Why have bond yields surged? A market monetarist perspective
Plus, Michael Lewis writes (yet another) infinitely bad book
The surge in global bond yields to pre-2008 financial crisis levels has occasioned a lot of head-scratching, as well as challenging the valuation of other assets relative to the risk-free rate. The US equity risk premium (proxied by the earnings yield on stocks less the bond yield) has collapsed, implying very little compensation for investing in risky assets such as stocks. That’s another way of saying stocks are now very expensive relative to bonds.
A simple valuation benchmark for the 10-year bond is to compare it to nominal GDP growth. While this is a well-established point of reference in financial markets, it also happens to be very consistent with the market monetarist focus on nominal GDP as an indicator of the stance of monetary policy. We can think of long duration bonds as embodying expectations for future short-term interest rates, including the Federal Reserve’s policy rate, plus a term premium.
Looking at US and Australian bond yields relative to nominal GDP growth suggests that bond yields are rising to levels more consistent with aggregate demand growth (yields shown are quarter averages to date). At the same time, nominal GDP growth has been moderating to be more consistent with 10-year bond yields. In both jurisdictions, the two series seem to be meeting somewhere in the middle. In the US case, I added to the chart the nominal GDP forecast from the Survey of Professional Forecasters out to Q3 2024. The run up in bond yields makes them more consistent with these expectations for nominal GDP growth.
This is also consistent with Scott Sumner’s view that the stance of monetary policy, as reflected in nominal GDP growth, has not been especially tight. That in turn helps explain why economic conditions have held up better than many expected at the beginning of the year, conditioning on what many thought was an overly aggressive tightening cycle threatening a 2023 recession. It also suggests that further tightening in the stance of policy will be necessary.
The US 10-year bond yield also maps very well on to the Mercatus NGDP gap, which has shown very little moderation relative to the record high (since Q1 1997) of 5.9% set in Q1 2023 in the wake of the latest GDP revisions. Again, bond yields are just playing catch-up to the level implied by the Mercatus NGDP gap measure. Note that the pre-2008 fit is much better than for the post-financial crisis period, which is consistent with Sumner’s critique of Fed policy, at least in the immediate post-2008 period.
Apart from expectations for monetary policy, long bonds also reflect a term premium to compensate investors for duration risk. We don’t observe term premia directly, but they can be backed out using a variety of methods referenced in the sources for the charts below.
Term premia famously turned negative in the pre-pandemic period, helping explain low bond yields, not least relative to our nominal GDP growth benchmark. Term premia have turned positive more recently in the context of a global monetary tightening cycle, particularly in Australia. Against the backdrop of high inflation and tightening monetary policy, it is not surprising investors are demanding greater compensation for duration risk.
Much of the run-up in bond yields has fairly straightforward fundamentals. From a valuation perspective, the implications are equally straightforward. Unfortunately, not for the first time, much of the investor community got on the wrong side of the bond trade based on a misunderstanding of the effective stance of monetary policy.
Investors ignore Scott Sumner at their peril.
Michael Lewis writes (yet another) infinitely bad book
That Michael Lewis has written a bad book about SBF and FTX should not come as a surprise. Writing bad books is what Michael Lewis does. In a former role, I had to do the local clean-up in the wake of the publication of Flash Boys, his book on the rise of high frequency trading. See my discussion of high frequency trading in this article for Policy.
In Flash Boys, Lewis fell in love with a one-sided narrative that was simply untrue. It appears he has done the same thing with respect to SBF and FTX. Indeed, the two books are loosely connected, as discussed in a review of Lewis’s latest by Max Chafkin:
Lewis told 60 Minutes that he imagined his book as a “letter to the jury,” but the argument he attempts probably says more about his own biases (journalistic and otherwise) than it does about the case. Before he began reporting on FTX, Lewis had vetted Bankman-Fried on behalf of Brad Katsuyama, the subject of Flash Boys, Lewis’ 2014 book on high-frequency trading. Katsuyama had been considering selling a stake in his company to FTX. Lewis, as he humblebrags early in the book, told his friend to go for it; and then showed up on stage in last year with Bankman-Fried and showered him with praise. Lewis discloses this conflict of interest, as is appropriate, but it’s not quite what you’d expect from a totally objective journalist.
For a similar perspective, see Molly White’s review here.
As many people have noted, the fact that FTX blew up before Lewis could publish his hagiography could have saved him a great deal of embarrassment. But apparently wanting for a better narrative, Lewis chose to double-down on it anyway.
Suffice to say Lewis has form. As Kevin Drum once noted about a Lewis piece on Greece:
Unfortunately, buried within its 10,000 words or so was….nothing. Greece’s finances are in terrible shape, he said, because Greeks don’t pay their taxes. That’s it. I think I’m summarizing the piece pretty fairly when I say there was virtually nothing else to it aside from scenery.
You could also ask people in Iceland, said by Lewis to be populated by mousy-haired and lumpy people with only nine surnames who believe in elves.
Then there was his piece on Germany, nicely summarised by Felix Salmon in Feces, Fascists, and Michael Lewis: A flop from the best writer in financial journalism. A credulous Salmon still gave Lewis the benefit of the doubt, failing to draw the obvious conclusion that Michael Lewis was not, in fact, the best writer in financial journalism.
If you want a great book on SBF and FTX, read Zeke Faux’s Number Goes Up. I recall Faux saying in a podcast interview that while he was writing the book, although he knew Michael Lewis was on the scene, he remained confident that his book would at least have a different take compared to Lewis. Based on Lewis’s past efforts, that should have been a very easy judgement to make.
Even now, reviewers are still struggling with the notion that Lewis wrote a bad book. The question they should ask themselves is whether Lewis ever wrote a good one.
ICYMI
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