00:00Stephen Major of Tradition Dubai writing, central banks can initiate rate hiking cycles to tame inflation,
00:05but underlying debt dynamics ultimately dictate how those cycles end.
00:11Stephen joins us now for more.
00:12Steve, my friend, it's good to hear from you. It's good to see you.
00:15Hi, John.
00:15Are we on the brink of some bond market pushback, limiting the ability to hike rates here at some of
00:19these central banks?
00:21The focus is Jackson Hole already.
00:24I know it's a week or so away, but people are now discussing what's going to come up at these
00:29meetings
00:29because it's very often the case that big set-piece moves happen at these conferences.
00:35I think that you've reported the impact of debt and fiscal dynamics on bond yields and earnings.
00:42And I think that you're quite right.
00:44It's a bit more complicated than just the debt levels or the fiscal position
00:49because when earnings are so strong, then the risk premium that goes on to the bond yields or the term
00:55premium has to be higher.
00:56I mean, try explaining to a young person why they should buy bonds when equities keep blowing the lights out
01:02every week.
01:03So it's quite simple.
01:05There's the risk premium, and I think the fiscal dynamics are somewhat worrying.
01:12I guess you could say there's an international effect as well on the long end of bond curves here in
01:18the JGBs at the moment.
01:20But a few weeks ago, it might have been Gilts or Boons or Australia or something.
01:25So I think there's a whole list of factors that are explaining this drip, drip higher in bond yields at
01:33the long end.
01:33Steve, can I pick out one?
01:35And it's supply.
01:35I remember a fantastic paper that you published a number of years ago.
01:39You know where I'm going with this.
01:40Bonds aren't potatoes.
01:42Can you talk to us about the importance or maybe the insignificance of supply traditionally to DM sovereign debt markets?
01:50The point of the paper was that the supply gets taken down.
01:55Bond yields reflect the policy rate and the expected path of that policy rate and where it ends up.
02:02So it should be that all available information is factored into the price.
02:06Where I think the model has kind of broken down is with these huge shocks like COVID, where we had
02:15a big shift and shift in the level of debt, maybe 20, 25 percent level shift like GFC in 2008.
02:23The thing about it is, John, if you look at the two year that you were covering just now, the
02:28two year is totally explained by the policy rate and where it's going to go next.
02:33Just in the space of the last six months or so, we've had a move from markets looking for three
02:38rate cuts to as many as two rate hikes in a year's time.
02:42So that's a net five rate hike move.
02:46And that explains the entirety, if not more, of the shift in those yields in the two year, even out
02:53to the five year.
02:54It's when you get to the 10 year plus that something else is clearly at work.
02:58And those yields don't want to go back below five percent at the moment.
03:02And I think there is a supply dynamic.
03:05But I think it's a bit cheap to say that there's too many bonds around.
03:10That's why the yield's going up.
03:12I think the explanation is a bit more sophisticated.
03:14I think it's related to the performance of stocks, what's happening in Japan.
03:19And yes, there is some fiscal risk premium.
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