Roy Lichtenstein (1961)
There’s a great Sherlock Holmes story called “Silver Blaz
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This commentary is being provided to you as general information only and should not be taken as investment advice. The opinions expressed in these materials represent the personal views of the author(s). It is not investment research or a research recommendation, as it does not constitute substantive research or analysis. Any action that you take as a result of information contained in this document is ultimately your responsibility. Epsilon Theory will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. Consult your investment advisor before making any investment decisions. It must be noted, that no one can accurately predict the future of the market with certainty or guarantee future investment performance. Past performance is not a guarantee of future results. Statements in this communication are forward-looking statements. The forward-looking statements and other views expressed herein are as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Epsilon Theory disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein. This information is neither an offer to sell nor a solicitation of any offer to buy any securities. This commentary has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Epsilon Theory recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
As a long-time deficit scold - now cowed - I’ve learned this about deficits: they don’t matter until they do.
The trigger / the catalyst / the tripwire / the moment seems unknowable in advance (at least in advanced countries). Pick a putative trigger - some percent of GDP, some ratio, something - and Japan shows it can be blown through without any consequences.
QE, monetization, what have you - it works until it doesn’t, but if we have no guide as to when “it doesn’t” is, then it’s probably a three-body problem.
Can we have an inflationary world - sure, but Japan has taken deficits to unfathomable heights while doing everything it can to generate inflation with almost no success.
So, I close where I opened, I’ve learned this about deficits: they don’t matter until they do.
A bearish steepener for the bond market, that’s what happens first. Haven’t seen that for many, many years.
Will bonds be once again called “certificates of confiscation” as they were when I first entered the investment world?
Maybe, but not until we see many years of a bond bear market.
Anyway, clear drag on equities but only on a secondary basis.
Ben, this echoes my own thinking as much as anything you have written. I was thinking the exact same thing as I watched the election postmortems. In all the analysis, the discussions of the issues that people cared about and the charts and graphs showing the relative importance of those issues----deficits and debts were nonexistent. Somehow a ragtag band of refugees wandering through Mexico was more important than a trillion dollar deficit.
My father served in the Maryland state senate for 24 years and was involved in the efforts in the 80’s and 90’s to get a balanced budget amendment added to the US Constitution. His main emphasis was to get two thirds of the state legislatures to petition for a constitutional convention for the purpose of writing an amendment to the Constitution to mandate a balanced budget. They fell a few states short of two thirds and then the balanced budgets in Clinton’s final years put an end to the amendment movement.
I’m not arguing that amending the Constitution is or isn’t the answer. What I am saying is that what was once a major issue 25 years ago is totally removed from the political and public discourse today. It amazes me that hardly anyone thinks it odd that an economy running at full speed could result in a federal deficit approaching a trillion dollars. But the day is coming when the dog will bark.
it’s not a bear steepener. That implies bond holders would be shortening duration rather than outright selling if inflation expectations were to accelerate. Also would imply the FOMC (or ECB) would sit on their hands rather that move to subdue inflation with higher front end rates. Questions on central bank independence as we see in EM from time to time would indeed be the steepener trade.
The story here diverges from Japan when you see employment, consumer spending, and credit all growing smartly and gov’t spending throwing fuel on the fire (C+I+G). Demographics and a lack of attractive domestic investment opportunities have scuttled that factor convergence in Japan, despite a spectacular degree of “G”. Tough to see what the right implications of this theme is for the bond market, other than to remain short relative to equities and commodities.
I would expect “Austerity” to get the same reception in the US as it has in EC countries where preached. Benefits once received are very difficult to suspend. Therefore, after some longer period of time than we expect, the flash point will come.
Besides looking for companies with sufficient “moats” (to ensure demand, at least), I am accepting that some or much of the recent paper wealth increase will be given back in the reset. Hopefully not, but maybe so. (Back to you, Ben.)
CNBC right on que - 11/12/18: “Rebuilding America”
Well, maybe today’s WSJ article about interest/debt service as a percent of budget, revenue, and GDP will be among the voices to change the narrative. Tho not the boy who sees an naked emperor, just maybe heading in that direction.
Haul-ass, bypass, and re-gas!
Long bonds would be under the greatest threat in the environment Ben is describing.
Both lose ( hence bear steepener ) but 30 year bonds at greatest risk from out of control deficits and inflation.
Fed has no appetite for all out , damn the torpedo, inflation fighting.
That requires support from the populace, like Volcker had when people wanted, needed relief from the raging inflation of the late 1970s.
They will lag what is really needed until the people demand it. Long bonds will hate that.