Our Call on Long-Term Bonds: An Email from Senior Macro Analyst Darius Dale

Dear XX,

Thanks for the shout – all great questions. Keith and I are en route home from three days of client meetings in California and, without a doubt, the debate on where inflation and rates are 6-12 months from now was the #1 point of pushback in each discussion.

Fortuitously, we were marketing in NYC two days before our 4Q18 Macro Themes presentation last Thursday so we were fortunate enough to have already incorporated our responses to each of those questions in the presentation:

• On Wage Growth: Contrary to popular belief, history shows that there is no relationship between wage growth and core CPI in the short-to-intermediate term (slides 46 and 47);
• On Crude Oil: Brent prices have to average some crazy figures for energy inflation to accelerate in each of the next three quarters – figures that appear extremely unlikely absent a major geopolitical shock (slide 40);
• On Tariffs: China accounts for ~22% of U.S. imports, so even assuming a 25% tariff rate on all Chinese imports, the “Trump bump” equates to a ~550bps tailwind to import prices, which is perfectly offset by the annualized appreciation in the Trade-weighted Dollar Index (slide 44);
• On the 10Y: History shows that there is no relationship between wage growth and the direction of bond yields in the short-to-intermediate term… yes, the short end will take its cues from the Fed – which is always too hawkish far too late in every tightening cycle – but the long end of the curve has many other factors to consider (slide 123).

All told, our call for reported inflation to roll over – which we detail on slides 15, 17, and 27 – already incorporates each of the aforementioned factors (hence the conviction in my tone). I think once the JUN/JUL peak in CPI is squarely in the rearview mirror (it might be as of the SEP data; the 3MMA is already sloping downward as of AUG), the debate will become a lot less contentious. We have to remember that tops are processes, not points and that this top is no different. I remember how intense our Reflation’s Rollover call from late-2011 was too.

Thankfully the notes we’re receiving in response to buying bonds at 3.10-3.15% on the 10yr are a lot nicer today than the hate mail we received from macro hedge funds for shorting $1900 gold then! #progress

Hope that information is helpful; let me know if you still would like to do a call. Can’t say I have much to add beyond the analysis above, but I’m always happy to connect with you guys.

Kind regards,

DD

Darius Dale
Managing Director