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Joe, are we going to spend this episode just arguing about the term premium?
I do know, like, yeah, maybe you know, I've always like, I've always been sort of I wouldn't say a term premium denier, but I yes, you are, okay, but like, and I was totally ready to capitulate. I was like, Oh, it's all the term premium. And I was like, I'm totally convinced the term premium is this really important concept that can be measured analytically with precision. And then to people like, ah, it's actually you don't really have to
go that far. It's sort of straightforward. I still, you know, there's.
A middle path where you can say that the term premium is hard to measure because you have to estimate like a risk neutral rate, but but it still exists. It might mean different things to different people.
But I've never been good in life at taking the middle path in anything. I oscillate between extremes. I did a deadlist.
I'm both the most popular trader and most successful trader at Citadel.
That is going viral.
Uh barges.
This is an after school special, except.
I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the US.
Black goals.
These are the important questions that robots taking over the world.
No, I think that like in a couple of years, the AI will do a really good job of making the Odd Lots podcast. One day that person will have the mandate of heaven.
How do I get more popular and successful?
We do have.
You're listening to lots More where we catch up with friends about what's going on right now, because.
Even when The Odd Lots is over, there's always lots more.
And we really do have the perfect guest back with Jay Berry. He is now the head of Global rate Strategy at JP Morgan. The last time we had him on was in October of twenty twenty three, and the headline on the episode was like Jay Berry on the big sell off in bonds and we can just recycle all that again.
Was that the peak when we had him on then?
I don't know.
At that time, Yeah, Jay, do you believe in the term premium?
Well, Tracy, I think it's funny you talk about the last time I was on because ten year yields are basically at the same level they were then, and at the time, the funds rate was one hundred bases points higher than it is right now. So term premium is hard to measure. But I'm a simple man, and I think of it as the slope of the yield curve, and the slope of the yield curve is steeper for a given level of policy rates. So I think it tells you that there is more term premium in the
curve right now. Absolutely.
Ira Jersey, who does rates your Bloombering Intelles, had a chart and you just said, look, yes, one term premium, all that. But one part of the story is just that the markets estimate of the terminal rate is now higher than it would have been, say, six months ago, et cetera, at the start of the cutting process, and that a big part of the story with the rise and the long ends in September is just that you know, there's not as much cutting baked in.
I think that's exactly it as well. Joe. I think that's a really important point because this is.
Just now the middle ground. It's like, part of it is the term premium, and part of it.
If we get Joe to a middle path, is a success.
Yeah, I'm a middle of the road guy, and I don't think a single explanation or a single factor can explain the bond sell of but term premiums one tracy, but Joe, FED policy expectations matter because it's fascinating. When the FED cut fifty in September, we were pricing in a terminal funds rate of like two and three quarters. Yeah, and now we're pricing in a terminal fund rate of four percent. It's a huge change and that's driven it as well, and it's so unusual, and I think it's unusual.
But what the Fed did was unusual because basically, by preemptively cutting fifty, they said, even though inflation hasn't come back to target, we do not want to sacrifice this expansion and this probably means better growth outturns in the future, higher inflation in the future, thus justifying fewer cuts down the road and actually higher rates. So that's a big piece of the puzzle because that's been one hundred and twenty five basis point move as well.
The one thing I would say, though, I mean, I agree Jay, Obviously bond yields react to FED expectations and
the near term path of the economy and inflation. But the one thing I would say is, like in October, there were other things you could look at to measure nervousness about a potential Trump woin, Like you know, puts on the TLT that suggested that a bunch of investors really wanted to shed long term bond exposure right after the election, And this was happening, like you know, those were going up as Trump's pulling odds were going up.
So I feel like there are other things that suggest some of this nervousness is like secular in the long end. But anyway, the thing I wanted to ask, Jobs Day is coming up, So we're recording this on Thursday, January ninth. The bond market is actually off early today for Carter's funeral.
But how big a deal is the bond market reaction gonna be to the Job's Day, Like if we're debating whether this is some secular, maybe politically related change versus something about the FED and the path of the economy and inflation, it feels like jobs are going to be a big factor here.
I think they absolutely are, And I think it depends on which part of the term structure you're talking about because what's been interesting in this move is that the front end has remained tracy, really well anchored. Right I think it's because the FED has been asymmetrically dubvish in its reaction function. Right now, even with what happened in December, with the dots showing only two cuts for next year, the FED and aggregate is talking about cutting further, albeit
at a slower pace, or just going on hold. Nowhere in the discussion is hikes, and that's why the money market curve, even though we're pricing in few er eases, is still inverted. I think that could start to change if you see the labor markets start to tighten again. So if the unemployment rate starts to come back down, that could be meaningful for repricing the front end in the opposite direction. But at the same time, even though the labor markets are not as weak as that we
perceive them to be. Back in August and September, there has been a steady slowing in private payroll growth. There's been a steady slight increase in the unemployment rate, which tells you that the demand for labor is moderating. And if you get another sense of that, tomorrow, and I think consensus is one hundred and sixty k with the unemployment rate at four to two. We're one fifty four to two, so we're very close. I think that probably anchors the front end and tells you that it's probably,
you know, relatively stable. Here. The long end is a different story. I think if the pace of employment growth is stable, but you see something like the rate come down and average hourly earnings firm back up, you know, then the markets can price out a bit more of the FETE easing that we've got priced in, and it becomes a bit more of a parallel shift because that justifies higher long term rates as well. So I think it's important with some asymmetry that the front end is
better supported than the rest of the curve. But this has been kind of our whole thesis too, and the employment data tomorrow is a key piece of that puzzle.
The ecomomy overall seems very noisy to me right now and hard to parse because there do seem to be signs like, look, growth continues, no real signs of slipping into recession. But on the other hand, there are signs that the labor market is softening. Maybe the labor market is strengthening. I think it's actually really noisy. Let's zoom out those sort of big picture to talk about. I guess since September what's happened, So there's been a few developments.
First of all, just looking at the ten year you know, that bottomed at about three point six on September sixteenth. It's currently at four point six four six ' five as of this second, when we're talking at eight oh one a m. January ninth, twenty twenty five. Since then, obviously we did have the Trump way in we did, we're not going into there are still no signs of
imminent recession. How would you tell the story basically of just what's happened, you know, and explain perhaps the upward repricing of that terminal rate since that initial fifty basis point.
I'm glad you asked that, and I think it's fascinating that that trough and yields was a day before the FED thing, right, So that was when we were priced for maximum dubbishness.
And so at that point we had seen the unemployment rate had been solidly ticking higher in the months before, and you could maybe it turned out to be wrong but you could at least tell a story then Oh, this looks like what happens before recession.
Yeah, And it wasn't just the unemployment rate, because I think it's tough to disentangle what's happening with the rate because there's obviously supply side factors going on there. But the pace of private payroll growth had accelerated.
US sharp as well.
So that was a big one with what the July and August data showed. So I think since then, first, it's what the Fed did when they went fifty. I'm not going to sort of toot our own horn, but Mike Fole, my colleague in our chief US economis, I think, was one of the few calling for a fifty. And I think that was a surprise of the markets because it showed the Fed's hand with respect to its reaction function. It really valued the labor markets over inflation and did
not want to sacrifice this soft landing. And again that generates better growth out turns and higher inflation in the future, which was a turnaround in rates because perversely enough, it requires fewer eases down the road. So that's a big dominant driver, and I think we can see that in the interim since then, to support this, growth expectations have
moved up. And just for example, we've got our series of forecast revision and disease and our year ahead growth forecasts over the last three months have gone up something like a percentage point. And right we've come off consecutive three percent quarters. It looks like we're running two and a half percent right now. So that's a piece of
the puzzle. The second is, and this is where we'll get back to Tracy in term premium, is the change in the fiscal expectations because of the reelection of President elect Trump. And that is meaningful because we expect the TCGA to basically be extended in full and that's going to add an additional four trillion to deficits over the next decade on a baseline of what I believe was
about twenty two trillion to begin with. And that matters because I think, as we spoke about the last time we were here, the budget deficit running at six to seven percent of GDP when we're close to full employment is highly unusual, and the growth of the treasury market is just outstripping demand from its sort of most price in sensitive historical investors the FED and US banks and foreign official investors. So we've got to find other price
sensitive investors to underwrite this supply. And when that happens, it just requires a higher term premium and higher yields and a steeper curve for a given level of policy rates. So I think those are the few drivers there. And it's a global story. Yes, the US is led the way, but it's been happening everywhere as well.
So back in October, I think I think it was October, you had a note where you sort of mentioned your former colleague Josh Younger's famous Volfefe index. I think probably the only piece of JP Morgan bond research to ever make it into New York Magazine's like Hot or Not graph at the end of the magazine. You remember that shoe?
Uh do they still have they still have that hot I don't know.
If they do, but they did when.
It was first Do you remember that that was a.
Good hot idea approval matrix?
Yeah, that's right, and you sort of you mentioned it. Are you guys going to be reviving it under the Trump administration?
So I can't comment on things that we intend to research, Tracy, But as you said, we talked about it a few times in the last few months, and I think it's important to understand that during the first Trump administration that announcing policy via Twitter or via x right Now or truth social as the case may be, was something that did actually raise implied rate volatility, and higher rate volatility necessitates higher term premium and thus more sticky higher rates.
So it's something I think in the background that we're sort of focused on. And it's funny talk about Josh actually was on the phone with him yesterday, and so I think this is all kind of coming full circle. But I think that's something in the background that we need to focus on as well. No doubt.
Why is this a global story? I get the the labor market looks stronger, perhaps than it did six months ago or five months ago, but a lot of headlines this week about the UK specifically and now the global seat. I can ask you UK question, so why is this a global story? And maybe tell us something about the UK?
Yeah, thanks for that, Joe. But I think there's a policy story globally that's divergent. Right, So the FED and the US isn't a very different spot from rest of world. Euro Area ECB is cutting and cutting twenty five until it goes into slightly accommodative territory, we think. So there's a slightly divergent factor there. BOJ is in the midst of normalizing rates.
The ES rates are going high.
In the rates are going higher exactly. And then you ask about the UK. I think the UK is sort of stuck somewhere in between the US and the Euro Area because it's got the fiscal issues that we're talking about in the US, it's got the sticky inflation that we're talking about in the US, but it lacks the labor supply and productivity benefits that we've had in the US. So you've got a central bank that's kind of getting stuck here and can only ease at a somewhat more
gentle pace. And there's nothing really we can point to this week in the UK about the fiscal pressures, but they're just there in the background. And it's the same way the US has sort of seen that's moved a higher rates since we've walked into the new year, that they're coming back in full force.
So just to summarize the sort of core tension, it has the same fiscal pressures as the US but it doesn't have the same productivity growth as the US. Therefore, all that spending is running into a less productive economy and that sort of creates that upward moving rates and the inflationary pressure. And so far is that the idea.
It is to an extent, and I think it's also more idiosyncratic Joe as well, because look at what happened with the UK market. What was it back in September October of twenty two when the LDI sell off happened. It's a market which, yes it's smaller than the treasury market, but it's less liquid, it's more concentrated in its ownership.
So when you have a market where I think it's a bit more concentrated in its ownership than a very diffuse set of ownership in the treasury market, you can go through these balances of idiosyncrasy where it's hard to identify a single driving factor to see what happened with this sell off, but it can get exaggerated by those factors as well.
There is also a reflexivity at play here where if bond yields are going up, particularly at the long end, when the US is planning to do more long issuance that means the cost of borrowing is going to go up, which maybe increases the fiscal burden, and then yields go up even further. Is that the kind of risk that we should be thinking about in twenty twenty five.
I think it's a slow moving train there, Tracy, because the average maturity of the US Treasury market debt's about six years, So higher rates will definitely lead to higher interest expense and will add to the burden. But I think a large part of that burden and that increase occurred as the FED was raising rates rapidly, and we know that T bills are about a twenty percent share of total debt outstanding, so there's a fair amount of short term deat outstanding, and it's less expensive than it
was a year ago. So this will continue to feed through, but it will be at a very slow rate. So I think it's certainly there in the background as well, but not as primary or secondary driver as these other factors that we've been talking about.
You know, speaking of policy by Twitter, I don't think that Cure Starmer or what's the chancellor's name reeves in the UK they're not doing as much posting policy by Twitter, but the owner of Twitter is posting a lot about the UK these days, so to the extent that there is just a lot of noise about the government going on. Setting aside everything else, there is a lot of just political noise in the UK on top of all the sort of core economic stuff.
And it's not just the UK, Joe, I think this fiscal noise is going on everywhere. Right, We're talking about the TCGA and the fiscal bird in the US. You're talking about fiscal in the UK. Look at what's happened with France right with its government falling and they've got deficit issues to try and get back out of the EDP over the next few years, which seems unlikely. You're talking about it in Japan as well. So fiscal and supply is a belief, a global story to varying degrees
across developed markets. Right now.
You need to do a vall Elon index.
That's right, vall X Oh vall x is good. The volt Yeah, a global VOLA you can have that one. A global Blex index, just a measure of social media talk around the world relating to fiscal policy. That's a free one to break it down my country there on that yeah, the volat I'm gonna trade vult, I'm gonna trade vall X. I like that idea. What about central
bank like QT? People I don't know. People don't seem to talk about as much about QT, But what about the role of central bank asset purchases or sell offs in this story or on wines.
I think I think it's something in the background, right. I think back to twenty eighteen when share Pell talked about QT and referred to it as watching paint dry, and I think it is just sort of going on in the background. And of course in the US it's at a slower rate than it has been for most of the last couple of years. But in our work, the Fed's balance sheet as a share of GDP matters for rate levels. It matters more for curve slope as well.
So that's something that's happening in the background, because the Fed's balance sheet has been not only shrinking on a nominal basis, but shrinking relative to the size of the economy. And we found that every one percentage point move relative to the size of the US economy has been worth a handful of basis points on the yield curve. So as it continues to normalize. That is something that's in the background also placing steepening pressure on the yield curve.
And it's of course a global dynamic because you've got the ECB, the Bank of England, and now the Bank of Japan all doing this as well. And you can see it not just in curve slopes globally, but visa v swap spreads. I think there's been a story where swap spreads until recently have been narrowing globally across the DM as well, so you can see the imprints of
QT there. It's there, but I think it's probably again kind of a third order factor when considering the term structure of rates in the US and globally as well.
This might be a weird question, but since we brought up QT and earlier you were talking about the need to find new buyers for bonds, what exactly can the US do if a bunch of traditional buyers like banks the FED for the past more than a decade, are stepping away from the market other than yields going up, is there anything else they can do to market debt to the outside world or I don't know even internally how banks buy more bonds.
So it's funny because the Treasury Department can only deal with the symptoms and not the root cause. But the Treasury and it's sort of cadre of private sector advisors. The Tea back have done a lot of strong work on this, and there are charge questions that are asked at every single we're funding process, and one that was asked of the Tea BAC a couple of quarters ago is what new products and processes can we open up to sort of widen the spectrum of demand. I think
they're asking this question Tracy for that very reason. And two products that were talked about were adding another floater at the short end of the curve. There's a lot of demand for short duration floating rate product that's latent. The other is adding another point on the TIPS curve. And the TIPS product has been around for close to thirty years right now, but we've only had three points on the yield curve. We've added three or four bill points.
We've added three nominal points. So in order to make sure that you're maintaining the TIPS product as a share of the treasury market and your commitment to it, you can add tips as well. So they're certainly focused on it, and that's one way to try and widen the spectrum. The other less from the treasury, perhaps more from the regulatory side, is thinking about how you make it easier to intermediate in the treasury market for banks and dealers
and own treasury. So there's been a lot of focus on potential regulatory developments in the context of Vice Chair bars announcement earlier this week, and I think that's something that we can think about in the background over the medium term. But would just offer that the timeline for regulatory reform is probably years to sort of unfold and not months, and even when it occurs, I think some
important points that we've made. The banks aren't leverage constrained right now, so bank demand for treasuries is not being constrained by leverage ratios. So it's something that could happen once again down the line, but it's not inn ishe right now?
Do you have like a fair value here? So again we're at like four point sixty four whatever. A lot of it seems to be explained by, you know, just the sort of overall change in the outlook since September. Then there's various reasons for volatility. Maybe Tracy would call it the term premium, but obviously more issue in uncertainty, higher deficits, etc. Where does that put us?
Does it?
Are we around where it quote should be? Like what makes sense to you? Or where could it go?
And it's funny to draw the parallels again, Joe, because the last time I was on, we talked about and we made the case at that time that ten year yields looked about thirty five to forty basis points too high relative to that fair value metric. Yeah, and that's adjusting for how the market's pricing FED policy, inflation growth, and the size of the Fed's balance sheet. We're at a similarly high level right now, so the fair value
would be probably closer to four and a quarter. The only thing I'm going to sort of caveat there and not to say that we're losing the anchor. That's an important valuation framework we have, atchiape Morgan, is that we've been trading either at fair value or cheap to fair value for the last two to three years. And I think it's because in the background we don't have a term premium factor in that model, and we have to be sensitive to the fact that that is something that's changing.
So even though we're called it two standard deviations cheap right now, my argument is that the propensity for mean perversion is probably lower than it's been in the past.
Joe, are you a term premium convert yet?
Yeah? Sure, of course sure.
Hey, I mean say the sentence, say the sentence.
I believe in the term premium. Now you won't do it.
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