Lots More on the Global Selloff in Government Bonds

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1:22Yes, you are. OK. But like and I was totally ready to capitulate as like, oh, it's all the term premium. And I was like, I'm totally convinced the term premium is this really important concept that can be measured analytically with precision. And then some people are like, oh, it's actually you don't really have to go that far. It's sort of straightforward. I still don't know. You know, there's a middle path where you can say that the term premium is hard to measure because you have to estimate like a risk neutral rate. But but it still exists. It might mean different things to different people, but.

1:53I've never been good in life at taking the middle path in anything. I oscillate between extremes. I did a deadlift. I am both the most popular trader and most successful trader at Citadel. Fed has gone viral. Barges. This is an after school special, except. I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Black gold. These are the important questions. Is it robots taking over the world? No, I think that like in a couple of years, the AI will do a really good job of making the Odd Lots podcast. One day that person will have the mandate of heaven.

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2:50Back with Jay Barry. He is now the head of global rate strategy at JPMorgan. The last time we had him on was in October of 2023. And the headline on the episode was like Jay Barry on the big sell-off in bonds. And we can just recycle that headline. Yeah, call that again. Was that the peak when we had him on then? I don't know. It might have been. Probably close, right? Close, yeah. At the time, yeah. Jay, do you believe in the term premium? Well, Tracy, I think it's funny you talk about the last time I was on because 10-year yields are basically at the same level they were then. And at the time, the funds rate was 100 basis points higher than it is right now.

3:27So term premium is hard to measure, but I'm a simple man, and I think of it as the slope of the yield curve. And the slope of the yield curve is steeper for a given level of policy rate. So I think it tells you that there is more term premium in the curve right now. Absolutely. Ira Jersey, who does rates here at Bloomberg Intelligence, had a chart. And you just said, look, yes, one term premium, all that. But one part of the story is just that the market's estimate of the terminal rate is now higher than it would have been, say, six months ago, et cetera, at the start of the cutting process. And that a big part of the story with the rise in the long end since September is just that, you know, there's not as much cutting baked in.

4:06I think that's exactly it as well, Joe. I think that's a really important point because this is now the middle ground. It's like part of it is the term premium and part of it is the terminal. If we get Joe to take the middle path, this is a success. I'm a middle of the road guy, and I don't think a single explanation or a single factor can explain the bond sell-off. But term premiums, one, Tracy, but Joe. Fed policy expectations matter because it's fascinating. When the Fed cut 50 in September, we were pricing in a terminal funds rate of like two and three quarters. And now we're pricing in a terminal funds rate of 4%.

4:36It's a big change. It's a huge change, and that's driven it as well. And it's so unusual. And I think it's unusual. But what the Fed did was unusual, because basically by preemptively cutting 50, they said, even though inflation hasn't come back to target, we do not want to sacrifice this expansion. And this probably means better growth outturns in the future, higher inflation in the future, thus justifying fewer cuts down the road and actually higher rates. So that's a big piece of the puzzle, because that's been a 125 basis point move as well. The one thing I would say, though, I mean, I agree.

5:06This is just me and Tracy debating through Jay. Obviously, bond yields react to Fed expectations. You're the mediator. And the near-term path of the economy and inflation. But the one thing I would say is, like, in October, there were other things you could look at to measure nervousness about a potential Trump win. Like, you know, puts on the TLT that suggested that a bunch of investors really wanted to shed long term bond exposure right after the election. And this was happening like, you know, those were going up as Trump's polling odds were going up. So I feel like there are other things that suggest some of this nervousness is like secular in the long end.

5:48But anyway, the thing I wanted to ask, Jobs Day is coming up. So we're recording this on Thursday, January 9th. The bond market is actually off early today for Carter's funeral. But how big a deal is the bond market reaction going to be to the jobs date? Like if we're debating whether this is some secular, maybe politically related change versus something about the Fed and the path of the economy and inflation, it feels like jobs are going to be a big factor here. I think they absolutely are. And I think it depends on which part of the term structure you're talking about. Because what's been interesting in this move is that the front end has remained, Tracy, really well anchored, right?

6:28I think it's because the Fed has been asymmetrically dovish in its reaction function. Right now, even with what happened in December, with the dots showing only two cuts for next year, the Fed in aggregate is talking about cutting further, albeit at a slower pace, or just going on hold. Nowhere in the discussion is hikes. And that's why the money market curve, even though we're pricing in fewer eases, is still inverted. I think that could start to change if you see the labor markets start to tighten again. So if the unemployment rate starts to come back down, that could be meaningful for repricing the front end in the opposite direction.

7:01But at the same time, even though the labor markets are not as weak as we perceive them to be back in August and September, there has been a steady slowing in private payroll growth. There's been a steady, slight increase in the unemployment rate, which tells you that the demand for labor is moderating. And if you get another sense of that tomorrow, and I think consensus is$160K with the unemployment rate at$4.2K. We're$150K,$4.2K, so we're very close. I think that probably anchors the front end and tells you that it's probably relatively stable here. The long end is a different story. I think if the pace of employment growth is stable, but you see something like the rate come down and average hourly earnings firm back up, then the markets can price out a bit more of the Fed easing that we've got priced in.

7:41And it becomes a bit more of a parallel shift because that justifies higher long-term rates as well. So I think it's important with some asymmetry that the front end is better supported than the rest of the curve. But this has been kind of our whole thesis too. And the employment data tomorrow is a key piece of that puzzle. The economy overall seems very noisy to me right now and hard to parse because there do seem to be signs like, look, growth continues, no real signs of slipping into recession. But on the other hand, there are signs that the labor market is softening. Maybe the labor market is strengthening.

8:10I think it's actually really noisy. Let's zoom out, though, sort of big picture to talk about, I guess, since September. What's happened? So there's been a few developments. First of all, just looking at the 10-year, that bottomed at about 3.6. on September 16th. It's currently at 4.6465 as of this second when we're talking at 8.01 a.m. January 9th, 2025. Since then, obviously, we did have the Trump win. We're not going into, there are still no signs of imminent recession. How would you tell the story, basically, of just what's happened, you know, and explain perhaps the upward repricing of that terminal rate since that initial 50 basis point.

8:52I'm glad you asked that. And I think it's fascinating that that trough in yields was a day before the Fed meeting, right? So that was when we were priced for maximum dovishness. And at that point, we had seen the unemployment rate had been solidly ticking higher in the months before. And you could, maybe it turned out to be wrong, but you could at least tell a story then, oh, this looks like what happens before recession. Yeah. And it wasn't just the unemployment rate, because I think it's tough to disentangle what's happening with the rate, because there's obviously supply side factors going on there.

9:20But the pace of private payroll growth had decelerated sharply as well. So that was a big one with what the July and August data showed. So I think since then, first, it's what the Fed did. When they went 50, I'm not going to sort of toot our own horn, but Mike Ferroli, my colleague and our chief US economist, I think was one of the few calling for a 50. And I think that was a surprise of the markets because it showed the Fed's hand with respect to its reaction function. It really valued the labor markets over inflation and did not want to sacrifice this soft landing. And again, that generates better growth outturns and higher inflation in the future, which was a turnaround in rates because perversely enough, it requires fewer eases down the road.

9:59So that's a big dominant driver. And I think we can see that in the interim since then to support this, growth expectations have moved up. And just for example, we've got our series of forecast revision indices and our year ahead growth forecasts over the last three months have gone up something like a percentage point. We've come off consecutive 3 % quarters. It looks like we're running 2.5 % right now. So that's a piece of the puzzle. The second is, and this is where we'll get back to Tracy in term premium, is the change in the fiscal expectations because of the re-election of President-elect Trump.

10:30And that is meaningful because we expect the TCGA to basically be extended in full, and that's going to add an additional$4 trillion to deficits over the next decade on a baseline of what I believe was about$22 trillion to begin with. And that matters because I think as we spoke about the last time we were here, the budget deficit running at 6 % to 7 % of GDP when we're close to full employment is highly unusual. And the growth of the treasury market is just outstripping demand from its sort of most price insensitive historical investors, like the Fed and US banks and foreign official investors.

11:05So we've got to find other price sensitive investors to underwrite this supply. And when that happens, it just requires a higher term premium and higher yields and a steeper curve for a given level of policy rate. So I think those are the few drivers there. And it's a global story. Yes, the US has led the way, but it's been happening everywhere as well.

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12:15Giving teams across your organization an easy way to order from a huge variety of restaurants, all on one platform. All while consolidating your corporate food spend so you can control costs, streamline billing and payment, and simplify reporting. EasyCater, your business tool for food. To learn more, visit easycater.com slash podcast. So back in October, I think it was October, you had a note where you sort of mentioned your former colleague, Josh Younger's famous Volfefe index. I think probably the only piece of J.P. Morgan bond research to ever make it into New York magazine's like hot or not graph at the end of the magazine.

12:57You remember that, Joe? Wait, do they still have that hot or not? I don't know if they do, but they did when it was first published. Yeah, I do remember that. That was a good— And Volfefe was hot. And the idea was— The approval matrix, as our producer Dash reminds us. Yeah, that's right. And you sort of—you mentioned it. Are you guys going to be reviving it under the Trump administration? So I can't comment on things that we intend to research, Tracy, but as you said, we talked about it a few times in the last few months. And I think it's important to understand that during the first Trump administration that announcing policy via Twitter or via X right now - Or Truth Social.

13:33Or Truth Social, as the case may be, was something that did actually raise implied rate volatility and higher rate volatility necessitates higher term premium and thus more sticky higher rates. So it's something I think in the background that we're sort of focused on. And it's funny you talk about Josh. I actually was on the phone with him yesterday. Oh, yeah. And so I think this is all kind of coming full circle. But I think that's something in the background that we need to focus on as well, no doubt. Why is this a global story? I get the labor market looks stronger perhaps than it did six months ago or five months ago or whatever.

14:05But a lot of headlines this week about the UK specifically. And now you have the global seat. I can ask you a UK question. So why is this a global story? And maybe tell us something about the UK. Yeah. Thanks for that, Joe. But I think there's a policy story globally that's divergent, right? So the Fed and the U.S. is in a very different spot from the rest of the world. Euro area, ECB is cutting and cutting 25 until it goes into slightly accommodative territory, we think. So there's a slightly divergent factor there. BOJ is in the midst of normalizing rates. Also, rates are going higher in Japan.

14:39Where rates are going higher, exactly. And then you ask about the UK. I think the UK is sort of stuck somewhere in between the US and the euro area because it's got the fiscal issues that we're talking about in the US. It's got the sticky inflation that we're talking about in the US. But it lacks the labor supply and productivity benefits that we've had in the US. So you've got a central bank that's kind of getting stuck here and can only ease at a somewhat more gentle pace. And there's nothing really we can point to this week in the UK about the fiscal pressures, but they're just there in the background.

15:11And it's the same way the US has sort of seen this move to higher rates since we've walked into the new year that they're coming back in full force. So just to summarize the sort of core tension, it has the same fiscal pressures as the US, but it doesn't have the same productivity growth as the US. Therefore, all that spending is running into a less productive economy, and that sort of creates that upward move in rates and the inflationary pressure and so forth. Is that the idea here? It is to an extent, and I think it's also more idiosyncratic, Joe, as well, because look at what happened with the UK market.

15:44What was it back in September, October of 22 when the LDI sell-off happened? It's a market which, yes, it's smaller than the treasury market, but it's less liquid. It's more concentrated in its ownership. So when you have a market where I think it's a bit more concentrated in its ownership than a very diffuse set of ownership in the treasury market, you can go through these balance of idiosyncrasy where it's hard to identify a single driving factor to see what happened with this sell-off, but it can get exaggerated by those factors as well. There is also a reflexivity at play here where if bond yields are going up, particularly at the long end when the U.S.

16:19is planning to do more long issuance, that means the cost of borrowing is going to go up, which maybe increases the fiscal burden and then yields go up even further. Is that the kind of risk that we should be thinking about in 2025? I think it's a slow-moving train there, Tracy, because the average maturity of the U.S. Treasury market debt is about six years. So higher rates will definitely lead to higher interest expense and will add to the burden. But I think a large part of that burden and that increase occurred as the Fed was raising rates rapidly. And we know that T-bills are about a 20 % share of total debt outstanding.

16:57So there's a fair amount of short-term debt outstanding, and it's less expensive than it was a year ago. So this will continue to feed through, but it will be at a very slow rate. So I think it's certainly there in the background as well, but not as primary or secondary driver as these other factors that we've been talking about. You know, speaking of policy by Twitter, I don't think that Keir Starmer or what's the chancellor's name, Reeves, in the UK, they're not doing as much posting policy by Twitter. But the owner of Twitter is posting a lot about the UK these days. So to the extent that there is just a lot of noise about the government going on, setting aside everything else, there is a lot of just political noise in the UK.

17:42on top of all the sort of core economic stuff. And it's not just the UK, Joe. I think this fiscal noise is going on everywhere, right? We're talking about the TCGA and the fiscal burden in the US. You're talking about fiscal in the UK. Look at what's happened with France, right? With its government falling. That's right. And they've got deficit issues to try and get back out of the EDP over the next few years, which seems unlikely. You're talking about it in Japan as well. So fiscal and supply is, believe a global story to varying degrees across developed markets right now. You need to do a vol-elon index.

18:15That's right. Vol-X. Oh, vol-X is good. The vol - yeah, a global vol - you can have that one. A global vol-X index. They're just a measure of social media talk around the world relating to fiscal policy. That's a free one. That's great. Break it down by country there. You can do an ETF on that too. Yeah, the vol - I'm going to trade vol-X. I like that idea. What about central bank, like QT people? I don't know. People don't seem to talk about as much about QT. But what about the role of central bank asset purchases or sell-offs in this story or on wines? I think it's something in the background, right?

18:54I think back to 2018 when SharePal talked about QT and referred to it as watching paint dry. And I think it is just sort of going on in the background. And of course, in the US, it's at a slower rate than it has been for most of the last couple of years. But in our work, the Fed's balance sheet as a share of GDP matters for rate levels. It matters more for curve slope as well. So that's something that's happening in the background because the Fed's balance sheet has been not only shrinking on a nominal basis, but shrinking relative to the size of the economy. And we found that every one percentage point move relative to the size of the U.S.

19:27economy has been worth a handful of basis points on the yield curve. So as it continues to normalize, that is something that's in the background, also placing steepening pressure on the yield curve. And it's, of course, a global dynamic because you've got the ECB, the Bank of England, and now the Bank of Japan all doing this as well. And you can see it not just in curve slopes globally, but vis-a-vis swap spreads. I think there's been a story where swap spreads until recently have been narrowing globally across the DM as well. So you can see the imprints of QT there. It's there, but I think it's probably, again, kind of a third-order factor when considering the term structure of rates in the U.S.

19:59and globally as well. This might be a weird question, but since we brought up QT and earlier you were talking about the need to find new buyers for bonds, what exactly can the U.S. do if a bunch of traditional buyers like banks, the Fed for the past more than a decade, are stepping away from the market other than yields going up? Is there anything else they can do to market debt to the outside world or, I don't know, even internally have banks buy more bonds? So it's funny because the Treasury Department can only deal with the symptoms and not the root cause. But the Treasury and its sort of cadre of private sector advisors, the T-BAC, have done a lot of strong work on this.

20:38And there are charge questions that are asked at every single refunding process. And one that was asked of the T-BAC a couple of quarters ago was, what new products and processes can we open up to sort of widen the spectrum of demand? I think they're asking this question, Tracy, for that very reason. And two products that were talked about were adding another floater at the short end of the curve. There's a lot of demand for short duration floating rate product that's latent. The other is adding another point on the TIPS curve. And the TIPS product has been around for close to 30 years right now, but we've only had three points on the yield curve.

21:08We've added three or four bill points. We've added three nominal points. So in order to make sure that you're maintaining the TIPS product as a share of the Treasury market and your commitment to it, you can add TIPS as well. So they're certainly focused on it, and that's one way to try and widen the spectrum. The other, less from the Treasury, perhaps more from the regulatory side, is thinking about how you make it easier to intermediate in the Treasury market for banks and dealers and own Treasuries. So there's been a lot of focus on potential regulatory developments in the context of Vice Chair Barr's announcement earlier this week.

21:40And I think that's something that we can think about in the background over the medium term, but would just offer that the timeline for regulatory reform is probably years to sort of unfold. and not months. And even when it occurs, I think some important points that we've made is that banks aren't leverage constrained right now. So bank demand for treasuries is not being constrained by leverage ratios. So it's something that could happen once again down the line, but it's not an issue right now. Do you have like a fair value here? So again, we're at like 4.64 or whatever. A lot of it seems to be explained by just the sort of overall change in the outlook since September.

22:18Then there's various reasons for volatility. Maybe Tracy would call it the term premium. But obviously, more issuance, uncertainty, higher deficits, et cetera. Where does that put us? Are we around where it, quote, should be? What makes sense to you, or where could it go? It's funny to draw the parallels again, Joe, because the last time I was on, we talked about this. And we made the case at that time that 10-year yields looked about 35 to 40 basis points too high relative to that fair value metric. And that's adjusting for how the market's pricing Fed policy, inflation, growth, and the size of the Fed's balance sheet.

22:51We're at a similarly high level right now. So the fair value would be probably closer to four and a quarter. The only thing I'm going to sort of caveat there, and not to say that we're losing the anchor, that's an important valuation framework we have at J.P. Morgan, is that we've been trading either at fair value or cheap to fair value for the last two to three years. And I think it's because in the background, we don't have a term premium factor in that model. And we have to be sensitive to the fact that that is something that's changing. So even though we're, call it two standard deviations cheap right now, my argument is that the propensity for mean perversion is probably lower than it's been in the past.