Macro Report/Insights: Bonds, The Yen and Growth

The current flows driving markets

Hey everyone,

There are several things I am going to cover today:

• The bond market in connection with the macro report

• The Yen increasing in variance

• FX flows

• The growth picture

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The bond market in connection with the macro report

As you know, I wrote a macro report breaking down how I am thinking about things into the end of the year:

In the macro report, I noted that there is a mispricing of inflation and the forward Fed Funds curve. Over the last week, we have seen yields rise considerably, specifically at the long end.

The move in yields has primarily been driven by the long end, causing the yield curve to steepen marginally:

This is a direct result of the mispricing I noted in the macro report.

I continue to receive questions or direct messages about bonds, so let me share a couple of thoughts:

• First, I don’t want to take any large long bond positions with a longer-term view (over 3 months) until I see the market pricing a reasonable path for inflation and a reasonable path for cuts by the FED.

• Second, just think about what happened during the SVB crisis. There was a flight to safety and the entire forward curve went from pricing hikes to aggressive cuts. The problem is that the inflation situation didn’t change at all.

Could the FED have started cutting after the SVB crisis in confluence with what the forward curve was pricing? Certainly, but then we would be back in a 2021 scenario where the FED was conducting loose monetary policy at the same time growth and inflation were accelerating.

When I think about the economic system, I always start with understanding how the flow of capital and money is functioning. This is why I want to have a really clear understanding of fixed income and the various scenarios being priced by breakevens, real rates, and their respective forward curves.

We don’t have an FOMC meeting this month, so there won't be a hike or official pause. The market is still pricing a marginal probability of a hike for the next two meetings, and Powell has definitely left the door open for it.

I will expand on this more in the last section of this article. However, from the big-picture perspective, I am not stepping in to buy bonds here. Could this be the technical level at which they reverse? Yes, of course, but in my analysis of the risk-reward (as shown in the macro report), I don’t see much of a reward for buying them yet.

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The Yen increasing in variance

I want to shift to the topic of the Yen now, as this will be important for US bonds. I remember Weston Nakamura once saying that Japan and the Yen are to the US bond market what OPEC is to the oil market. This is an excellent analogy!

Understanding the Yen correctly will be instrumental in analyzing WHEN to buy bonds, so this section will be important.