30% Drop in the Long Bond?


Memo: Inflation is here. Could turn into stagflation.


Markets have not yet discounted this.


Authorities are adding more fuel to the inflation fire as we speak.


Blaming Putin for current inflation created before the Ukraine invasion does not wash.


The Fed still has fed funds at 0% and is still suppressing mortgage rates. CPI at 7.9%. These are monetary and fiscal policy mistakes of historic proportion.


It is a new era. The financial history of the past forty years is over. Change your thinking, financial models and algorithms to incorporate the new reality from deflation to inflation and maybe stagflation.

Hard to see how long duration assets do not drop a minimum of 30% from here over time with sporadic flights to quality due to war. That assumes the 30-year treasury bond yield only moves up a modest 1 3/4% from 2 1/4% to 4%. The peak in the 30-year treasury in the last inflation cycle was 15% in 1982 as a point of reference.


It is also possible that the US economy is so over leveraged with debt that any modest increase in interest rates simply places a wet blanket on the economy and snuffs economic growth fires in which case the long bond does not drop as much, and could actually increase in value. That is what happened the last time the Fed was in a hiking cycle in 2019. The economy flamed out with fed funds at 2.5%.


That means the US is more similar to Japan than many would like to admit. So what? It means asset returns going forward will have trouble producing even an annual 5% return. Just a reminder, Japan's stock market is at the same level it was in 1988. Zero percent return over forty years.


Hard to see a good outcome in any case with inflation at 7.9% and stagflation looming.

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