#950 - Is It Time To Fade Bonds? With Bob Elliott

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0:41is it time to fade bonds hi everyone welcome to the real vision daily briefing with me today is bob elliott co-founder ceo and cio of unlimited funds hi bob welcome back hey how's it going it's going pretty well it's going pretty well we're kind of making our way through the first couple weeks of the trading year. And it feels like we're kind of a little range bound, right? We saw decent gains across the board for U.S. stocks today. We had the 10-year yield creeping a bit, up a bit ahead of that CPI Thursday, PPI Friday. But everything feels like it's just kind of been in a bit of a range as we wait for sort of new clues on the economy and the Fed.

1:20So what are you expecting from the inflation reports? Well, I think everyone's sort of taking a beat after what was one heck of a couple of months there finishing up last year. And I think some of the internals, though, are starting to get interesting in the market. So even today, just a really simple dynamic where stocks were up and bonds were down starts to get to something that highlights a different market dynamic than we saw in the last couple of months and one in which the growth story may be a more important story in terms of what's going on than the inflation one. And so what's going to happen on Thursday with the CPI report is it's probably going to be not that interesting, which I know is probably not something that gets clicks in terms of news.

2:07But pretty much we're going to be in the 0.25 to 0.3 month over month core, a little lower on headline. that's still a little elevated relative to the Fed's target. And so it still keeps that concern out there in terms of whether the Fed really is going to deliver all those cuts that are getting priced in. Yeah, I guess that's what you're getting at with the growth story being more important, right? So we know that runaway inflation is better behaved. But just what happens with the economy that's going to prompt the Fed to go? I guess that's why the focus is on growth. So what are we looking at when it comes to that?

2:49Because now, if you look at all the easing priced in, we've got a recession coming. But man, people have been off on the timing of that. Oh, yeah, they have been. And I think that's what's really interesting about the pricing. The Fed has come in and said, we're probably going to do a couple of maintenance cuts over the course of the year, which you could quibble. Maybe that makes sense. Maybe it doesn't, given inflation is falling. But the Fed is not giving any indication that they're going to deliver the types of cuts that are currently priced into the market, right? Those sort of between roughly six-ish cuts that are priced in the market through the end of the year.

3:29And so I think that's why growth is the real focus here, because if the economy is slowing rapidly, given that inflation is relatively contained, maybe not fully dealt with, but relatively contained, And that gives the Fed a lot of credence to start to move quickly. But growth isn't really deteriorating very much when you look at what's going on. We're seeing the compilation of the data for fourth quarter growth. It looks like we're going to be around potential growth or a little bit above it. Actually, timely weekly indicators, like the Fed's weekly economic indicator measures, which brings together 10 different measures, that shows growth actually picking up.

4:07And so you see that in claims data. You see that in some of the mortgage data that is contracting less rapidly than it was before, which is actually a positive for growth. And so all of those things sort of look on the margin like growth is probably picking up a tad here at the end of 23 and early 24, which really calls into question whether all those Fed cuts are going to get delivered that are currently priced in. So what's supporting the economy? Why are we seeing growth pick up again? Well, I mean, the first thing I'd say in terms of the economy, and I think a big thing that many people missed, is traditional macroeconomic cycles are pretty boring.

4:45They're very slow moving. And so what we're seeing is just – has the Fed hikes – have they had some effect? Yeah, of course they've had some effect. And lots of people can point to the various corners of the economy where that's happening. But the overall momentum in the economy, particularly an economy where wage growth is growing at 4 % to 5%, depending on how you measure it, nominal and where asset prices, particularly stocks, are at all-time highs and house prices continue to rise, there's a lot of momentum in the economy. And there's money that consumers have to spend. And if anything, the falling inflation has given them some more real purchasing power, which has been beneficial to them continuing their spending behavior.

5:26And so all of those things are sort of combining. No one of those is probably a big enough deal to keep, you know, to have a significant acceleration of the economy. But, you know, you put enough of these things together and we're getting, you know, a slight improvement in the economy from one that is already, you know, doing pretty well. And so that's the basic story. So if inflation is contained, although it's still elevated from the Fed's rate, and the economy's chugging along and doing all right, I mean, is this that kind of, you know, all of the phrases are kind of a bit overused, but is that that sort of Goldilocks, soft landing, whatever you want to call it?

6:10I mean, is that a pretty good scenario for markets? Or is there something about that that we need to be thinking about in terms of the fact that markets kind of look into the future? It doesn't sound too bad. No, and I think it isn't all that bad, particularly from the stock side. If you hear that, you sort of say to yourself, okay, well, what's the problem? It seems like liquidity is ample. The economy is going well. earnings would be in that as growth continues will be fine to good. And if you go sort of bottoms up and you look at how this earnings season might translate, it looks like it'll probably be pretty good, not lights out the way it was when nominal GDP was growing at double digits, but it's still going to be pretty good.

6:59And so when you look at stocks, you sort of say, I add that all up and it seems like it's a fine area, it's fine time for stock to hold equity risk, and particularly maybe some of those sort of under unloved segments of the equity market. I mean, everything except, you know, all the prices of the stocks at seven? Everything except for MAG-7. Exactly, exactly. And I think that's kind of what we're learning in the equity side of things. Like maybe these small cap companies are not nearly as badly structured and positioned for, you know, a tighter monetary environment than, you know, people had expected.

7:38And so maybe we get some convergence. We've seen a fair amount of rotation in the market, but there's still some to go. And then I think the real thing is on the bond side, there's so much pessimism priced into the bond market that it's just hard to believe that we're going to – if we have a growth situation like this, that we're going to get the type of cuts that are priced in the economy. I mean, I said at the beginning of the year, sort of kick off the year, I said, look, if growth is, you know, at potential or a bit above and unemployment's at secular lows and inflation is, you know, in the ballpark of the Fed's mandate, maybe a touch higher than that, why should the Fed do anything?

8:20Yeah. Why should they? It seems like they're getting everything that they want. Yeah, which is, I think, what happened when Powell came out and they put the easing on the dot plot. Because why did they do that when, theoretically, they could have just kept it chugging along? I think that that's what was the catalyst that got everyone going. I mean, there's two sides to that, right? There's the fact that they're pivoting. Okay, great. Preemptively, perhaps pivoting. But the other side of that is do they know something we don't know? Yeah, I mean, the Fed doesn't know anything that we don't know.

8:55I thought you were just going to stop it. The Fed doesn't know anything. It doesn't know anything. I mean, I do think, I think it's important. Too often people are trying to, too often people think that the Fed has some sort of prescient knowledge. That's not true. The Fed is a terrible predictor of what's likely to transpire. They respond to the conditions that they see, and they act in ways that are relatively predictable in that way. Why did they respond? Why did they, knowing that they were going to get a market reaction, they had to know that? Why did they float the idea of easing when they didn't have it?

9:31There's two interesting points. One, I think they were surprised by the actual market response. Well, that's ridiculous. The market before that meeting was pricing in four cuts, and they said three in the dot plot. Now, normally what you'd expect the response to be is, oh, you expected four and we said three. That actually should be bad for bonds and bad for stocks. But the market basically took that and said, you say three and I'll double, you know, and really kept going. So, you know, you might think that that makes sense or not. I think the other thing that gets overlooked in terms of the dot plot is that it's not – you don't want to think about it just as from an outcome perspective as if it's a predictive outcome.

10:13You want to think about it from a reaction function perspective. And in that dot plot also was a set of unemployment rising by the end of 24 to 4.1, 4.2 in that range. And so what they're saying is if we have a weakening of economic conditions and inflation is moderated towards our target, then we'll do some maintenance cuts. Okay, well, you hear that combination of logic and you say to yourself, that's actually – that seems like reasonable. That's the monetary policy that I probably would run if I was in their shoes given the circumstances. But people too often forget that important point, which is unemployment has to rise into the fours for those maintenance cuts to happen.

10:59Right. There's a big if. There's a big if in that. Yeah. In the context of growth that's growing above potential. I mean, you could – I think one of the positions that's basically totally unpriced in the market is what if the unemployment rate in 2024 falls? it's it's it's absolutely possible and essentially there is zero probability priced particularly into the short rate markets of an outcome where the fed does little to nothing and that is a very interesting circumstance given i'd say the weight of the evidence is that the probability of that is certainly higher than zero hey everyone we're going to take a quick break right now to hear a word from our partners.

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12:50So we have a lot of really good questions coming in. I'm going to get to them, everyone. If the bond market is too pessimistic, if these things have to line up, if they're sort of over their skis in terms of Fed rate cuts. And I think you have a chart that shows like they've got way more factored in than the Fed. I'm not sure if we have that one or not. But where's fair value? Where should fair value be for the 10-year in that scenario? What looks reasonable? Yeah, I think you can easily see in the curve, this chart showing the Fed dots. It's kind of the Fed only tells us end of the year numbers.

13:30So it's kind of guessing when they'll do their three cuts that are in the dot plot versus the gold line, which is what's priced in the markets. This is at the end of the year. It's come up just a little bit from the end of the year. But the basic story is still the same. And so, you know, what does that look like? Like, well, I'd say, you know, even just moving from 150 basis points or 160 basis points of cuts priced in to 75 basis points of cuts priced, you know, that's a 75 basis point move on the two-year rate. And it's likely to occur in a circumstance where growth is doing pretty well and where we may get a curve steepening occur.

14:11And so we could easily see the curve, you know, are we going to retest five? I, you know, maybe. I'm not sure I'm necessarily there, but you don't have to be there to trade this market, right? The first 50 basis points are a little clearer than, you know, the next 50 basis points. And so, you know, could we easily see, say, the 10-year move into the mid-fours, back into the mid-fours again? I think given this complexion of circumstances, that seems like a very plausible outcome that we could see through the first half of the year. So, and I think that's the worry, right? That the two camps that are out there, that's the worry on the part of some that the bar market is just way ahead of itself in terms of what's going to happen from an easing perspective.

14:58Mark is asking if there's little or no easing, where are the danger areas on a sector or asset basis? Well, I think we just discussed the fact that bonds look like they'll need to reprice. Would you expect, and it sounds like you're saying you can expect more of that on the short end? I mean, where would you be most concerned about bonds? Yeah, I mean, I think the short end pricing is the most extreme in terms of the mispricing. And we've seen a few cycles of this. Last year, it kills everyone. I mean, how many narratives did we have last year? We went from recession now to start the year, to hire for longer, to credit crisis, to hire for longer, to Fed cutting 160 basis points.

15:46We go up and down. And I think this is kind of the complexion of the market. If you look back over the last 15 years, people sort of learned to follow the trend. And so you wanted to catch the twists in the trend because the trends extended for a long time. But what we've had really over the last 18 months is we've had the macro economy, sort of the aggregate trend of the economy sort of meandering, not really moving very much. And you've had expectations whip around up and down and up and down. And you've actually been a better position to fade extreme pricing than you have been to try and call the trend shift.

16:25And I think we're in another one of those circumstances where the pricing got a little overextended, particularly at the end of the year. And we're now sort of fading back to a more reasonable pricing dynamic. I just want to underscore that because I think that this is a really, really important point because this is kind of a strategy, right? And I think you're really giving voice to the fact that everybody has recency bias and what serves you well is catching the turn, right? Getting ahead of what everybody else was a beat later on seeing and that was a turn in the cycle. But you're saying now, or the turn in prices that identify the change in conditions, what you're saying now is really it's hard to tell what's going to happen.

17:10So be on the lookout for an overextension and sort of fade what looks like an extreme move because we've seen – does that mean there's more volatility? Does that suggest that we're just in a more volatile period and you're going to want to look out for those overextensions? Yeah, I think we've seen a lot of overextensions. Part of that, I think, is the uncertainty, a lot of uncertainty in the market about how it will respond, how the economy will respond to the monetary policy that we're seeing. And so in some way – and circumstances that people haven't really seen in their careers. So like I think a lot of people, as an example with the SVB circumstance, didn't really have the benchmarks and the depth of understanding to recognize was this like a 2008 crisis or was this not that big a deal.

18:06And so, you know, they went right to crisis because that was a bit of a framework that they had or an easy way to move into the market and then backed off of that as they realized it's not that big a deal, all things considered. And plus the government responded to it. Yeah, well, that's the other. That's what makes it confusing, right? So by the way, in my life of four trades, if you haven't seen it with David Rosenberg, he gives a great story about how he started in 87 and the biggest lesson he learned that day and this first day at work, which a couple of the people. That's incredible. Oh, yeah.

18:38A couple of people in our community. But I mean, like Brandy knew while eyes wide open, a couple of people in our community, by the way, and you might be in the chat, have mentioned that that was also their first day, which is incredible. But he went around and the conversations they were having were exactly that. Is this a credit event or is this a solvency event? And your reaction based on what's happening, you know, is there a contagion that's going to grow throughout the system or is this isolated, in which case, buy that dip with everything you have, which is the argument that his boss was making and it turned out to be right.

19:12Yeah, for sure. So that was like one of the important lessons. So really, really important to understand that. I'm glad you brought it up, Bob. But the problem is, even if you think you know, we've got these new vehicles that are being created by the government. And then so it's a little bit confusing as to whether you can identify which it is because they act so quickly now. And in fact, the crisis unfolds so quickly that you don't have time to ask. We talked about that instantaneous run on a bank is kind of unprecedented. So things are new that I think it feels like it's hard for everyone to work through.

19:44In fact, Ralph is asking why – I think you missed a word or two in here, but I think we've got the gist of it. Why is the pickup in the BTFP, the facility they created, not a sign of stress in the banking sector? No sign of stress in the banking sector related to BTFP. I think very important – actually, I put out a tweet about a few hours ago highlighting you can see the BTFP is structured in a way where you pay the one-year interest rate. And because there are cuts priced in, the one-year interest rate is lower than the deposit rate that you get at the Fed. And just as that arbitrage started to open, you saw a pickup in borrowing.

20:26It's also not a big pickup in borrowing. The overall BTFP is less than 1 % of aggregate deposits in the banking system. So first of all, we're not talking – BTFP is like a rounding error in the scheme of the overall economy. It's like talking about Grand Rapids to have a conversation about the U.S. economy. We love you in Grand Rapids if you're listening. Grand Rapids. No disrespect. I come from Michigan, so whenever I need sort of a generic small town that no one really – You must be very happy after the football championship. Mason blew through and through. My parents went to the University of Michigan and retired there.

21:03So they are very excited. It's about time. Hopefully it doesn't take 26 years for the next one. We can talk about where Harbaugh is going after this, but we don't have time for that. Let's say Freak is on the market. This is not sports talk. Damn it, it's not. Okay. We could definitely spend a lot of time talking about it. But, you know, I think the BTFP, it's not that big a deal. It mattered in a moment, right? There was a question of whether there was - It mattered a lot in a moment because it ring-fenced the crisis of confidence that was unfolding. Exactly, and whether it was going to metastasize.

21:39And what the government said is we're not going to let this metastasize. And if anything, the promise for it to not metastasize matters a lot more than the particular money and the BTFP. And then there's this goofy thing more recently about the arbitrage thing. And plus they said that they're going to roll the loans that are in it on the date that it closes. And so there's some urgency if you want to take advantage of it to sort of move it forward. Right, so some technical stuff going on. A bunch of technical stuff. The thing to look at is the weekly bank deposit numbers. You can get those. The H8 report comes out 415 every Friday.

22:17And what you see in the bank deposit numbers is deposits after the SVB thing have flattened out and they've actually improved in the last couple weeks, which is an indication that the issue is not a bank issue. Deposits are up, not down over the last couple weeks, reflecting the fact that banks are doing pretty well. So if you really want to nerd out on the banks that are Friday, 415, I don't know what you're doing Friday at 415. Usually I'm cracking a beer open, putting my feet up, but also looking at some bank data. I love it. I love it. Listen, you are home with the fellow nerds, Bob. We love that.

22:53Everyone's going to be cracking beer this weekend because Ryle's doing an AMA at 4 o 'clock. Mark your calendar. So you can geek out, nerd out, and have your drink of choice. I mean, it doesn't get any better than that. So you were talking about the impact of monetary policy. I just want to circle back because we talked about that recession, no recession, credit crisis. Oh, my gosh, it's overheating. and one of the things that was an issue in terms of monetary policy for the first time in a long time and maybe something people didn't have experience with was fiscal and ryle and julian sat down for their monthly macro insider chat talked about the role of fiscal stimulus let's listen to a clip from that and then we'll talk on the other side i'm very much in the camp that we are now you know that politicians have discovered this new toy and it's going to be very difficult to wrestle it out of their hands.

23:43And even in places like the UK, where I think the guilt crisis last year was testimony to the fact that we were risking that point where the bond market was saying, you know, enough is enough. The sort of fiscal limit, fiscal dominance kind of point, which we've written about, which I think is very dangerous and is a real threat to all those countries in the developed world because of, you know, a lot of them anyway, that are running very large budget deficits and current account deficits. I just think it's hard to track it real time. We're going to take another quick break to hear a word from our partners.

24:22We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

24:30That full interview is on our website. If you are not a member, go to realvision.com and sign up. We've got all kinds of fantastic macro talk, crypto talk, everything you want to know. And in-depth, really smart stuff, which is why we're joking about being nerds. But it's really important to kind of dig in and reset. And this month is education month as well. So we're going to take you along on the journey if you feel like you need a refresh. And Bob, we need a refresh on fiscal, right? It's been a long time. But the point that Julian brings up is really interesting that, listen, now maybe they're addicted to this.

25:02And we're going to, you know, even though we've got these blowout deficits, get more of it. That's a big debate, but we are in election years in so many countries. I think I read some place, and someone can check this out, I don't know if it's right, but the most elections since 1800 or something like that, all over the world, people are going to be going to the polls. How are you thinking about this impact from fiscal? Are people figuring out how to track it? It seems like the lag from that, getting into the real economy, is really tricky. Yeah, I think fiscal policy has, is always a bit of a challenge because you have to track how all the money flows and important to recognize the delays that exist in fiscal policy.

25:46I always like to talk about after the financial crisis, there was a reinvestment act. They kept working on a road by my house for 10 years, 10 years after. You don't live in Boston. It wasn't the big dig, was it? Right, the big dig went on for 15 years, 20 years. But, you know, that gives you a sense of these things is that the timing matters. And so as an example, you know, there was with the Infrastructure Act, you know, money was allocated. The bonds were borrowed, right? The bonds were issued to finance that, but it's going to take a while for that to actually flow through the real economy.