No short-term lack of demand for U.S. Treasurys, says Damped Spring's Andy Constan

Key Concepts:

• Ten-year Treasury yield
• Federal Funds Rate
• Economic Contraction/Recession
• Portfolio Positioning (Short vs. Neutral)
• German Bunds vs. US Treasuries
• Home Bias (European Investors)
• Tariffs and Fiscal Policy
• Foreign Direct Investment (FDI)
• Trade Surplus/Deficit
• Domestic Savers

1. Interest Rate Outlook and Economic Contraction:

• The ten-year Treasury yield had decreased to below 3.9% and was closing just under 4% in mid-January.
• Andy Hughes believes that for the ten-year yield to decrease significantly further, an actual economic contraction, not just the fear of one, is needed.
• He anticipates the Federal Funds Rate potentially reaching 3%, aligning with JP Morgan's forecast.
• In this scenario, Hughes expects the ten-year Treasury yield to settle around 3.75%.

2. Portfolio Positioning and Recessionary Baseline:

• Hughes states his portfolio positioning has been based on the assumption of a recession.
• He acknowledges that market prices have changed significantly in the past six weeks, with the Nasdaq down 22.5% and the S&P 500 down 17.5% from their highs.
• While a recession could push stocks further down, Hughes believes that a deeper recession would be required to significantly lower stock prices from current levels.
• He describes his current portfolio stance as "fairly neutral, slightly short."

3. European Bonds and Home Bias:

• The discussion touches on the relative attractiveness of French, Italian, and German Bunds compared to US Treasuries on a 3-6 month basis.
• When hedged, the pickup in yield from owning these European bonds is not substantial compared to US Treasuries.
• The question is raised whether European investors will exhibit a "home bias," favoring investments in their own region.
• The potential impact of this home bias on demand for US Treasuries is considered.

4. Treasury Secretary's Influence and Market Dynamics:

• The interviewer suggests that Treasury Secretary Yellen seems focused on lowering the ten-year yield.
• The question is posed whether the pace of the yield decline is too rapid and if it's contributing to other market dynamics.

5. Tariffs, Fiscal Policy, and Global Capital Flows:

• Hughes attributes the anticipated US economic slowdown to a combination of tariffs and fiscal contraction.
• In contrast, Germany is experiencing fiscal expansion, which is expected to improve its growth outlook and potentially lead to higher German Bund yields relative to US yields.
• Tariffs are expected to reduce global imports, which in turn reduces the supply of dollars held by foreigners.
• Foreigners typically invest these dollars in US assets, including Treasuries, foreign direct investment, and US public equities.
• While tariffs won't eliminate foreign demand for US assets, they will reduce it, meaning that US deficits and assets will need to be absorbed more by domestic savers.

6. Demand for US Bonds and Foreign Direct Investment:

• The US bond market is rallying significantly, indicating strong demand, likely driven by the economic slowdown.
• This demand is not attributed to foreign selling or concerns about issues like taxing income for foreigners or selective defaults.
• The discussion highlights a potential conflict: the US government is seeking more foreign direct investment while simultaneously implementing trade policies that reduce the flow of dollars to foreigners.

7. Conclusion:

• The conversation explores the interplay of economic contraction, interest rate movements, and global capital flows.
• Hughes emphasizes the importance of an actual economic contraction for further significant declines in the ten-year Treasury yield.
• The discussion highlights the potential impact of tariffs on reducing foreign demand for US assets and the increasing reliance on domestic savers to absorb US deficits.