Bridgewater chief funding officers say the market has entered the second stage of tightening

The upward adjustment in bond yields was warranted and isn’t carried out but, say the co-chief funding officers of hedge fund big Bridgewater Associates.

Bob Prince, Greg Jensen and Karen Karniol-Tambour, in an article posted to the agency’s web site, say the market is at an uncommon stage the place modifications in financial situations aren’t the most important drivers of modifications in yields and asset costs. “At this stage of the tightening cycle, what matters most will be whether the desired levels of conditions have been met; so far, they have not,” they are saying.

They stated the market has re-priced higher-for-longer charges given inflation continues to be reasonably too excessive, wage progress too excessive to permit inflation to settle right into a goal vary, labor market situations too robust to exert a downward stress on wages and actual progress not so weak as to justify an easing.

After an unusually robust retail gross sales report, the Atlanta Fed’s GDPNow estimate of progress for the third quarter was 5.4%. Consumer costs in September rose 3.7% year-over-year, the unemployment price was 3.8%, and the employment value index within the second quarter grew 4.5% year-on-year.

“Looking ahead, if the T-bill rate stays at 5% or higher, to get a risk premium in bonds you need a bond yield of 5.5% or higher. And given the coming supply of bonds and the withdrawal of central banks from buying them, demand will need to come from private sector investors, who will require a risk premium relative to cash,” says the Bridgewater crew.

The 3-month Treasury invoice
on Wednesday was yielding 5.5%, whereas the 10-year Treasury
was yielding 4.85%.

U.S. authorities borrowing on the lengthy finish of the yield curve is about to rise to very excessive ranges, “well in excess of the existing demand to buy bonds,” they add.

What will this new stage of the tightening cycle imply? They anticipate “grinding pressure on growth,” and for the fairness market to turn out to be extra uncompetitive relative to bonds.

The S&P 500
has gained 14% this yr, although it’s down 5% from the highs of late July.

“Given grinding pressures on growth and restrictive policy that discourages an acceleration in credit, it is not likely that an acceleration in earnings will restore the competitiveness of equities relative to bonds, as earnings are more likely to be a contributing drag. Instead, restoring risk premiums in equities relative to bonds and bonds relative to cash likely requires higher yields and lower prices,” they are saying.

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“The pricing can make more sense if we are on the verge of a substantial and sustained rise in productivity. The level of wages would imply a lower inflation rate. The discounted growth in earnings would make more sense. And a higher level of real interest rates could be sustained with less impact on the economy. Bond yields would still need to rise to provide a risk premium to the new equilibrium level of real short-term interest rates, but the economy and equities could more easily withstand those interest rate effects,” they are saying.

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