I liked this framing from John Authors and Ian Harnett; the old Fed model is back in favour of bonds, has been for a while, but the divergence obviously grows as rates grind higher. Below is the low/weak/small dividend yield (and hence the rise of the comparative acronym, There Is No Yield (on stocks)) vs shorter dated yields.

…and the below is the classic model, earnings yield vs the 10 yr.

The recent rise in yields has been due to a) stronger than expected US growth b) more persistent inflation. The below is from Ernie Tedeschi (former academic) and highlights a) the dramatic fall in inflation may have been “ahead of the skis”, and b) so too might this recent uplift. Basically “bumps in the path” to target, but just as we should overextrapolate the decline over 2023 nor should we extrapolate the recent rise either.

His reasoning is that all of the “bump” in inflation is coming from housing, which we have good reason to believe will decline as a driver/contributor given the new rent index is much, much weaker than the lagged average.

CPI breadth, on his analysis, is no more elevated than normal, and so it’s unlikely to be getting away from us.

What’s the overall point?

Well, in our view, it means it is a good time to allocate to bonds. We’ve been overweight them for a while (indeed too early), and it feels like bonds have been at or above 4% forever (in reality, it has been since October 22) and that we’ve been saying “yields above 4% are good portfolio ballast”. It has been a drag, but, doesn’t make it any less true.

It’s also worth noting that outside the US, things are nowhere near so robust (meaning, actual in excess of potential, with regard to labour markets or output). Look at Canada, now above 6.1%, look at NZ, moving steadily up to and above 4%, look to the UK, where it stands at 4.2%, and is trending back up again, after some unusual volatility. We think Australia will likely behave in the same way (employment data out tomorrow) where the unusual drop (30bp move in the unemployment rate) seen last month will likely reverse out.

Most of our fixed income exposure is Australia. Maybe the more interesting way of saying it is that <20% of our fixed income exposure is the US, where rates are grinding higher. So, most of our exposure is to places that we think have a) good all in yields, e.g. at or above 4%, but likely to fall over time.

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