A thread I wrote to myself, mainly for interaction with other economists and fund managers, but one that still makes for good reading.
I would have thought the economics field, which was so confident in secular stagnation, demographics, deleveraging, and the other horsemen, would be more vocal about the eventual return to 2% for 10s.
Instead, they are spending most of their time tweeting out what the actual rate is, in some alarm, and reiterating that policy needs to be even tighter.
30 years of fundamentals (living longer, lower fertility rates, lower productivity) didn’t just suddenly go away overnight. Long and variable lags (the famous quote from Milton Friedman, that characterises the time frame and speed with which monetary policy is meant to impact the economy) are doing exactly that.
In other words, monetary and fiscal policy decisions, from the past 2 years, are still washing through. Presently, policy is now set in the complete reverse, tight by way of stance, from easy then, and it will take time to wash through too. You can see the change in the money supply below (top row, middle, and stance of the budget, bottom right).
Reading most of today’s commentary, you’d think we’d just dropped L&V as a catchphrase, one without meaning.
And that’s just the policy side, and the demographics side.
The pandemic labour market restructure is unlikely to be a decade long phenomena.
Work from home, hybrid arrangements, those are metrics that are stabilising at new levels, which suggests in turn that household formation rates settle, which suggests rental dynamics settle down, meaning OER (owners equivalent rent) settles down.
If that sentence seems unclear, the prevailing wisdom is that much (if not most) of the increase in dwelling price and the increase in rent since the pandemic has been a function of new homes formed as a shift in consumer preferences to working from home (needing a bigger space, an extra bedroom, not spending all one’s time with flatmates who are also trying to have Zoom calls).
That impact was massively inflationary to direct and indirect housing costs.
EPOP (employment to population) and other measures show we are not eschewing work in some meaningful new way, even if the exact jobs sought, and the conditions they come with, have. So there’s no reason to think that the labour market is impaired in some profound way. We are not a nation of “quiet quitters”, a phrasing you might have heard elsewhere.
A period of adjustment to match new preferences, is, I think, the root cause of most the mystery here. Also if it is an empirical fact that the Beveridge curve has shifted out, well, it is a perfectly fair hypothesis to think it might shift back, particularly if the poaching dynamics hypothesis turns out to be true.
If we add this to all we know about the direction of MP + FP, and the other things you can point to (COVID case rates, or supply chains measures like those shown below) surely it is cause to rethink that r* is somehow now at 2.5% from -1%.
In our view, it is likely that we settle back down to something far more akin to the 2019 range for the 10yr, oscillating between 2-3%, back unlikely to be much above 4%.
Yields above that range, in our view, are very attractive for an asset classes that should give some low to negative correlation to equity market risk, at that level of carry.
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