Zero Lower Bound? Zero Upper Bound?
One of the more fascinating people I've had the pleasure of working with recently is Dr Keith Suter. Interesting chap with a wild thesis about a "Digital Geopolitical Order."
His argument is today's roughly-200 nation-states and international organisations with defined borders and rules are being displaced. We are now entering a phase where mega corporations are more economically powerful than many sovereigns and the platforms & corporations that run the world (eg Mag-7) accumulate unprecedented influence. Apple, for example, has more turnover than half the UN member nations.
So very simply, over time, corporates will effectively have greater leadership and influence than governments. Power migrates from the public sector to the private.
Makes me think that everyone keeps talking about the shift in reserve currency.
Instead, this is a shift in where the reserve power lies.
In my view this shift in power is like the Catholic Church being more influential around the world than governments.
You can see the influence of major corporates in our lives today. In your pocket or in your hand right now is an Android or an iPhone, so you're forever stuck in either the Google or Apple ecosystem. Both have power (and responsibility?) through the sheer number of individuals they touch through their platforms. Same story with AI where the Mag7 have direct or indirect ownership of all the leading-edge models.
The Capital Management Divide
Corporates are profit-seeking institutions that know how to manage capital and are typically well-governed. Governments are well-governed too (or at least half the country thinks so at any given point in time), but they've clearly shown an inability to manage capital effectively. Poor fiscal control has led to outsized budgets and mounting debt burdens.
There's been a lot of leeway given to governments regarding spending and debt issuance (developed markets have not seen the consequences in generations), but over the last few years, we've witnessed two major events where markets clearly drew a red line. The Liz Truss debacle in 2022 and the recent Trump bond market dummy spit this year. Both events saw bond markets lose faith in fiscal responsibility.
Developed markets have been pushing the boundaries of what can be achieved and are now trapped in coffin corner. There's no reasonable outcome here in my view.
The Impossible Choice
(some of) The choices are stark: inflate your way out (which kills the consumer), cut spending (but you gotta keep the lights on!) or default. I have no idea which way it goes, but we know the destination(s) if not the path.
Source: St Louis Fed
Bond yields are normalised today relative to the last 30 years, the aberration that was 08-22 was NOT NORMAL. We're back to normality now.
And I'll even go as far to say, that US10YR bond yields aren't really pricing in anything other than business as usual today. Rates are being cut to bring policy setting back down to normal, whatever that is. And the longer-dated stuff (10yr+ US Treasuries) is reflective of demand for bonds with yields sometimes pricing in chaos when someone says something silly.
There is so much commentary about rising yields, but the reality is that bond yields have actually been fairly stable for some time now and bond market volatility is falling.
There is arguably no premium for any sovereign debt issues in US bond markets today.
Directionally, I take the view the risk premium for sovereign debt will continue to increase. One of those things again where I am unsure of the path but surer about the destination.
Who's the real money maker?
While the rising risk premia for sovereign debt rises, the Mag-7 (and other quality businesses) continue to absolutely print cash money. These companies have fortress balance sheets, predictable cash flows, and dominant market positions. Which brings me to a provocative question: how long before we see negative credit spreads for corporate credit?
It's a weird implication but a genuine possibility.
(I'll take a moment here to acknowledge swap spreads make this mechanically untrue in a pure sense, but I can't help but explore this because of how sensational it sounds.)
The Unthinkable Becomes Thinkable
On the jagged edge of this logic, do Apple bonds trade below USTs? Sure, why not! How long before we see a <SOFR +5bps> raise? What about a -50bps raise? It sounds absolutely absurd, but we're living in interesting times.
My wild idea is that negative spreads could potentially be the negative bond yields of this cycle. Think about it, if you believe Apple is more creditworthy than the US Treasury, why wouldn't you demand a lower yield for lending to Apple?
The mechanics would be fascinating. Corporate treasurers issuing debt at (or even below!) sovereign benchmarks while governments pay ever-higher premiums for fiscal profligacy. It would represent a complete inversion of the traditional credit hierarchy.
Silly thinking but seeing corporates trade inside treasuries persistently in the US is possible.
The Deflationary Wild Card
I've also been thinking about the other tail outcome, the deflationary angle.
What about deflation brought about by productivity improvements from AI and an aging population? If we're heading into a sustained deflationary environment (which I'd argue isn't priced in at all), the companies driving that productivity revolution (our beloved Mag-7) would be the ultimate beneficiaries.
Deflation rewards creditors and punishes debtors. Guess who the biggest debtor is? Governments. Guess who's sitting on massive cash piles and generating enormous free cash flows? The corporates that could theoretically fund themselves more cheaply than sovereigns!
Either way, this is an incredibly painful outcome for government balance sheets. Especially if we start doing yield control and helicopter money again.
As an aside, if we end up deflationary, a way of expressing this view is long bonds (20yrs+) which have awesome convexity in that outcome. Don't discount it.