Bond Market Observations: The World is a Risky Place

A millennial potentially with impulse-control issues holds the nuclear launch codes in North Korea. The US military just dropped the heaviest nonnuclear ordinance in its inventory. Randomly in major cities, lone-wolf terrorists inflict horrific damage. Add to this the angst associated with orderly transitions in stable democracies as an election looms in France and another appears on the horizon in Germany.

Agreed. The world is a risky place. In our blinkered bit of that world, geopolitical concerns must be an important part of the recent rally in Treasury yields. As shown in the chart, the nominal ten-year Treasury yield shed 35 basis points in the past month. The flight-to-safety benefit to the US is evident in the estimate of the term premium, now at minus 15 basis points, as assessed by staff at the Federal Reserve Bank of New York.

The bad news is that this is climate, not weather. While we expect to get past the near-term political events in one piece and investors to settle down, safe assets will enjoy an outsized premium for some time in a world where official holdings remain large and risks are multifarious. Until then, though, we are wary of duration and desirous of protection from tail risks in the near term.

The Standish global macro view has not changed since last month’s Global Macro Views and Bond Market Observations. If our economic forecast eventuates, steady global expansion pulled along by above-trend growth in the US and China helps to calm investors. True, the Trump administration has shown an enormous capacity to surprise, mostly of the disappointing sort of delaying change in economic policy. But we never let much enthusiasm about promises being kept creep into our outlook. We look to the data, which have run stronger than consensus. Once past the first-quarter statistical pothole in the US, advanced economies will be seen as expanding slightly faster than trend, pushing inflation up a tad. Advanced economies’ advance and stable commodity prices provide a stable culture for growth in emerging market economies.

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