Attack the Week (ATW)
August 21, 2023
Hope you had an amazing weekend. I am writing this on a very early flight back to British shores. I spent the weekend in Switzerland with a friend who invited us to their place in a town just outside Zurich called Baden. Every 10 years, the town celebrates a 10-day fest called “Badenfahrt”. This time around, it marked their 100-year anniversary. It was damn hot, about 34 degrees Celsius. The town was heaving. Tons of bars and food places, and music tents were on display, welcoming possibly 10 times the town’s population on a daily basis. My friend commented how a relatively quiet town erupts in a 10-day mass party every decade. It surely did not disappoint. We didn’t get home until 5 am, which should give you a good indication.
Everything works in cycles; town parties and markets are no different in this regard. Reflecting on some of the last week’s commentary about how bonds are now doomed made me think about how bond vigilantes get louder every once in a while. Remember how QE was inflationary back a decade ago? Remember how Powell’s higher R-star mantra caused the bond vigilantes to declare the end of bonds in 2018? Remember Larry Summers’ coining of secular stagnation not too long ago while we are now facing structurally higher inflation ahead according to his latest thoughts, secular highflation, so to speak. Big opinions and narratives always resurface AFTER market prices change. Whether this truly reflects the market’s true destination is the obvious question. I’d say that, more often than not, those narratives get falsified over and over again. This time will be no different. 2 years ago, 10-year treasuries traded at 50 bps, yet I didn’t hear many vigilantes highlighting the likely path forward. It’s always easy to join the crowd, ~400 bps later.
Similarly, curves mostly flattened this year, which is not untypical for a tightening cycle. The likely end of rate hikes, coupled with BoJ altering YCC and supply pushing out risk premia, have now woken people up to the possibility of higher neutral rates. Higher for longer isn’t something new. The Fed was telling us about it for months. This should surprise no one. In my piece about inverse optimal control, I talked about how the theoretical minds within the Fed would likely view the current policy stance using the classic Taylor model concept. Read the piece again.
With Jackson Hole looming, I think chances are very slim that Jay changes any tune. Things have moved in line with the FOMC’s forecasts. Higher for longer still makes sense, and the market gets it. Will he pull another party trick like he did in 2018? It’s possible, but I very much doubt that. He’s a pragmatic chair these days and knows that keeping all options open is the best way forward, especially at the current juncture. He will unlikely push back against recent steepening. Also, remember that all the spending since Covid was “pre-funded” by supportive QE. The final bill has now arrived. Any party, like my weekend one, has to show up with some kind of hangover eventually.
Remember that much of the higher R* discussion coincided with a piece on the Liberty Street Economics blog, which mentioned the possibility of a higher short-term R* in the post-pandemic world. This lines up nicely with the announced topic for Jackson Hole, "Structural Shifts in the Global Economy". If this is being seriously considered by the rest of the FOMC, it could signal the need for higher rates now, followed by more cuts in 2024. Remember that this is a highly theoretical discussion for now.
Now, let’s look at what else is shaping up for the week ahead and what some of the charts are setting us up for …