Jamie Dimon Backtracks on Yields and Plays Down the Curve
(Bloomberg Opinion) -- Eight months ago, JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said that the likelihood of the 10-year U.S. Treasury yield reaching 5 percent was “a higher probability than most people think.” Presumably, that was based on solid economic growth and further interest-rate increases from the Federal Reserve and other central banks.
A lot has changed since August, including, it seems, Dimon’s outlook. He warned in his annual letter to shareholders on Thursday that the market volatility in the final months of 2018 “might be a harbinger of things to come.” As Bloomberg News’s Michelle F. Davis noted, “Dimon’s more cautious tone is a shift from the full-throated optimism he’s conveyed in the past few years, and even from his last letter in 2018.”
Of course, JPMorgan’s business benefits from rising interest rates, particularly at the long end. So it was little surprise last year to see Dimon saying things like “I think rates should be 4 percent today.” But it’s nevertheless noteworthy to see him backtrack now that 10-year yields have dropped to 2.5 percent and a much-watched portion of the curve has inverted for the first time since before the last recession. From his letter:
“10-year bond spreads have been suppressed in some way by the extreme quantitative easing around the world. If that ever reverses in a material way, how could it not have an effect on the 10-year bond? Finally, I would not look at the yield curve and its potential inversion as giving the same signals as in the past. There has simply been too much interference in the global markets by central banks and regulators to understand its full effect on the yield curve.”
That’s a big “if” to start the second sentence. As I wrote this week, it’s becoming clear that central banks have little choice but to keep monetary policy relatively easy because of the buildup in global debt over the past decade. That means, yes, there seems to be a cap to how high long-term yields can go.
That didn’t come out of nowhere — for the most part, this has been readily apparent for much of the post-crisis era. Sure, some investors in recent years quibbled about how many interest-rate increases the Fed would be able to pull off before reaching “neutral,” and most ended up aiming too high after Chairman Jerome Powell’s abrupt pivot to start the year. But any forecast of 10-year U.S. yields reaching 4 percent or higher was always seen as an outlier. I don’t pretend to have anything close to the feel for the markets and the economy that Dimon has, but I did note this in August:
The 10-year yield again failed to sustain a breach of 3 percent last week, even in the face of a humming U.S. economy and a surge in Treasury borrowing. That next percentage point is going to be tough, to say nothing of another two.
Certainly, there’s an argument that unprecedented monetary stimulus by global central banks is keeping sovereign interest rates artificially low. And as they pare back on easing, yields should return to loftier levels. ...
But that process will be slow — at least much more gradual than some traders expected earlier this year — and by the time they start tightening in earnest, the bull market’s time may be up.
At this point, tightening is effectively a thing of the past, and doubts are creeping in about how much further stocks can climb. In fact, none other than JPMorgan strategists urged investors to snap up hedges against the risk of a U.S. recession in a note on Thursday. More specifically, they advocate scaling back on corporate bonds and boosting holdings of cash and government securities. They argue that the divergence between equities and Treasuries means financial markets could be in for another bout of turbulence.
As for the yield curve, I understand the impetus to play down its significance because of the unprecedented monetary policy from global central banks. At the same time, Bloomberg News’s Vivien Lou Chen went back and found no shortage of examples of policy makers, investors and strategists who said in 2006 and 2007 that “this time is different.” Yes, the “term premium” on 10-year Treasuries is as sharply negative as anytime in history, a reflection of central-bank distortion. But that doesn’t change the fact that rates on cash-like assets are now just as high as long-term debt. No matter the reason, this will eventually shift economic decisions.
That’s different from saying a downturn is inevitable. Dimon’s letter says “we are prepared for — though we are not predicting — a recession.” He reiterated that if one happens, it’ll probably be due to a “cumulative effect of negative factors” rather than mirroring past crises. One of those negative factors might just be the yield curve, should it remain inverted in the months ahead.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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