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, and 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, bonds 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 in the level of debt, maybe 20%, 25% 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, and that explains the entirety, if not more, of the shift in
02:50those yields in the two-year, even out to the five-year.
02:54It's when you get to the 10-year plus that something else is clearly at work, and those yields don't
03:00want to go back below 5% at the moment.
03:02And I think there is a supply dynamic, but I think it's a bit cheap to say that there's too
03:09many bonds around.
03:10That's why the yield's going up. I 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.
03:21Steve, can I add in maybe corporates as well and the rising competition for capital that we are starting to
03:28see increasingly in the debt market too?
03:30What kind of an influence is that having in a way that maybe it didn't in years gone by?
03:34It's so right, John. And in fact, thank you for reminding me of that.
03:38In many ways, I include it in the risk premium category.
03:42But faced with the choice between a household name that's issuing long bonds that has a very good credit
03:48and the U.S. Treasury, where some people are even questioning the credit,
03:53when you can get even more yield in that household name electronics company, whoever it might be,
03:59guess what's going to happen?
04:00So traditionally, you have a crowding out when yields get high enough and the government always gets done.
04:09So there shouldn't be a problem.
04:11But that crowding out now faces a challenge from other needers of capital.
04:17So there is this demand for capital to invest.
04:22I think that is part of it as well.
04:24So let's add that to the list, John.
04:26Steve, given the reality we're in right now, where does this leave the Treasury Department in terms of their auctions
04:33and where are they going to sell debt?
04:36Yeah, well, at the moment, Anne-Marie, they've got enough data to be comfortable.
04:42So we're looking at the covers and the tails and the indirect bids, etc.
04:47But we might be getting a bit twitchy further out on the curve.
04:52So the 30-year bonds may not be so much in demand, even when the yield is so fantastically high.
04:58So that says cut back the supply of the long-dated paper and increase the supply of the shorter-dated.
05:04Now, of course, they're already doing that.
05:06And you can't keep doing this forever.
05:08So it seems to me that the U.S. Treasury is not doing the U.S. taxpayer any favours by
05:15issuing long bonds north of 5% yield.
05:19They're doing a great favour to the savers who are able to lock in those yields,
05:23but they're not really doing anyone who's paying tax a real favour there.
05:27So I think reducing the quantity at the longer end makes sense.
05:33I think also there needs to be a bit more fiscal rigour.
05:36There needs to be a plan.
05:38At the moment, it just seems to me there's no accountability.
05:42And you'll see that countries like Germany and, to some extent, Australia, Switzerland, where they've had debt breaks.
05:50And even in the U.K., I think that there's at least a five-year plan to try and balance
05:55the book somewhat.
05:56The U.S. doesn't even seem to have that at the moment.
05:59So I think markets would appreciate guidance on the fiscal outlook.
06:03There is a risk, of course, Anne-Marie, that this bond market forces that guidance, forces that call for action.
06:09Exactly.
06:10And we've actually seen this bond market force the president reverse policy.
06:14So when it comes to tariffs last year, so potentially you could see it again.
06:18And twitchy.
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