In the past week, the bond market has experienced a historic selloff. Yields on benchmark 10-year US Treasuries soared towards 4.9% while those on 30-year debt reached the highest since 2007. But the exact cause of these dramatic moves in the most important market in the world aren't entirely clear, with people looking at everything from the Federal Reserve's outlook for interest rates, to the the jump in the price of oil, or booming supply as the deficit expands, as well as more technical things like the term premium. So what's driving the selloff and how do we disaggregate interrelated things like supply and demand? How do you decompose longer-term and short-term factors feeding into the price of US Treasuries? What can stem the big moves? And what are investors saying about their appetite for US debt? We speak with Jay Barry, co-head of US interest rate strategy at JPMorgan, about the big bond market selloff. This transcript has been lightly edited for clarity.
Key insights from the pod:
Why are bond yields surging? — 3:28
How do you analyze what’s driving bond yields? — 7:10
The role of the Bank of Japan — 10:05
The retreat of price insensitive buyers — 11:16
The term premium — 14:47
Sentiment around bonds — 17:20
Buy the dip and why own a bond at all? — 19:50
Do drawdowns matter in bonds? — 22:44
Peak deficit talk — 24:08
JPMorgan’s forecast for bonds — 26:45
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Tracy Alloway (00:00):
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal (00:14):
And I'm Joe Weisenthal.
Tracy (00:15):
So Joe, the big story in markets up until relatively recently has been the bond selloff, quite a dramatic selloff across the fixed income space.
Joe (00:26):
Yeah, really over, I guess, the last couple months. So the yield today, well we can sort of talk about the bond market up until today, but you know, we had been like in the threes and then the fours and then we got almost as high as 4.9% on the 10-year. We've had a little bit of a pullback. We're recording this October 10th, but we are very high by any recent standards.
Tracy (00:48):
Yeah, it is not lost on me that we are recording our bond selloff episode on the day when treasuries are recording their best one-day performance since I think March of last year. But you know, we're trying, we're trying here. But you're right, the recent bond market selloff, it was one of those times when you see a lot of superlatives around a lot of like highest yields since 2007. A lot of talk of standard deviation moves when we try to start calculating, you know, how many normal trading days it would take to get moves of this size.
But the interesting thing about this whole dynamic is it's not really clear what the proximate cause of the selloff is. So you have a lot of people blaming, you know, the recent FOMC meeting when they release the dot plot showing higher for longer. You have some people blaming oil, you have people talking about supply. Some people are looking at more technical aspects. You have some people blaming the term premium, which I find absolutely hilarious because to me a higher term premium is like a symptom of the selloff, not the actual driver of it. But anyway, all of this means we really need to try to get into the weeds of what is happening here and what it might mean for the wider market.
Joe (02:02):
Right, because even if, okay, maybe last Friday right after that jobs report, when we got that very brief spike, maybe that was the peak, who knows? But I do think it's important to try to disambiguate these things because, as you said, I guess it's one of those things when there's a lot of explanations for something, none of them are like very satisfying. Like, a lot of deficit talk lately. But it's like, what? I think we knew that the deficit was really big for a long time. There was that recent Fed meeting, but again, okay, like the 2024 dots came up a little bit.
Tracy (02:33):
They were not outrageous.
Joe (02:33):
But does that really explain 4.9% on the 10-year? Exactly, nothing is quite satisfying as to what happened and why we're at this sort of like new level where we're at.
Tracy (02:41):
Exactly. Well put. So today I am very pleased to say we do in fact have the perfect guest. We're going to be speaking to a bond analyst. I've been a fan of his research for a long time. He used to work with one of our other favorite Odd Lots guests, Josh Younger. We're going to be speaking with Jay Barry. He is the co-head of US interest rate strategy at JPMorgan. We're going to be trying to get a handle on what might be driving the moves in bonds, but also how you go about as an analyst trying to disaggregate all these different factors. So I'm very excited. Jay, thank you so much for coming on Odd Lots.
Jay Barry (03:16):
Tracy, thanks so much for having me. Really appreciate being here.
Tracy (03:19):
So, I guess maybe just to begin with, I mean the simple question, what is driving the selloff? We'll start there and then we can try to dig into different pieces.
Jay (03:28):
Well, I mean Joe just said there's a whole host of reasons that have been bantered about and that maybe none of them are all satisfying. But I really think it's the confluence of a number of different factors here. So I mean in aggregate now we're off the highs in yield, as you said, but we're still about a hundred basis points higher than we were in the middle of the summer. And to me it's like what's changed over that period?
And I think the early part of the move, you could say was definitively a story about the US economy and fundamentals because I look back at where we were very early in the summer and where we are right now and over that period, we increased our second half growth expectations at JPMorgan by about two and a half percentage points — from like the mildest of recessions, if you can call it that, to looking for above trend growth the second half of this year.
And that's like a meaningful driver I think of the move in long-term rates because it's given us more confidence that the recession may be a bit further off. But it's also helped sort of anchor Fed expectations at higher levels as well. So you know, we haven't really changed the expected peak in the Fed funds rate since the early part of the summer, but we pushed out the timing. And we pushed it out from, you know, at that time thinking it was going to happen around now to sort of pushing it out to the early part of next year.
But then the more powerful influence is that we've dis-inverted that money market curve a bit and, you know, early in the summer we were pricing about 150 basis points of cuts for 2024. Now we're pricing in — still cuts — but we've taken out about 40% of that.
So I think the first part was fundamental, but then I think the drivers began to shift. And more recently, since September, you know Fed and growth expectations have been pretty stable, but inflation expectations been rising and we like to look at five-year ahead, five-year inflation expectations from the Tips market from the inflation-linked Treasury market. And those breakeven expectations have gone higher by about 25 basis points over the past six weeks.
Joe (05:10):
Wait this is the five-year, five-year forward break even? Is that the thing that you like to look at? I'll bring that up on my terminal while you're talking about it. So I understand growth has picked up versus expectations certainly compared to the beginning of the year when, as you say, like almost everyone expected recession, now we're at above trend growth, maybe it'll moderate etc.
What is the link between that and 30-year yields or the long end of the curve? Because of course I get it the short end it's very easy to draw a very bright line between short-term rate expectations and the two-year bond or whatever. But then when you get further out it's like okay, why does the growth picking up in Q4 of 2023 affect what people are going to pay for a bond that matures in the 2050s or whatever?
Jay (05:53):
No, I think there still is some sensitivity of policy that sort of reverberates through the term structure and the sensitivity may decline the further out you go. But it's still there. So just for a number, you know, every hundred basis point change in Fed policy expectations three- to six month- forward tends to sort of change long-term yields by about 40 to 45 basis points.
And similarly, like every change in year ahead growth expectations tends to move long-term yields by five to 10 basis points. So yeah, the further you go out the term structure, the more I think idiosyncratic it becomes but there still is sensitivity to what's happening to the underlying economy and to what's happening with Fed policy. So I think it's still there, just with a lower sensitivity than that at the very short end.
Tracy (06:34):
How do you actually go about, as a strategist, sort of decomposing the different moves into different factors or drivers? And I know that you have at JPMorgan, for instance, this fair value model of where you think Treasuries should be trading. And I think last week you were saying that you thought that yields had overshot fair value, which, you know, I'm guessing you didn't expect what happened over the weekend in Israel to actually happen. But it seems to have been quite prescient because we have seen yields come down a little bit. But how are you actually analyzing the different drivers of a move in rates?
Jay (07:10):
Yeah, so you've talked about the fair value model. I think that's a key input to what we do. Because we try to identify empirically what have been the largest drivers of yields over time. And we can look back over windows of five or 10 or 15 years and we've got a host of factors that are sort of always consistently in the framework.
And we talked about Fed policy growth and inflation expectations being the three key drivers, like the triumvirate, so to speak. And then other factors which at various points over the last, you know, 10 to 15 years have been important and less important. I mean there was a time when with policy rates at zero and negative territory globally, we had the share of the bond universe that was trading at a negative yield globally because policy rates being anchored at very low levels helped anchor US rates lower and that was important but less important right now.
So that starts and, you know, if we have a sort of centering universe about where we think Fed policy growth and inflation are headed, that's a starting point. And you're right, like when we adjusted for those factors, there was a point last week where it looked like we were trading about 35 or 40 basis points too high where, you know, you're talking about standard deviations before that was something like a two and a half standard deviation move relative to fair value in our framework and one which we hadn't seen since this time last fall after the UK LDI crisis.
Tracy (08:23):
Which was the other big bond sell off.
Jay (08:26):
And really since the spring of 2020 too. So I think, you know, we take notice of that because it's hard to say, you know, I think we've all been pretty humbled to the fact that the economy's been resilient. It's been tough to call. But we have to have something that sort of centers like where should rates be and how far have they gone? And this was at least a flag to us that they'd gone too far.
Tracy (08:43):
You mentioned sort of factors driving the US Treasury price and how those have evolved over time. Can you spell that out in a little bit more detail? I would be very curious to hear more about what is driving moves now versus say maybe pre-2020.
Jay (08:59):
Yeah, I mean I think, you know, pre-2020 we just briefly talked about one of those factors, low and negative policy rates elsewhere meant that even as the US was increasing rates during the 2015 through 2018 cycle, that was something that helped anchor long-term yields at lower levels. And you could see the influence there when you talk about the hedged yield pickup for US bonds versus most foreign currency pairs.
And that has since of course eroded because basically every major developed market central bank has been increasing policy rates at a rapid rate and the last of which that's out there, the Bank of Japan we think at some point will completely lose its YCC band and will at some point exit negative interest rate policy next year. So that was an important factor which we now don't have as a factor in the model.
Joe (09:45):
The Bank of Japan, it was about a month and a half ago or two months ago, like sometime in August, I forget because I have to admit like all these Bank of Japan headlines about whether they're going to keep the 10-year at zero whatever, they all sort of blur. But there was like some news that happened, it was something out of the Bank of Japan that like changed the entire tenor of the market all at once. Can you remind me what I'm like forgetting here?
Jay (10:05):
Yeah Joe, in late July, the Bank of Japan basically allowed JGBs in the 10-year sector to trade even wider around its sort of plus or minus 50 basis point target and it effectively kind of gave you notice that at some point it was getting closer to completely removing that YCC.
Joe (10:23):
Because they're having their highest inflation in years too, right?
Jay (10:26):
Exactly. So, I mean I think on a partial basis you can argue that was a catalyst as well.
Joe (10:31):
Can you talk about, when you talk about these foreign buyers, as you say the sort of like price-insensitive demand from a foreign sector, the disappearance of these price insensitive foreign buyers, how much does that affect rates versus say just like rates volatility?
Tracy (10:46):
By the way, this is why I really wanted to get Jay on for this podcast. Because he wrote a great note about a year ago, basically talking about the retreat of price insensitive buyers in the form of foreign central banks and the Fed as well, as it was winding down its balance sheet. I think I wrote it up under the headline, “ JPMorgan is Worried About Who's Going to Buy all the Bonds” and at the time it got a lot of pushback, but fast forward a year and again it seems like you were broadly directionally correct.
Jay (11:16):
No, I think it's an important driver over a longer period of time. Like, it's hard to say and Tracy, you said this before, whether it's the proximate cause of the selloff. But I think in the background it's something that's contributing to what's going on because to us at JPMorgan, you know, we look at three sets of buyers who have been the main price insensitive sources of demand for the better part of the past two decades at various points.
You talk about the foreign demand story; I mean we know that FX reserves peaked about seven or eight years ago [and] the dollar share of those reserves had been coming down. But there was a point in time at the beginning of the century where FX reserves were growing so rapidly and the share of those reserves held in in dollars grew so rapidly that the deposit of that savings into the US I think was something that kept long-term rates low.
And you remember Chair Greenspan talking about this and the conundrum in 2005 about why long-term rates were not rising even as the Fed was tightening. So that's a key driver right there and we look at it, FX reserves we don't really expect to grow appreciably from here and we're not in the de-dollarization camp. But the dollar share of those reserves have been on a downward trend as central banks globally have been diversifying. So it's just saying that if that was a tailwind for rates for the better part of the first half of this, you know, last 20 years, it’s not there.
The second one, and this was more local, are the US banks where they bought about three quarters of a trillion of Treasuries over 2020 and 2021 when supply was heavy. Largely due to the fact that deposit growth outstripped loan growth. And now we know deposits have stopped coming down like they did in the spring but they're not growing. And I think one would think even as deposit growth picks up, that banks after what's happened here might, generally speaking, bias their purchases shorter along the yield curve with less duration risk.
And then the final piece of the puzzle is the Fed. And I think we lose this, that even though we're coming to the end of the Fed policy rate tightening cycle where we think it's actually concluded, balance sheet policy’s operating in the background and just as the BOJ, Joe, was really important at the end of July, I think Chair Powell's comments at the July press conference were as equally important, because a reporter asked him about whether the Fed could continue to do QT while it actually lowers interest rates as inflation comes down next year.
And he made the point that you'd be normalizing both. The policy levers may be in opposition, but you're normalizing the balance sheet as you're normalizing rates. And I think the extended runway for QT matters because we found over a longer period of time, the Fed's stock of holdings matters for yield levels. And as that unwinds that should slowly keep long-term rates anchored at higher levels and re-steepen yield curves.
Tracy (13:59):
So you have these longer-term factors, I guess, happening in the background, the retreat of these three groups of price insensitive buyers. Just going back to some of the short-term catalysts here, you know we mentioned term premium in the intro. Term premium is one of those concepts, I feel like it gets bandied around quite a lot. Not everyone quite understands what it means, but also there is no consensus.
Joe (14:25):
Like myself. I'm about to learn something that I've always been wondering about
Tracy (14:28):
But see, you're missing out Joe, because you should just start saying ‘term premium.’ Just blame everything on the term premium and just use it as a scapegoat for any like move that you don’t agree with or that you are on the wrong side of. That's how most people seem to use it. But okay, maybe just to begin with, what is the term premium and what has happened to it in recent weeks?
Jay (14:47):
Yeah, so the term premium, and you're right, it's a nebulous term, I think, is the extra compensation required for investors to buy longer duration assets.
Tracy (14:54):
That is a perfect definition that I'm pretty sure I have used in my own copy before.
Jay (14:59):
I just made sure I Googled it before it came, that's all. No, but I think there's a number of ways to look at it and I think we can start and just talk about our fair value framework, and I think we can say everything outside of these fundamental drivers, one might possibly attribute to term premium. That in the absence of being able to explain with growth and inflation and Fed policy expectations, that that's a driver there.
There's also a series of very widely watched academic models. There's the ACM model from the New York Fed, the Kim Wright model that the Federal Reserve Board in DC watches, which are a series of, I think, no arbitrage term structure models, which are kind of mean reverting in nature. And those were sitting relatively low until recently and they actually would attribute most of the selloff over the past six weeks to term premium.
You know, I think we've done a paper on this, and we think that there's some idiosyncrasies with the way that these models are constructed because they are sampled over a period of declining rates that they attribute a lot more to changes in policy expectations than term premium.
Tracy (15:55):
Oh, interesting.
Jay (15:55):
So at turns, they can be less sort of influential or less, I think, insightful. They're still very valuable, just less insightful at these turns. And then there's finally more empirical ways to measure it too because there's survey-based measures of where economists expect policy rates to be. Like the survey of professional forecasters, and the survey of primary dealers where you can observe where economists think policy rates will be over the next five to 10 years and you can compare them to 10-year rates to get a sense of the extra compensation that's required.
Joe (16:21):
Right. So this is the key, right, because the basic idea is a long rate is just a series of overnight rates and so that gap, if you have some estimate of where the overnight rates are going to be over the next 10 years, then you look at the yield then theoretically that gap is the term premium.
Jay (16:36):
Exactly.
Joe (16:37):
Can you talk about sentiment, and you know, it strikes me, Tracy, that we are recording this basically literally a month after we interviewed the bond king, Bill Gross, in which he said he doesn't own any bonds. And so it really strikes me that, well, people hate bonds right now. Like people really hate them and everyone, like in that month since we talked about, first of all when we had that conversation the 10-year was closer to 4.2%. So very timely call. But you know, in that month I do not recall there was so much talk about the deficit. There's so much talk about all these things, higher inflation, higher for longer, we can't get it under control. Like, how do you measure sentiment and how much does that drive some of these moves?
Jay (17:20):
I'm glad you asked that Joe, because I think it can be really influential over shorter periods of time, let's say four to six weeks. So there's a host of metrics that we like to watch from the CFTC'S data on sort of speculative positioning and interest rate futures to some more empirical models that sort of track the performance of hedge funds and asset managers.
But my favorite, and it's very close to my heart because it's been something I've been working with for like more than two decades, is our weekly JPMorgan Treasury client survey. It's a bit of a misnomer because it's really our duration survey of the aggregate exposure of our rates franchise and every week we ask the same number of clients in our franchise whether they're long, neutral, or short duration either outright or relative to benchmark.
And we found that when that measure sort of moves very sharply away from average levels, it can have a mean reverting effect on yields [in] the opposite direction. So you talk about sentiment, I think everyone through the spring and summer was trying to handicap when the Fed would be done raising rates, thinking the next move is going on hold, which would be the precursor to rates moving lower.
And our survey back in July and August was as long as it had been in over a decade, and it gave you a signal that over the next five to six weeks there could be some risk that rates move higher on a systematic basis and that's what we've had. Now walk that forward in our latest survey, which is about a week old right now, it’s back at its most neutral level since April.
So I get the sense that perhaps part of this move over and above the fundamentals could be investors reassessing those duration positions as we've priced higher for longer, or you talk about the supply dynamic here at work, maybe that's in the background against the backdrop of large deficits, but I think sentiment is a really large driver over shorter periods of time.
Tracy (18:57):
So two questions on that. One there has been this argument that as yields go up and prices go down, you are going to see some maybe ‘buy the dip’ buyers start to come in and support the market. So one, would you expect that to happen? And then two, on the duration portion of it, like how much appetite is there for duration structurally in the financial system nowadays?
And I guess a simpler way of asking that is why buy a bond at all, especially at a time, you know, I understand maybe you're a pension fund and you have long liabilities and you're trying to match them or something like that. But on the other hand, you do have the Fed really taking a harsh look, or a harsher look, at duration risk, telling banks — big buyers of bonds as we were discussing earlier — that they are going to be looking at interest rate exposure and things like that. So what is the attraction of bonds at all in the current market?
Jay (19:50):
No, I think that's a great question and I mean bonds are an investment alternative that are viable for the first time in 15 or 16 years here, right? I mean you talked about it about [in] the opening, Treasury yields hitting, you know, pre GFC highs across the curve. You know aggregate fixed income yields for like an aggregate fixed income bond index are probably still close to 6% right now. And so I think that's a viable investment alternative just for a broadly diversified portfolio.
So I think that means there's probably a pool of asset managers that could have demand for bonds over time, but I think that's only one piece of the puzzle because it takes, you know, a very attractive yield level, which we've got, but also it takes sort of more stable returns. And you started to see that at the beginning of the year, when yields started to stabilize, inflows into bond funds started to accelerate. But that sort of petered back when volatility began to pick up. And because now, year to date, we've got fixed income returns negative for the third consecutive year. So perversely I think it's a little bit of like a chicken and egg.
You need the attractive yields, but you need stable returns as well, and we haven't gotten that yet with the speed of the backup, but it's been talked about a lot. I mean you look at the money and government and Treasury money market funds, it's over four and a half trillion dollars and that obviously increased as bank deposits were falling earlier this year. But I think there's reasons to think that as yield stabilize and you consider the Fed on hold, there's room for that money to extend out along the curve. So that's one big buyer right there.
I think the others that we've looked to in the past are the US pension fund community, defined benefit in nature and that's a three and a half trillion dollars universe in AUM. Their funded ratios are above a hundred percent really sustainably for the first time since the financial crisis and their fixed income asset allocation’s been rising for the past decade-plus. I think they had an existential moment back in 2011/2012 when funded ratios were well under a hundred percent and their fixed income asset allocation was only something like 35% for managing a longer duration liability.
But it's now over 50% and one would think that there's probably more room for demand there. But again, I think the nature and speed of these moves mean that most active investors who have I think more leniency before they add duration, are sitting back waiting to see sort of vol recede first.
Tracy (22:02):
That's interesting that the upside of this violent bond selloff might be pension funds being sort of fully funded for the first time in a long time. But on that note, so one thing you often hear in the bond community is that drawdowns don't necessarily matter or, you know, prices are going down but these are mark to market moves and your yield is going up at the same time, and so what does it matter if the mark to market is going down because eventually you would expect to get all your money back from the US Treasury. Is that a viable claim or, you know, is it possible for everyone to look through these violent moves, or I guess another way of asking it is, at what point do these [drawdowns] become more of an issue?
Jay (22:44):
So I think you should be able to look through them, but for more active managers who are managing versus a benchmark, I mean we can look at series of returns on a weekly or a monthly basis and see how those various funds are doing relative to their peers. So I think, you know, there is some psychology to not deviate too far away from where average excess returns are headed.
And I think that's important because excess returns over and above index, which index being negative for the last three years, excess returns for the asset manager community have been on the average pretty challenging the last couple of years. So I think there is a degree of sensitivity there. So I think that's sort of an impactful story there, which means that there is some sort of psychology — particularly as the fundamentals are shifting — to kind of neutralize your positions more quickly even though you may be able to look through it.
And then there's a separate story about flows, which is over and above the existing stock of AUM you've got, that you probably need to see returns stabilized before you see incremental inflows from investors out of money market funds or out of other asset classes into fixed income as well.
Joe (23:44):
Can we talk a little bit more about supply? I mean we talked about the demand or the lack of the price insensitive demand. It really feels to me like awareness of deficit — people always talk about deficits and high deficits — but it really feels to me like focus on deficits really in the last like month or so, reached some fever pitch. When you talk to clients do you notice that as well? Just a lot of conversation about deficits?
Jay (24:08):
Joe, I haven't had as many conversations about deficits and Treasury supply over my, I think most of my career, as versus what I've had the last couple of months. It's hit a fever pitch.
Joe (24:17):
Wow. And so how do you think about deficits as a driver or like decompose the supply side when you talk [about] attributing aspects of this rate move?
Jay (24:27):
Yeah, I mean I think supply matters in the context of that demand that we were just talking about and there's a big shift that's happening. But to your point, I haven't learned anything incrementally new over the past six weeks or so that I didn't know a few months ago. And I think we've known that deficits over the next 10 years are expected to be wide for some time. And maybe you can say incrementally the last couple months because yields have risen, the expectations over interest expense at the federal level are higher, thus even adding to that pressure.
But I think people look at the Treasury's quarterly refunding announcement on August 1st as being a seminal driver there, where the Treasury made and announced a series of pretty large increases to coupon auction sizes — the first since the pandemic era — and sort of foreshadowed to the bond community that these were likely to continue for a number of quarters at a time. That's been on our minds for some time. Like, our issuance forecast for some time had been calling for a pretty sharp increase in issuance.
Joe (25:20):
Well, so like anyone who was plugged in, saw these coming?
Jay (25:24):
But I think maybe the fact that it was like, you know, the whites of the Treasury's eyes and actually seeing it mattered, but it's large. And I think we think coupon issuance in Treasuries is going to double next year from this year and in duration terms, you know, we think we're running about $2.3 trillion in 10-year Treasury equivalents this year.
We're probably going to issue about $3 trillion in 10-year equivalents next year. So it's a 35% increase in duration supply into next year and I think it matters because deficits as a share of GDP are larger now with the economy sitting above trend and growth and the unemployment rate sitting well below 4% that I think just in the background there's concerns that when there's a downturn, how big will these deficits be?
Tracy (26:02):
So we are recording this on October 10th and the benchmark yield on the 10-year Treasury is down from, I think it was like 4.87% last week, it's now at 4.6% partly because of this flight to safety that we've seen. Pulling it all together, you know we talked about the long-term factors here, including the decline of price insensitive buyers, booming supply, some of the short-term technicals, what's your outlook going into 2024? And I guess I don't mean to sound mean or incredulous when I say this, but like how can you have any certainty at this point about what's going to happen when what we've seen for the past year is this continued defiance of expectations?
Jay (26:45):
No, I think there's a lot of humility there because if we had sat here, you know, nine to 10 months ago and talked about the outlook for 2023, we would not have pegged 10-year yields sitting at 462 like they are right now. But as I think ahead and I look into the end of this year and 2024, let's think about the economy and again, we're not in the recessionary camp but we see and we forecast growth moving below trend under the weight of the shift in policy rates that we've had. But also because there's other incremental factors with higher energy prices, with the beginning of student loan repayments coming back, to think that growth will be slower next year than it was this year.
We think Fed policy is likely at a standing point with respect to policy rates, that it's on hold, which is typically something over a longer period of time that's been supportive of yields stabilizing, and we think inflation is coming down but coming down very slowly. So we've had a very strong disinflationary impulse the last three months. We think that's probably past its peak and that the journey from 3% annualized inflation to 2% is going to take some time.
So the Fed's probably done tightening but we think the Fed's also on hold for the next 10 or 11 months or so. All the while QT is still going on in the background. So I think we can historically go back and look at the end of Fed tightening periods as being very positive for yields peaking and coming back down. But I think these are the reasons a Fed on hold for longer while balance sheet policy is still kind of sitting in the background working and not just in the US but globally too because the ECB and the Bank of England are doing QT, and one would think that the Bank of Japan might have to defend its purchases or its YCC target less forcefully as well.
This is something that's going to keep rates elevated for a longer period of time versus what we've seen in prior Fed-on-hold periods, particularly when inflation remains above the Fed's 2% targets. So we see scope, if there's some mean reversion here, back to our model fair value for rates to fall about 30 basis points. But beyond that I think it's a struggle to think that yields will be much lower if the Fed’s on hold but QT is going on and inflation's coming down, but we're past the peak of the disinflationary impulse that we've had.
Tracy (28:50):
Yeah, this was kind of Austin Goolsbee’s point as well that, you know, even a hold is kind of a continued tightening of financial conditions. Jay Barry, thank you so much for coming on Odd Lots. Appreciate you doing this at relatively short notice.
Jay (29:03):
Tracy, Joe, thanks a lot for having me.
Joe (29:04):
Yeah, thank you so much. That was great.
Tracy (29:18):
So, Joe, I thought that was a really good overview of all these different factors going into the selloff at the moment and it does seem kind of complicated and there is still this overarching question, I think, over the timing and the past two weeks. And like yes, the dots moved slightly higher, but was that really enough to spark like this big — almost historic — selloff that we've seen in bonds? I think to Jay's point, it does feel like there are some more technical aspects that might be driving it.
Joe (29:49):
You know, there were a couple of things that stood out to those technical points, like his observation about sentiment and the fact that up until basically July, up until maybe July, middle of August, everyone was thinking like, oh the peak was in, you know, inflation's going to come down. And so there was just this sort of long Treasury bid, [it] is interesting that you know, he sort [of] confirmed my hunch that there's just been this like real big pickup in like deficit talk the way we haven't seen in a while. Anyway, I really found that to be very helpful conversation.
Tracy (30:18):
Yeah, it's kind of funny to think that like everyone woke up on like October 5th and decided to become a bond vigilante. But they didn't feel like that a month or two ago.
Joe (30:28):
I mean, we knew about the trillions in deficits for, you know, as far as the eye can see but it is weird, right? There hasn't been a ton of new information between, you know, whenever that recent peak was on Friday and a month before. But I do think it was sort of like that month basically between our Bill Gross interview and now, just the amount of negativity and then the intensity of hatred towards bonds. It just seemed to get wild.
Tracy (30:52):
The Bond king called it?
Joe: (30:54)
Yeah.
Tracy:
Alright, shall we leave it there?
Joe (30:56):
Let’s leave it there.
You can follow Jay Barry at
@jfbarryjr
.