Known Unknowns

Can bond buyers see the future?


Welcome to Known Unknowns, a newsletter about temporary things that become permanent and bond traders with psychic abilities.

Does the bond market lie?

So many things have changed in the last year – how we work, how we connect, and what we call a hawkish Fed. Apparently, considering raising the rate a quarter point in a few years, IF we have above-target inflation and lots of employment, it counts as hawkish now. Remember when the policy rates were whole integers and unemployment was more than 4%? Rate hikes were large, like 50 basis points (!!) and unexpected. Those were the days. But, hey, we had low predictable inflation for almost 40 years and that was something. No wonder no one under 40 is concerned.

Neither is the bond market. I’ve always found it odd that commentators put so much stock into the predictive power of bond traders. Like when the yield curve inverts but the stock market is up, we hear all about how a recession is coming. But I’ve never heard a reason why bond traders know something people in the stock market don’t and now yields are down (except for the day the Fed revealed its new hawkish ways). My latest Bloomberg column is on why the bond market really doesn’t tell us much about future inflation. It has a pretty terrible track record.

You may be thinking, “Allison, have you abandoned your belief in efficient markets? After all, inflation is an important part of bond returns. If bond traders aren’t pricing it in, this must mean they are wrong.”

No. The fact is they have the same information as the rest of us. Inflation is unpredictable, and bond traders aren’t psychics. Yields can be low, even if they are using all available information.

Besides, bond buyers have become a small part of the market. The Fed is now the biggest buyer of bonds, more than 50% of them last year. There are also regulations that requires institutions to buy lots of bonds, no matter their inflation outlook. QDIA requirements mean lots of retail investors are in target date funds which automatically re-allocate to bond funds as people age. All which means policy can flood the market and overwhelm whatever bond buyers think.

Now you might ask, “Allison, does this mean you’ve adopted MMT and think the Fed controls the yield curve?”

Nope. I still believe in term premiums. The current curve should give you no comfort. Inflation may turn out to be non-transitory. AND, if it isn’t, then maybe the Fed will stop buying so many bonds and start selling instead – or foreign buyers will get nervous and sell what they’ve got. That would cause some serious dislocations in the bond market. If you think we dodged a bullet last year, just wait.

Women going back to work

Speaking of transitory things that may turn permanent. I was on the Indicator to talk about women leaving the labor force. I also wrote about it for the City Journal. It seems like everyone is looking for a single reason why women aren’t going back to work. Could it be lack of childcare or enhanced unemployment benefits? I say it is both. As an economist, I always presume people make decisions on the margin – or childcare options are poor and expensive, and you get paid more to stay at home. All of this factors into your decision and then one tips you over the edge.

But we should be concerned, even if school restarts and benefits expire. The longer you are out of the labor force, the harder it is to return, which means these policies can have lasting consequences. We seem reluctant to pull back on pandemic measures, but there is also a danger in keeping the foot on the gas for too long.

Risk-taking gone mad

To be fair, it is hard. People still have a lot of fear. We are an anxious society and just had a major scare. I also wrote about dread risks. This is when a rare but catastrophic event happens. We tend to fixate on that risk and even minimize common everyday risks. A good example of this is the many New Yorkers I see biking along the city streets, without a helmet, but wearing a mask. From a risk perspective, it makes no sense at all.

We may fear big catastrophic risks because, back in the hunter–gatherer days, a big risk that would wipe out your community would be worse (in terms of carrying on your DNA) that a normal, mundane risk that only applied to you, like being eaten by a bear.

So, we tend to overweigh big, visible risks and underweight normal ones – which can lead us to take more risks overall.

Be safe out there.

In other news

There is no free lunch, even with private equity

Until next time, Pension Geeks!