00:00You've been writing about this idea of bond yields moving higher and for now it's been an incredibly resilient risk
00:04market.
00:04Stocks ended the week higher by more than 1% even with bond yields at multi-decade highs.
00:09You're concerned that that might not last. Why?
00:13Well, something has to give and I think that while many are saying, hey, yields are going up on the
00:19long end for the right reasons
00:21because the economy is strong and that's what it's telling us, that is true.
00:26And also I think that having yields over 5% is not abnormal if we look at history.
00:33But what is abnormal is how dramatically fast yields have gone up on the long end.
00:39And also what's a historical anomaly is how high our government debt load is.
00:47And so we have to recognize that even if yields are going up for the right reason, which I don't
00:52agree with,
00:53but there's certainly some coherent arguments to make for that, that still is going to weigh down on the U
01:01.S. economy.
01:02And in fact, we got a bunch of different warnings last week on it.
01:06Institute for International Finance, we heard from the OECD, we heard from the IMF.
01:10And several of them called out the U.S. in particular because we have a widening deficit to GDP ratio.
01:18We're at about 6% now.
01:20And so that is a problem because that means that there are going to be more and more bond vigilantes
01:26coming out
01:26as investors recognize and believe the U.S. is not as fiscally responsible as they'd like them to be.
01:35Why don't you buy the argument that strong economic data is pushing yields higher?
01:39Because you're entirely correct.
01:40Those who defend equity markets say that that is the reason why yields are moving higher and therefore equities can
01:45survive it.
01:46Well, because I think there are just some other critical drivers, like, for example, inflation.
01:51I mean, we started to see this take off after, of course, the war began at the start of March.
01:57We saw yields start to go up pretty significantly.
02:00That's around concerns about inflation.
02:03And then, of course, also fiscal sustainability.
02:05We are we hit our 40 trillion mark.
02:09We've we've had a lot of milestones in the last several months that I think have been part of why
02:14yields have gone up on the long end.
02:16So what's most vulnerable in this market then when it finally caves into the pressure?
02:20So I think that there are a number of things that could go wrong.
02:24First of all, what we have is a very financing dependent economy.
02:28Right. Because increasingly, AI CapEx, which has been a huge driver of GDP growth thus far, is very reliant or
02:36is becoming more increasingly reliant on debt issuance.
02:41So when debt becomes more expensive, that's problematic.
02:44We've already heard that the hurdle is quite high to make back one's money, that return on investment for AI
02:52CapEx.
02:53That's actually going to get bigger with debt financing going up.
02:58And so I think that we have to recognize that it could easily slow.
03:02I mean, certainly there are other factors that could slow AI CapEx, but that is one of them.
03:07And then, of course, there is that potential that as yields go up, they do draw investors away from equities.
03:13What we have seen is a lot of competition for investment dollars.
03:19Treasuries have had to compete with AI-related bond issuance, and now equities will have to compete with treasuries and
03:29those AI-related corporate bonds.
03:31Do you think we're at that point yet where the yields on treasuries are attractive enough to pull investors away?
03:37Or is the underlying volatility of this bond market still a concern for giving us the green light to dive
03:43into the market?
03:44I think for most they're not high enough yet, but I think they could get there.
03:48I mean, we just sat and talked about this probably a few weeks ago, and yields have gone up on
03:53the long end so much since then.
03:54So we could easily get to 5.5% before year end, and then we could probably draw some investors
04:00over.
04:01My other argument for why this can be problematic for the economy is just because the 10-year yield is
04:07so closely correlated with mortgage rates,
04:10is so closely correlated with a lot of consumer borrowing.
04:13And we know the consumer is already under pressure.
04:15This is only going to add to that pressure.
04:17But the consumer still has been spending.
04:19It's this paradox, right?
04:20And, you know, the K-shape has been talked about ad nauseum.
04:23Is there a level where it starts to break down, that the middle of the K also has a problem?
04:28I mean, I would be happy so we could stop talking about the K-shape, but obviously it would not
04:33be a great thing if that's what causes the wider consumer to start to cave in.
04:37At what point do we get to that level where we cease to say, oh, it's just the lower, the
04:40bottom income consumer, that's a problem, but the rest of it is still held up?
04:44Well, let me start by saying that we don't have to ever refer to the K-shape again.
04:48Oh, thank goodness.
04:48I think the bigger issue is that it is P-shaped when we think about net worth.
04:53Okay.
04:53Right, and so that there is those top, the top tier of households have so much of the overall wealth
05:01in this country.
05:01And so that makes them very, very resilient in terms of spending, although they could certainly face headwinds from, for
05:09example, an equity sell-off.
05:11So if we get an equity sell-off because yields are going up, that could be quite problematic for consumer
05:16spending because so much of the consumer spending has been coming from that top part of the P.
05:22I think of it as arms holding on to almost all the wealth.
05:27That is such an interesting point, especially as we enter this rate-hiking cycle.
05:31I wonder how much, again, this is not a great thing for this economy, but if the Fed has decided
05:36that in order to curb inflation that's coming from oil markets,
05:39their only tool really is to hammer the consumer if the wealth effect becomes increasingly important in that.
05:45And let me also add this.
05:49Typically, raising rates, monetary policy tightening, tends to be more effective when it's about demand-driven inflation.
05:58When you have supply shocks that are driving up inflation, there is a limited potency from rate hikes.
06:07But that can be very problematic for consumers.
06:11And so that's where stagflation risk increases.
06:15How big of a risk do you think that is at the moment?
06:17I think it's quite significant, actually, because I think that the U.S. economy has been limited to two key
06:23drivers, right?
06:24We've got AI CapEx and we've got consumer spending.
06:27Both are quite vulnerable.
06:28And so I could easily see an environment, not where we necessarily go into a full-scale recession,
06:34but we see a significant slowdown and get to that point where we are very much in the throes of
06:39stagflation.
