I would love some more actual recommendations other than buying bitcoin and gold, which is difficult to do with a 401k. Dalio is reticent to recommend anything but he’s held to a different standard when giving investment advice too. Thanks for another amazing post.
Enjoy your point of view and see that you’re clearly well researched and smart. This isn’t my world so a few questions: 1. Wouldn’t the value of these bonds rise if the feds simply lowered rates again? Assume it would take a year or two, but if new 10 yr T’a are low again, the T’s issued in 2021/22 would rise? 2. It seems like much of inflation was supply side and demand side - the 6-7 trillion Trump printed/added to national debt in his short time certainly hurt, but much of the price increases seem to be due to tons of demand for limited goods. People like Raoul pal continue to say it was mostly transitory. There is some “sticky” inflation though.
Really curious to get youryy thought on the 1st question though. Thanks
I guess the question is, where do we go from here and how bad is the catastrophe?
It seems to me, all this was done to attempt (idiotically) to prop up the system. Ultimately, I don't see any outcome that doesn't end in very strict austerity.
With regard to the cadence on your content, I would prefer:
1) Daily content posts on your various social accounts, which are likely highlights from your longer form content from the week and real-time content.
2) Weekly email digest of your longer form content from the the week that I might want to check out.
3) Monthly roll-up email newsletter that has what you feel are the best of the best content pieces from the month - in case I missed something. This is also where you can re-promote some of your best of the best historical content if it’s evergreen.
The above would ideally allow me to control the volume on you and participate in all three or just a subset. But, just like the news, you have to be consistent so I can get into a rhythm of consuming what you’re putting out.
Balaji, I subscribe and listen because I find most of your analysis mind expanding. This post feels pointed, personal and (unfortunately) political.
Who didn’t know rates we’re going up -- had to go up?! I’m a total noob, but happened to be buying a house at the time and was in a race against the clock that entire summer.
The fact that you stand with these poor feckless bankers and insurers so you can score points against the Fed is...a bummer.
For financial people this one is over the top. An insurance company should have the duration of assets close to the duration of liabilities (you know when you pay a life or health policy, that's why we have actuaries). It's pretty easy to be well within a standard deviation.
For banks, a majority of the liabilities are demand deposits. The demand deposits are exactly that, due on demand. Common sense says a duration of a year for a bank portfolio should be about a year. Much like a money market. Runoff plus time decay of even days helps in the event of a run. Selling short term assets does not cost much (minimal losses) and banks should look at this vs. their reserves when running a portfolio. That regulators let these banks (there are others) buy 10 year bonds and did nothing after years is double incompetency.
For pensions, again the principal of duration of assets and liabilities is the same as an insurance company. They will have losses on their books but those as vs liabilities they booked knowing the interest they would receive is enough to pay the liability. Additionally, insurance companies will be actively taking losses vs. income going forward by selling loosing bonds and buying current coupon bonds thus deferring paying taxes. This will force yields of deep discount bonds wider temporarily and cause a short term opportunity to pick up a little yield and arbitrage them if you think a little.
While saying the fed devalued bonds is true, you had to be asleep to miss the multi- month prelude they gave to raising rates. They talked about it more than I have ever seen. It was weird. These people running portfolios buried in duration mis- matches let their ego get in the way. They had plenty of time to sell and take small losses, realistically offset by gains. I told everyone I knew not to buy bonds for years before they raised rates. What good is a 3% bond?
The real crime in my opinion is the misrepresentation of inflation. It was said to be ~2% forever while the basket of goods changed. Oh well, if you want to see real inflation, wait for the worlds China manufacturing dependent economies come to terms with doing what they tell you. If the USA has an economic war or physical war with them expect 30% increases in costs for everything at Walmart and home depot to start.
With all due respect to Balaji (I love the guy), this sounds like total BS propaganda. We were at the end of a 40-year bond bull market. Bond rates were at an all-time low and had only one direction to go: up. Even I knew to buy short-term bonds. As for Powell, he did exactly what Volker did 40 years ago when faced with a similar inflationary situation: raise rates. Since then, Volker has been hailed as a genius. I’m sure Balaji knows all of this.
One of the core premises of this post is disingenuous. If you watched the government print trillions fo dollars, money supply go through the roof, and inflation climb to levels not seen since the early 80s.... and believed that rates would never rise.... you live under a rock.
I'm sorry, I get it that Powell, Biden, and Yellen said its was transitory. Everyone with half a brain called them liars on this point.
I don't know why you harp so much on this particular point when I'm not sure it changes anything. I don't know that banks had time to respond to inflation and rate rise risk even if they wanted to.
Furthermore, the Fed has never wavered from its commitment to 2% inflation. Everyone knew that once it became obvious that inflation was going to settle north of 2%, the Fed would take decisive action. This is dogma, and every banking and insurance exec knows this. And the Fed acted entirely predictably on that point in the end.
Playing this out a bit, if we do see a mass event happen that causes systematically important institutions who are over allocated in long duration government bonds. What do you think is more likely:
1) The Fed to rapidly drop rates in order to increase the value of these impaired bonds. (Possibly impacting inflation/currency value)
2) Setting up a program to buy back bonds at par, or choose close to it (TARP v2)
3) Let them fail and build back better
We are going to see "bigger and better" bailouts because the moral hazard created by corporate socialism for losses has made it irresponsible to individually manage risks.
While the yield-curve inversion created challenges, I'm a bit surprised that a Libertarian leaning person would, by omission, give the Execs at the banks / insurers a free pass from responsibility. The Execs were happy to pursue growth to the fullest extent possible, as such a strategy rewarded them financially via their equity participation rights and bonuses that depend on meeting / exceeding KPIs.
Had the been more conservative / prudent, they could have avoided the bond bloodshed by a combination of hedging (which reduces profits) and reducing their long duration investments during the period of increased interest rate and economic uncertainty.
When greedy Execs play with 'the house's money', they should be called on it and held accountable.
To paraphrase Warren Buffet, when the tide goes out, we see who is swimming naked.
Of the thousands of banks in the US, very few were caught swimming naked by the Feds' actions.
We did have 10+ years of basically 0% interest rates and that put people to sleep. The only similar time I ever witnessed was when Bob Rubin ran the Treasury. He tamed the bond market which really helped President Clinton. We had record low volatility for a number of years. Rubin understood how to speak to the bond market, and what to do to keep it in check. Janet Yellen doesn't understand how to do it at all. Rubin was a Wall Streeter, Yellen an academic. She's in over her head.
You could have hedged. Here is a chart of 3 month SOFR futures at CME. https://www.tradingview.com/chart/rqcdi73I/?symbol=CME%3ASR31%21. Notice the price decline, is equal to the Fed hikes. My guess is if you look at Treasury futures in the 2-30 years, it would be similar.
Hedging isn't a hot potato. Futures markets are a zero sum game. Market makers buy and sell thousands of times a day. The market is gigantic. More money changes hands in one day in CME SOFR futures than changes hands on the NYSE in a year. There are all kinds of players and all kinds of strategies going on from speculators, to banks, to hedge funds, to governments and all kinds of other entities. FWIW, the overnight FOREX market makes the interest rate market look small.
Inflation isn't necessarily caused by the Fed, but by a massive increase in government spending. This is Milton Friedman 101. The Fed can contribute to inflation via poor policy. I have said for years that the 0% interest rate policy was terrible. Look at all the risky assets that saw values skyrocket---especially startup valuations. That is on the Fed. Too much money was created and risk preferences changed during 0% rates....how easy was it for people to raise a fund? The Fed didn't raise rates during COVID when the Government way overspent-and Biden did when he took office again. Suppose the Fed did raise during Covid, what would people have said? What would markets have done?
Inflation is super nasty because the interest that you get paid when you tie up money cannot keep pace with inflation and taxes. Hence, the inverse relationship between the price of the bond when you buy it and when you sell it after an inflationary cycle. Can you hedge inflation? Almost impossible but you can hedge the underlying treasury price.
You can also use options strategies, though often they are imperfect.
You misunderstand a "risk free rate of return"; that's MBA finance speak when comparing UST to stocks. Nothing is risk free. If it is, it's worthless. Even holding UST has some amount of risk.
I think there are a lot of incompetents at banks. They just got exposed and they are seeking to blame the Fed. The Fed has its own problems for sure. They aren't a white knight. But, incompetence is coming to light as the tide goes out.
Overall you are correct but small issue with Point 2., Technically hedging tails is possible although maybe not feasible. The futures markets provide such a mechanism. The problem is unlike Hold To Maturity accounting, the futures markets requires squaring the books with cash on a daily basis. By their nature, the tails are improbable and so hedging them makes those costs impractical compared to peers and the rest of your industry, and so infeasible.
Good article. It's unfortunate that we are stuck with banks and insurance companies, all of the leaders of which should be in prison. As Doomberg said in a nearby article, "Money is what the government says it is." So, also, is the value of that money, to the detriment of us all.
Florida is becoming uninsurable because of climate change related risk. No matter how stable bonds are it can't compensate for the wildly increased chances of unpredictable flood risk. This is what is breaking the models.
I would love some more actual recommendations other than buying bitcoin and gold, which is difficult to do with a 401k. Dalio is reticent to recommend anything but he’s held to a different standard when giving investment advice too. Thanks for another amazing post.
Really enjoy your posts and thinking.
Enjoy your point of view and see that you’re clearly well researched and smart. This isn’t my world so a few questions: 1. Wouldn’t the value of these bonds rise if the feds simply lowered rates again? Assume it would take a year or two, but if new 10 yr T’a are low again, the T’s issued in 2021/22 would rise? 2. It seems like much of inflation was supply side and demand side - the 6-7 trillion Trump printed/added to national debt in his short time certainly hurt, but much of the price increases seem to be due to tons of demand for limited goods. People like Raoul pal continue to say it was mostly transitory. There is some “sticky” inflation though.
Really curious to get youryy thought on the 1st question though. Thanks
-Tyler1729
I guess the question is, where do we go from here and how bad is the catastrophe?
It seems to me, all this was done to attempt (idiotically) to prop up the system. Ultimately, I don't see any outcome that doesn't end in very strict austerity.
With regard to the cadence on your content, I would prefer:
1) Daily content posts on your various social accounts, which are likely highlights from your longer form content from the week and real-time content.
2) Weekly email digest of your longer form content from the the week that I might want to check out.
3) Monthly roll-up email newsletter that has what you feel are the best of the best content pieces from the month - in case I missed something. This is also where you can re-promote some of your best of the best historical content if it’s evergreen.
The above would ideally allow me to control the volume on you and participate in all three or just a subset. But, just like the news, you have to be consistent so I can get into a rhythm of consuming what you’re putting out.
Hope this market feedback is valuable.
Balaji, I subscribe and listen because I find most of your analysis mind expanding. This post feels pointed, personal and (unfortunately) political.
Who didn’t know rates we’re going up -- had to go up?! I’m a total noob, but happened to be buying a house at the time and was in a race against the clock that entire summer.
The fact that you stand with these poor feckless bankers and insurers so you can score points against the Fed is...a bummer.
For financial people this one is over the top. An insurance company should have the duration of assets close to the duration of liabilities (you know when you pay a life or health policy, that's why we have actuaries). It's pretty easy to be well within a standard deviation.
For banks, a majority of the liabilities are demand deposits. The demand deposits are exactly that, due on demand. Common sense says a duration of a year for a bank portfolio should be about a year. Much like a money market. Runoff plus time decay of even days helps in the event of a run. Selling short term assets does not cost much (minimal losses) and banks should look at this vs. their reserves when running a portfolio. That regulators let these banks (there are others) buy 10 year bonds and did nothing after years is double incompetency.
For pensions, again the principal of duration of assets and liabilities is the same as an insurance company. They will have losses on their books but those as vs liabilities they booked knowing the interest they would receive is enough to pay the liability. Additionally, insurance companies will be actively taking losses vs. income going forward by selling loosing bonds and buying current coupon bonds thus deferring paying taxes. This will force yields of deep discount bonds wider temporarily and cause a short term opportunity to pick up a little yield and arbitrage them if you think a little.
While saying the fed devalued bonds is true, you had to be asleep to miss the multi- month prelude they gave to raising rates. They talked about it more than I have ever seen. It was weird. These people running portfolios buried in duration mis- matches let their ego get in the way. They had plenty of time to sell and take small losses, realistically offset by gains. I told everyone I knew not to buy bonds for years before they raised rates. What good is a 3% bond?
The real crime in my opinion is the misrepresentation of inflation. It was said to be ~2% forever while the basket of goods changed. Oh well, if you want to see real inflation, wait for the worlds China manufacturing dependent economies come to terms with doing what they tell you. If the USA has an economic war or physical war with them expect 30% increases in costs for everything at Walmart and home depot to start.
With all due respect to Balaji (I love the guy), this sounds like total BS propaganda. We were at the end of a 40-year bond bull market. Bond rates were at an all-time low and had only one direction to go: up. Even I knew to buy short-term bonds. As for Powell, he did exactly what Volker did 40 years ago when faced with a similar inflationary situation: raise rates. Since then, Volker has been hailed as a genius. I’m sure Balaji knows all of this.
One of the core premises of this post is disingenuous. If you watched the government print trillions fo dollars, money supply go through the roof, and inflation climb to levels not seen since the early 80s.... and believed that rates would never rise.... you live under a rock.
I'm sorry, I get it that Powell, Biden, and Yellen said its was transitory. Everyone with half a brain called them liars on this point.
I don't know why you harp so much on this particular point when I'm not sure it changes anything. I don't know that banks had time to respond to inflation and rate rise risk even if they wanted to.
Furthermore, the Fed has never wavered from its commitment to 2% inflation. Everyone knew that once it became obvious that inflation was going to settle north of 2%, the Fed would take decisive action. This is dogma, and every banking and insurance exec knows this. And the Fed acted entirely predictably on that point in the end.
Because inflation is INCREDIBLY destructive.
Playing this out a bit, if we do see a mass event happen that causes systematically important institutions who are over allocated in long duration government bonds. What do you think is more likely:
1) The Fed to rapidly drop rates in order to increase the value of these impaired bonds. (Possibly impacting inflation/currency value)
2) Setting up a program to buy back bonds at par, or choose close to it (TARP v2)
3) Let them fail and build back better
We are going to see "bigger and better" bailouts because the moral hazard created by corporate socialism for losses has made it irresponsible to individually manage risks.
While the yield-curve inversion created challenges, I'm a bit surprised that a Libertarian leaning person would, by omission, give the Execs at the banks / insurers a free pass from responsibility. The Execs were happy to pursue growth to the fullest extent possible, as such a strategy rewarded them financially via their equity participation rights and bonuses that depend on meeting / exceeding KPIs.
Had the been more conservative / prudent, they could have avoided the bond bloodshed by a combination of hedging (which reduces profits) and reducing their long duration investments during the period of increased interest rate and economic uncertainty.
When greedy Execs play with 'the house's money', they should be called on it and held accountable.
To paraphrase Warren Buffet, when the tide goes out, we see who is swimming naked.
Of the thousands of banks in the US, very few were caught swimming naked by the Feds' actions.
I see you points but have some disagreements.
We did have 10+ years of basically 0% interest rates and that put people to sleep. The only similar time I ever witnessed was when Bob Rubin ran the Treasury. He tamed the bond market which really helped President Clinton. We had record low volatility for a number of years. Rubin understood how to speak to the bond market, and what to do to keep it in check. Janet Yellen doesn't understand how to do it at all. Rubin was a Wall Streeter, Yellen an academic. She's in over her head.
You could have hedged. Here is a chart of 3 month SOFR futures at CME. https://www.tradingview.com/chart/rqcdi73I/?symbol=CME%3ASR31%21. Notice the price decline, is equal to the Fed hikes. My guess is if you look at Treasury futures in the 2-30 years, it would be similar.
Hedging isn't a hot potato. Futures markets are a zero sum game. Market makers buy and sell thousands of times a day. The market is gigantic. More money changes hands in one day in CME SOFR futures than changes hands on the NYSE in a year. There are all kinds of players and all kinds of strategies going on from speculators, to banks, to hedge funds, to governments and all kinds of other entities. FWIW, the overnight FOREX market makes the interest rate market look small.
Inflation isn't necessarily caused by the Fed, but by a massive increase in government spending. This is Milton Friedman 101. The Fed can contribute to inflation via poor policy. I have said for years that the 0% interest rate policy was terrible. Look at all the risky assets that saw values skyrocket---especially startup valuations. That is on the Fed. Too much money was created and risk preferences changed during 0% rates....how easy was it for people to raise a fund? The Fed didn't raise rates during COVID when the Government way overspent-and Biden did when he took office again. Suppose the Fed did raise during Covid, what would people have said? What would markets have done?
Inflation is super nasty because the interest that you get paid when you tie up money cannot keep pace with inflation and taxes. Hence, the inverse relationship between the price of the bond when you buy it and when you sell it after an inflationary cycle. Can you hedge inflation? Almost impossible but you can hedge the underlying treasury price.
You can also use options strategies, though often they are imperfect.
You misunderstand a "risk free rate of return"; that's MBA finance speak when comparing UST to stocks. Nothing is risk free. If it is, it's worthless. Even holding UST has some amount of risk.
I think there are a lot of incompetents at banks. They just got exposed and they are seeking to blame the Fed. The Fed has its own problems for sure. They aren't a white knight. But, incompetence is coming to light as the tide goes out.
Thanks for a great piece- in middle of re-listening to your Portal pod with Eric Weinstein.
How has your thinking around his key point shifted on the context of this bond issue?
Do you still believe in burn it down?
What’s the real politick approach to fixing the core issues here that has a shot of a non-apocalyptic result?
How does that end for Powell, etc?
Overall you are correct but small issue with Point 2., Technically hedging tails is possible although maybe not feasible. The futures markets provide such a mechanism. The problem is unlike Hold To Maturity accounting, the futures markets requires squaring the books with cash on a daily basis. By their nature, the tails are improbable and so hedging them makes those costs impractical compared to peers and the rest of your industry, and so infeasible.
Good article. It's unfortunate that we are stuck with banks and insurance companies, all of the leaders of which should be in prison. As Doomberg said in a nearby article, "Money is what the government says it is." So, also, is the value of that money, to the detriment of us all.
Florida is becoming uninsurable because of climate change related risk. No matter how stable bonds are it can't compensate for the wildly increased chances of unpredictable flood risk. This is what is breaking the models.