced view of the the short-term thinking doesn't indicate any flaws with your investment strategy, except possibly in the future when you imply that the day will come when the problem of over-indebtedness and excessive spending above tax receipts comes to an end or slows down (at least temporarily).
Of course, those who are selling "short-term can-kicking" as a clever low-pain solution to long--term issues, have tricks up their sleeve: like gross devaluation of USD against gold and magically making Cryptocurrency into virtually-tangible reserves, along with the Resources of Greenland and Alberta.
On the other hand, I was impressed by DOGE in that, any success in cutting unnecessary spending and personnel was a certainty to increase unemployment and reduce GDP: a double negative whammy. True and continuing success would trigger a technical recessions and a rising trend of unemployment that would have (perhaps) led to a quicker FED rate cut, without adding Jay Powell onto the unemployment rolls.
But DOGE didn't last. Why? Because it caused too much of an uproar by implementing quickly to deter the organization of effective protests?
And the money saved freed up cash to purchase more pork to by Congressional votes.
Bottom line is that reducing an insanely large deficit to a crazy-large deficit will not fix anything. It is a Value-Signal. I am pointing out that "saving" money by paying less interest is just going to just free more "found money" to spend on boondoggles like the technically impossible and super expensive Golden Dome or some bridges to nowhere. Has Japan fixed anything in the decades of the carry trade and the consequent US Panic of 2008 and the associated crash?
Nevertheless, the play on rates and devaluation makes a lot of sense...just not cause these plans will work.
Appreciated as always!
Thank you for writing this essay! I had been struggling with understanding the implications of going to short duration for several days. Your clearly expressed view both re-affirmed and challenged my own thoughts.
Do I understand this correctly when I say this sounds like a Nikkei scenario for equities? We get a last leg to this multi year bull market, but then when the budget deficit needs to be addressed in a few year we get a deflationary bust?
The deficit is being addressed with high GDP growth (or at least that's the goal here) and as far as the debt-to-GDP ratio is concerned whether or not that growth is nominal or real doesn't really matter especially if you control the yield curve
My point was stocks go up under the expectation of GDP growth due to massive stimulus, but when this is not realised but the debt has become unsustainable we get a deflationary bust. Just a scenario ofcourse.
Good post
D daddy e