Submitted by Taps Coogan on the 19th of January 2020 to The Sounding Line.
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We recently featured the first part of a round table discussion hosted by Jeffery Gundlach’s Double Capital. The second part of that discussion, which features a particularly relevant discussion of the outlook for inflation is featured below. The wide ranging discussion features DoubleLine’s Jeffrey Gundlach, First Pacific Advisors’ Steven Romick, Quill Intelligence’s Danielle DiMartino Booth, James Bianco of Bianco Research, Evercore’s Edward Hyman, and David Rosenberg of Rosenberg Research.
The discussion doesn’t lend itself to the excerpts we typically do, so enjoy the full discussion above.
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The problem is that the needy buyers of yield (japanese banks) are all on the same side of the table… +40bps on the 10y UST will translate to ~1.12% of IG bonds yields that or less. If those investors are leveraged with anything like portfolio margin (10x, probably higher in CLOs), thats ~11% losses.
On top of that, the risk curve is so nonlinear that at +70bps on the 10year is about ~4.83% of IG bonds yielding that or less than the 10y with 10x leverage is ~48% loss if you are exposed to the overall IG bond yield distribution.
Which begs the question, what happens if the economy meaningfully improves and what kind of losses would that imply for current holders of safe haven assets in a return to ‘normal’ inflation. Can the economy improve meaningfully if it means loses on tens of trillions if IG bonds?
I think people may end up finding out that interest rates going up towards ‘normal’ inflation doesn’t have to correlate well with an improving economy only… could correlate with supply side shocks due to over leveraged corporate balance sheets exposed to lower real growth than what any CB chooses to “fix” on the front end of the yields… real growth that may have never truly existing in the first place having had to been papered over by more than a decade of “Easing”.
Also possible, but I would have expected it already in Japan or the Eurozone if that’s the path