Thread by @dampedspring

I YR return Asset bull cases part 1a
10 Year notes

10 year notes yield 4% today. What's the bull case? Let's talk about an unusually good absolute return that would happen 1 in 6 times this year meaning 1STD or more. That would be a 6% price rise Along with a 6% price move

One would also get a 4% coupon generating a 10% return and an excess return over cash of 6.5%. That's pretty good and could be leveraged 2.5x to have the same risk as SPX and generate 16.25% return.

What would that mean mechanically?

A 6% price move would require 9 year yields which are roughly 3.95% to be 3.22
A year from now.

The bull case for bonds depends on whether the odds of 3.22% yields occuring is 1:6. If the odds are higher the bonds are a buy if lower then bonds are a sell.

Bond yields change

Based on many reliable drivers.

The major drivers are
A)The actions of policymakers to administer the rate
B) Investor inflation expectations
C) Investor alternative investments that generate a real return. (This is where growth expectations fits in)

A) policymakers have various levers to administer the 10 year rate to their desired level. The most well known and understood lever is the Fed funds rate and other policymaker controlled rates like SOFR and IORB. Other ways policymakers "control" the 10 year rate include but

Are not limited to. Forward guidance on the short term rate mentioned above, bank regulations which either encourage or discourage banks from buying UST, the composition of treasury bonds issued and those held by policymakers, active purchasing or limiting of issuance of various

Tenors of bond, notes and bills which push yields to the desired rate. One can debate the effectiveness of any of these levers and there may be more but the concept is the policymaker can administer the 10 year rate to its desired rate. You may have heard the quip don't fight

The Fed. This is similar but more general. Dont fight the administer.

So let's say the bull case is the policymakers are intent on administering the 10 year rate down by 73bp this year. Forget HOW just assume all else equal they can and want to.

What market forces are at play to offset the administers policy?

I'd break that down into two things.

Macroeconomic outcomes which force the "administer" to reverse their path

Market participant alternative investments providing better real returns to UST

This all comes down to whether the policymaker is administering a rate which will stimulate the economy or to slow the economy. The MOTIVATION for the policy is noise. It doesn't matter whether rhetoric is to reduce the taxpayer interest cost, or overstimulate the economy to

Win a midterm election or to actually manage the economy to achieve a quad mandate of stable prices, full employment, moderate interest rates, and financial stability. What matters is what is the administered target rate relative to what the neutral rate of the economy

In terms of the question at hand regarding the bull case for 10 year notes it should be brutally obvious to anyone on the planet that the current policymaker administered rate is substantially lower than 4%.

Sticking with 3.22% as the desired administered rate the question is can the policymakers succeed in getting to that rate? What's stopping them? Well if the rate is stimulative and the economy doesn't need stimulation the macro economic consequence will be twofold. Mentioned

Above.
Will the administration be reversed and/or will economic outcomes cause offsetting rebalancing.

On policymaker pivot if the administered rate is stimulative

1. Real Growth will be boosted. 2. Inflation will be boosted.

Except if you are a bond holder the first outcome is politically attractive. More growth, more jobs, more stuff for all. The second outcome is where the pressure on policymakers is felt. Do they care? That's the question

I mentioned inflation expectations and real rates above. The second outcome of boosted growth and inflation is where investors have to consider the investment alternatives they have relative to each other and relative to cash.

We all know that the desire administered rate

Is lower. Some think today's rate is stimulative, just right, or restrictive.

One very clear thing about the bull case for bonds is if in fact the current rate and perhaps the desired rate is restrictive you MUST own bonds as the macroeconomic outcomes and the desired

administered rate are all aligned. A lower desired administered rate, and a declining NGDP is massively bullish bonds even at 4%. People who have this view live on or are heading to recession island.

But based on various other markets like stocks and gold and based on very strong recent NGDP readings and a tight labor market the more prominent view is that the policymakers are intending to stimulate the economy even though the economy needs no stimulation.

In other words the administered rate is at or heading to below neutral

And now we get to market forces.

There are two games "Chicken" and "Fuck this" which are bearish bonds despite this clearly bullish direction of the administered rate

Both of these are market participants selling bonds or buying less bonds.

Chicken is bond investors moving toward cash because they expect the policymakers will be forced by higher inflation which will put political pressure on the policymakers to reverse.

"Fuck this" is bond

Investors saying if growth and inflation are going to be not only tolerated but encouraged why own fixed income at all. Sure they will rally because the administered rate is going down but jeez if it does. US stocks, foreign assets denominated in USD, gold will all do great

"Fuck this" is another name for the debasement trade. It's clearly happening in size!

Chicken is a bit tougher. Most bond holders are bearish the economy. They are paid to be so. Their investors own bond funds BECAUSE they want diversification in a slowdown/recession.

Going to cash when your fund is going great is really f'ing hard. Let's say the central assumption of bond investors was that the target administered rate was in fact lower than current and could be as low as the policymakers desired rate. Why play chicken. Chicken makes

Sense when the market rate is so close to the the adminstered rate as to be risk free to short. THIS NEVER Happens. So chicken starts at a slightly higher market rate.

Part 1b will be added to this thread

Part 1b.

So let's review.

The policymakers are clearly attempting to administer lower 10 year rates. That's BULLISH

It's significantly more likely that the desired administered rate is below neutral and thus stimulative which is BEARISH

Bond investors are a gloomy group

And as a gloomy group who also is allocated money by less gloomy but disciplined investors who like balance they are not supposed to fight the tape and go to cash. So playing chicken at cure t rates is not being played widely today

"Fuck this" is absolutely occuring in size but

Given the net the administered rate pressure still seems strong enough to hold bonds. But the given the fuck this flows and the imminent chicken flows selling I suspect the upside on bonds is extremely limited.

The bull case for bonds exists and it depends on the

Admiration continuing to manipulate the rate lower AND that rate not being low enough and recession island is the outcome. NOT an obvious trade and frankly going long bonds to bet on a recession outcome seems the worst priced way to do this