What Three Months Can Do

Three months ago, the global financial markets were at their short-term nadir, but few knew it at the time.? Long term bond yields bottomed then as well, which should be no surprise in hindsight.? Since that time, the average 10-year swap rate (what a AA-rated bank can borrow at) for the 10 nations that I track (USA, Germany, Japan, Britain, Switzerland, Canada, Australia, New Zealand, Norway, and Sweden) have risen 53 basis points (0.53%).? Equity markets have rallied, and implied volatilities and corporate bond spreads have fallen.

The correlated change in the global bond markets is significant, and if it runs another one percent or so, could derail the equity markets.? Bond yields would then be fair relative to equity yields, assuming that the current high operating profitability continues, which is not guaranteed, though I think it will persist long enough to embarrass those who say it must mean-revert imminently.

There is a change going on here, and as for my balanced mandates, I think it means that I toss out my long bonds [TLT] for a small loss, and keep my duration short.? As for my equities, no action for now, aside from ordinary rebalancing activity.? Don’t panic, but be vigilant, and use your ordinary risk control methods.

Full disclosure: long TLT, but not much

3 thoughts on “What Three Months Can Do

  1. David, I’m surprised that a former bond manager would let 90 days of trading distract him from the true long-term driver of TLT (and other 10-30 year Treasury vehicles): inflation.

    The core PCE (the Fed’s favorite inflation measure) for the past 12 months is now in the 1-2% comfort zone. GDP has slowed to 0.6%, and forecasts call for a rebound into the 2s or low 3s. The peak time for ARM resets is October, suggesting housing has further to fall and consumer spending will be pinched further. Truck miles traveled, railcar loadings, and containers arriving at the busiest U.S. port are all flat to lower YOY.

    I am adding to my long bond positions (I use TLT personally, buy 15-25 year taxable and tax-exempt bonds for clients).

  2. I could argue for higher or lower yields. But since my 401k has basically no bonds, I bought a tiny piece of intermediate today. Got to start somewhere.

    And Shawn, my opinion is that inflation is running maybe 6% and could go much higher. Our government is lying to us, as they are wont to do when it suits their purposes.

  3. sysin3: I’m on record over at RealMoney that I think inflation is understated by about 2%/year.

    Shawn: Inflation has a weak relationship to yields in the short run, and a strong relationship in the long run. At present, the confluence of indicators that I look at are saying 2-3% real GDP growth (as the government calculates it). Will that necessarily happen? No, but the economy has a number of conflicting cross-currents now that make it difficult to interpret.

    One other note: it seems that the behavior of the long end of the main yield curves has gotten more correlated recently. That might be a statement that the drying up of global liquidity by central banks has finally begun to bite.

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