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Kyle Bass Explains Why We May Never See Another Bear Market In Bonds

Tyler Durden's Photo
by Tyler Durden
Sunday, Dec 20, 2020 - 19:06

Erik Townsend opened this week's episode of "MacroVoices" with some commentary on the past few weeks in markets. Having anticipated the dollar's continued decline, Townsend warned that he sees more weakness ahead, especially if federal stimulus exceeds expectations.

Speaking from a purely technical perspective, the trapdoor might really open up for the dollar if the DXY makes it to 89, at which point resistance would evaporate, Townsend said.

Moving on, Townsend commenced with the show's feature interview with Kyle Bass, the founder of Hayman Capital. Bass has gained notoriety over the past few years thanks to his scathing criticism of the Communist Party, and his prescient warnings about the political upheaval in Hong Kong, as well as the impact of all of this on markets.

Bass and Townsend started with a discussion on inflation, and the notion that not only will we see more inflation in the coming years due to the debasement of the dollar, but that, thanks to the inexorable upward march of all assets from stocks, to bonds, to crypto etc., nothing today is as cheap as it was ten years ago, or so it seems.

Kyle: I don’t know, Erik. If you look around your life, is there anything that you purchased in the last 10 years that is much cheaper than it used to be?

I mean, in my life, whether you’re buying farm and ranch vehicles or whether you’re buying even technology-based investments, whether you’re buying a new PC or whether you’re buying a new iPhone, their capacity has greatly increased. But the actual net price tag has also increased.

And the way that the inflation experts, using chain weighting, calculate inflation, I basically am offended by the fact that people out there don’t believe we have inflation already.

We’ve seen enormous inflation, whether you’re buying automobiles, houses, technology.

Technology per storage unit or cycle unit has definitely gone down in value, but we have many more units in each device. Therefore the net price is higher.

So I expect pretty significant inflation. And it will widen the gap between the haves and the have-nots. And we can expect to see even more social discourse going forward, which will be the negative associated with the positive of (call it) rallying markets and enormous inflation.

Bass's outlook for energy prices is an important component of his inflation thesis. As the "vaccine-led recovery" roars in 2021, Bass believes a surge in travel activity and business demand will cause oil prices and other commodities to surge, as the markets are left unprepared with a paucity of supply.

We’re going to have pent-up travel demand, both business and recreational travel demand. Therefore, while I’m not saying we’re going to see oil demand go right back to where it was pre Chinese pandemic, I do think in a very short term, once the vaccine-led recovery happens, we’re actually going to see more people travel than have ever traveled before. And so I think we’re going to exceed hydrocarbon demand pre-COVID for a short period of time in 2021.

And the supply side will not be able to react. So I actually think you’re going to see a very large energy, energy move higher.

Moving from inflation to rates, Townsend wonders: is the 38-year bull market in bonds finally over? He first points out that others - including notoriously Jeff Gundlach - have declared the bull market 'over' in the past, only to see rates go 100 basis points lower.

What does Bass think?

"That's the best question you've ever asked me," he starts.

A lot of people were disappointed recently when the 10-year yield failed to break through 1%. And with rates pulling back, Bass argues that policy makers can only allow them to rise so much before it becomes a problem.

Kyle: That’s the best question you’ve ever asked me.

And I believe that we’re going to see significant inflation. I think we’re going to be able to run it, as the Fed calls it, run it hot for a while, i.e. exceeding the Fed’s inflation parameters.

But that doesn’t necessarily mean we’re going to see a major bond selloff or even have the bond vigilantes – if those that might be still alive show their faces yet again.

Given the amount of debt that the global pandemic has left all of the developed world – and even the lesser developed world – basically they’ve been saddled with, I think you’re going to see nominal changes in bond yields.

Maybe the 30-year US Treasury base – what, about at 1.65? – could that see 2.50? It could. But could the short end, do you think the US short end is going to go from zero to 2 or 2-1/2%? Absolutely not. Even if we run big inflation numbers we can’t afford to let those rates move. So my view is you might see some kind of shocking moves that might move 50 to 100 bits. And those would be shocking.

But if you just look back to the history of this massive bond market rally, really, since what? 1989 or so? I think you’re not going to see any kind of meaningful yield moves higher. I think you’re just going to see asset prices move higher.

And why does the Fed ultimately need inflation? Well, it's the same reason why the Fed can never again allow markets to dictate interest rates, and why we're now locked into this cycle where rates will have no choice but to go negative.

Kyle: That’s correct. I just think once you head down this road that the central banks have clearly headed down there is no turning back. There is no letting the bond market and the market rates dictate where, again, where an effective zero real rate would be. So I think we’re going to have negative real rates and I think that’s going to further exacerbate the Jeff Currie phenomenon of feedback loop of more and more inflation.

The coronavirus pandemic and its aftermath has left western policy-makers boxed in. They have very few options if they wish to avert near-term catastrophe. Unfortunately, Beijing, Moscow and other foreign players discontented with American hegemony are waiting for their chance to dethrone the dollar, and America's place in the global hierarchy along with it.

Watch the full interview below:

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