A Tale of 2 Bond Markets
1315 words, a 4-minute read.
Welcome to the start of a new year and to paraphrase The Who, “meet the new boss, same as the old boss”. I’m not sure the bond markets of the world are the boss but they are certainly pushing their weight around as we hop back on the saddle, after what one vaguely recalls was a nice break.
December was a tough month as risk assets gave back much of November’s pop, Santa failed to come to town and while the SPY rose during the 1st 5 days of January, the ultimate barometer, as goes January, so goes the year, remains in the balance as UST long rates continue to climb. This is true even as the Atlanta Fed Q4 GDP Nowcast softens to 2.7% and the CESI continues to roll over.
The rise in US long rates continues on the back of the job number with the 30 year breaking 5% and 10 yr UST hitting 4.75%. The good news is that the long end of the UST complex is now oversold and due for a bounce. Meanwhile, the USD continues to oscillate around key technical levels with DXY at 109 while stocks back and fill, taking out all the excess enthusiasm so prevalent just a month or so ago.
As investors try to make sense of the various gyrations there is a whole nother scene taking place in China where its opposite day as long rates continue to fall off a cliff. The Chinese 10 yr Govt bond yield has hit 1.6% down from 2% just a short month or two ago. X is filled with chart porn, much of it failing to note that real rates in China remain reasonably high given inflation of only 0.2% for 2024. Yes, its deflation that is the worry in China not inflation.
While the US worries about inflation & the Trump team’s policy incoherence, China worries about a stagnant consumer, afraid to spend and depositing savings into the banks who in turn buy Govt bonds given limited demand for credit. Today’s newsflash is that the PBOC will stop buying long duration Govt debt to take away one of the buying channels and hopefully lead bonds to stabilize and reverse.
That’s one of the global cross asset signals we have been waiting for in just the latest reminder that being patient is a big part of long term global macro investing. We have spoken and written it about this at length. The heavy dosage of algos driving day to day trading coupled with the macro morass leads to technical levels assuming even greater ST market importance. All of which combines to accelerate moves from point A to point B, especially in low liquidity holiday type trading. Trading this action is a mugs game; riding through the volatility requires a strong stomach.
Let’s throw one more asset into the mix, one that has been a surprise & just might be a tell. We refer to the commodity space, repped by the GS Commodity Index (GSG), itself heavily weighted towards oil. Amidst rising long rates and a strong dollar, GSG has broken out above its 200D resistance level. Energy really exemplifies the action underneath the index level with XLE down close to 12% in December and yet flying out of the gate in 2025, up 3% YTD. This has pulled GSG up 4%.
It's pretty unusual to have Commodities rally while China yields sink as most draw a straight line from China growth to commodity demand. Furthermore, Commodities typically do well with USD weakness as many are priced in USD so as the dollar declines the primary product becomes cheaper to non USD holders.
All this to say that there are some pretty wild cross currents moving through the markets, making it important to have a plan, a process and time frame that suits one’s personality. At TPW Advisory we expressed our LT time frame in our 2025 Outlook and we are comfortable riding through short term pullbacks cognizant of our proven inability to outfox the algos. This requires the temperament to adsorb some unappealing ST swings much as our Global Multi Asset (GMA) model did in December where we effectively gave back November’s big gains.
We remain focused on the evolution of the Tri Polar World (TPW) as discussed in our most recent article for Reuters. We continue to witness deepening regional integration in Asia and Europe driven in part by growing regional competition in the economic highlands of AI, Climate mitigation and Defense. The criticality of being a player in AI, of mitigating extreme weather events (our thoughts go out to those affected by the LA fires) not to mention the more traditional but yet still critical role of Defense means continued Govt spending. https://www.reuters.com/markets/us/forget-american-exceptionalism-its-tri-polar-world-pelosky-2025-01-09/
We believe that policy maker success requires execution of the new industrial policy melding fiscal and monetary policy and public private engagement together. China has led the way with its investments in clean energy; the US has responded under the Biden Admin and Europe faces an urgent need to regain competitiveness across all fronts.
We have discussed how we see this playing out in our last Musings namely Trump team policy chaos policed by bond vigilantes. We expect the Trump trade threat coupled with the clear domestic need to act forcibly in Asia and Europe will serve as positive catalysts. Specifically, we expect a new German Govt post next month’s elections to act decisively and ease the debt brake to shock the sick man of Europe out of its stupor. Likewise in Asia we expect China to further stimulate domestic demand, likely in March with the NPC meetings. This stimulus supports our global growth and earnings outlook.
We view the back up in long duration UST as a warning shot fired across the bow of the Trump Admin by bond investors who understand the potential for miscalculation given 6% budget deficits, the need for massive UST roll overs and the required full participation of all buyer bases including non US buyers. These last could well be spooked by US policy uncertainty while noting the improved policy pictures back home in China, Europe leading to investment repatriation & a weaker USD.
Our signposts remain the USD (roll over), Commodities (GSG to stay above its 200D support level), EM equity (can EEM regain that level - while broad EM has fallen back below, large cap China (FXI) remains well above) and ACWI & SPY ( remain above support) We want to see long duration UST bond yields fall and prices rise while looking for the opposite in China where rising long duration rates will suggest some policy traction.
We take comfort in our view of a global growth upcycle assisted by continued stimulus in Germany & China both of whom have significant fiscal room. We have noted how the two components of the Long Cycle, global growth and a global equity bull market, reinforce each other through the earnings channel. With Q4 SPY consensus earnings growth expected at around 11% we foresee limited downside risk and note consensus EPS for 2025 suggests EM E should outgrow DM E, suggesting support for our EM OW.
We remind folks that its not how much the Fed cuts or when it cuts but simply whether it is cutting into a growth cycle or recession. It continues to look like the former in which case earnings should be fine and stocks fine; we reiterate our expectation that year three of the bull market will be a modest return year for the SPY which creates the best environment for investor interest to gradually shift to non US equity. We think commodities are the tell that global growth will be fine and expect the bond vigilantes to continue policing poor public policy behavior be it in London or in DC.