MBS Live Day Ahead: Suddenly, Bonds Are Pretty Sure The Global Economy is Doomed

By: Matthew Graham •

In the day just passed, bonds sold off by a completely average amount in the context of recent volatility and new trading range.  Motivations were above-board and easy to confirm (trade war headlines).  The move was mirrored in stocks and other assets.  Bottom line: as far as moderately-paced sell-offs are concerned, this one was totally boring.  The overnight session was less boring with a slew of flat-to-weaker economic data around the globe.  It prompted a gradual rally at first, followed by a sharp rally bringing yields to new long-term lows before the open.

In the day ahead, traders who haven't figured out what's going on yet will continue to scratch their heads and try to piece together the new reality.  Actually, it's an old reality that has simply been coming into focus by increasing degrees this summer.  Most of it has to do with trade war fallout (by an amount that's already destined to occur based on existing issues as well as the additional amount we're likely to experience in the coming months), but there are bigger-picture, longer-term considerations as well.

The ability of shorter-term struggle to stir up gloomier longer-term outlooks is both interesting and dangerous.  For instance, if you've ever been down on your luck, struggling to make it in the world, you might be more inclined to ruminate on the realities of "the struggle" in general.  In other words, this bout of trade war fallout and the ensuing global economic slide can't help but make some of us wonder where "all this" is going.  By "all this," I'm referring to what is, in many ways, a grand experiment blending pockets of intense free market capitalism with rapidly evolving socialist economies, with numerous smaller and much more mature economies occupying the perimeter of the financial world.

You can walk into a bakery in Japan, for instance, that's been there for 1000 years.  Will the US have reached Japan's level of population density and birth/death rates when we have those bakeries?  (Trick question, the gluten police will make sure no bakery lasts that long, but I digress).  The point is that the endgame of global economic growth is not perpetual growth!  By the very nature of the laws of the physical universe, there must come a time when things level off more and more.  That doesn't mean growth stops any time soon, but the farther along we move through time, the more frequently we may dip into corrective growth patterns.  Take a look at how frequently Japan has dipped into negative GDP, for instance:

Over that same time frame, the US GDP story is very different:

Unless the human race is to sprint toward the finish line and extinguish itself with a bang, the only sustainable endgame is for these charts to evolve such that the lines are orbiting around the 0.00% level.  Hmmm... So scratch everything I just said.  Humanity won't be willing to type that destination into its emotional GPS, so "extinguish with a bang" it is!  Fortunately, this could take hundreds of years to play out.  Months like August 2019 just lend themselves to meditating on the topic.

Here was a meditation I prepared this morning that didn't seem to fit anywhere else in this rant: a quick annotated chart of rates that helps explains why we are where we are.

  1. The Fed may have raised rates a bit too high and been too slow to appreciate global economic risks that were building throughout 2018. "Let’s follow stocks lower and hope the Fed agrees it’s time for a change."
  2. This is the zone where bonds circled the wagons after escaping the perverse higher-rate reality that the market seemed to be rolling over and accepting by the fall of 2019.  They were waiting to hear from the Fed on March 20th.  The Fed was friendly and so the next rally ensued
  3. Surely, this "big" move from 3.25 to 2.40% is overdone and bonds have to undergo a correction?
  4. NOPE!  Trump tariff tweets!  (first China, then Mexico)
  5. OK OK OK, so the trade war stuff is dying down and the Fed is probably gonna cut rates, but it could be a one and done thing, right?  Maybe we'll work out the trade war stuff and there will be a glorious extension of this long-standing economic expansion.
  6. NOPE!  More Trump tariff tweets, this time joined by Chinese currency devaluation, crummy global economic data, an ongoing slide in domestic econ data  and the general fear that the trade war has already done enough damage to drastically effect global growth prospects for a long time.