May 2024 Newsletter: The Bond Market is the "Dumb Money" Now

🌈 Abstract

The article discusses how the bond market has lost its predictive power regarding the economy and inflation. It examines the reasons for this, including the increasing size and intervention of the Federal Reserve in the Treasury market, as well as the declining liquidity in Treasuries. The article also highlights the poor forecasting track record of the Federal Reserve and argues that the bond market is no longer a reliable indicator of future inflation and economic conditions.

🙋 Q&A

[01] When and how the bond market lost its predictive power

1. What are the key reasons cited for the bond market losing its predictive power?

• The bond market has become a large and slow market, with frequent interventions from the central bank, unlike its earlier status as a fast and nimble "smart money" market.
• The total supply of U.S. Treasury securities has increased much faster than the daily trading volume, leading to declining liquidity in the Treasury market.
• The Federal Reserve has become the largest individual holder of government debt and is often the largest buyer or seller of Treasury securities, reducing the informational value of the bond market.

2. How does the article characterize the changing nature of the bond market?

• The bond market transitioned from being a "fast and nimble speedboat" to a "big ship that takes forever to turn and sometimes runs into things while moving extremely slowly."
• The market is now more "artificial" and "devoid of useful information for economic forecasting" due to the high level of central bank intervention.

3. What examples are provided of the Federal Reserve's poor forecasting ability?

• The article cites several instances where the Federal Reserve, under different chairmen, failed to accurately forecast future inflation, interest rates, and economic growth.

[02] The bond market's inability to forecast

1. How does the article argue that the bond market has lost its ability to accurately forecast inflation and economic conditions?

• The article presents a detailed analysis contrasting its own views on the inflationary impact of fiscal and monetary policies in 2020-2021 with the bond market's dismissal of those inflationary pressures.
• It highlights how the bond market failed to anticipate the worst bond market sell-off in modern history, as yields soared to 5% in 2023 despite the bond market's predictions of low inflation.

2. What is the key argument made about the informational value of the bond market?

• The article argues that the bond market is no longer a reliable indicator of future inflation and economic conditions, as it has become a "managed market" that requires constant intervention by fiscal and monetary policymakers.
• It suggests that the bond market's predictive power has been diluted due to the high debt levels and central bank involvement in the Treasury market.

3. How does the article characterize the relationship between the bond market and policymakers?

• The article suggests that the bond market has lost its independence and is now heavily influenced by the actions of fiscal and monetary policymakers, reducing its ability to provide accurate forecasts.