Sometimes, You Get What You Need
Unexpected post
Lots of chatter as Secretary Bessent has begun what I believe are the first steps outlined in my piece, “What the Treasury Needs”:
I want to be very clear that this is an indication that the aircraft carrier has begun to turn, it is NOT an executed turn. The initial impact will be a further flattening of the yield curve and a sharp correction LOWER in real rates. The initial reaction is exactly as I expected:
This should send the US$ lower and gold higher WITHOUT a meaningful increase in inflation expectations. Note the forward inflation swap above (5y5INFSW in orange) has ticked lower on Day 1.
The next step in this process requires Fed Chairman eMarriageus Kevin Warsh to do the right thing and cut rates at the next Fed meeting. This will steepen the curve and should start a bull steepener, which will catch macro accounts in the bear steepener asleep—the steepening will offset their losses in long-end bear positions until they are trapped.
In turn, the steepening and long-end rally will begin to release duration from the mortgage market, compressing elevated mortgage spreads. Index funds will buy in proportion to market cap, not notional, raising the bid for long-end bonds. A positive cycle can commence that compresses artificially inflated real-rates to the benefit of the economy and the detriment of the rentier class.
I’ve emphasized that long bonds and, in particular, inflation-protected long bonds were the neglected asset class. Secretary Bessent just told you supply is going to shrink of the most convex components of that asset class. Rising bond prices support equity through systematically rebalanced target-date funds (and others rebalanced similarly). Positive correlation between equities and bonds had already quietly returned — inconvenient to the growing ETF-industry cry of “bonds can’t diversify equities anymore!" Today’s announcement sent the more easily displayed rate-equity correlation (rates move inverse to bond prices, so negative rate correlation is positive bond price correlation) to the lowest levels in over a year:
The aircraft carrier is turning. Whether it can execute the turn in the straits that it’s in remains the question.
As always, thoughts, expressions of dismay at the unwanted intrusion, and Tier1 inquiries are appreciated.
