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Historically speaking, the significant investments and advancements in the world economy that took place directly after World War II, helped drive growth - inflation and eventually yields to such icarus heights, that countries, corporations and individuals have enjoyed the voluminous book-end benefits of a declining rate environment for well over 30 years. Comparatively, the secular peak in yields in 1981 was over three times as high as the previous secular peak in 1921 - and the broader span from trough to trough of the current move (1941-2021' ~80 years) will likely be over twice the previous cycles length (1901-1941'). Simply put, there's a lot of debt out there in the world. Raising rates here at home in the U.S. will have significant knock on effects throughout the financial markets - especially if the balance of the world is aggressively easing monetary policy. Believing that the broader system can normalize and reboot to the next long-term cycle without a prolonged period of transition (i.e. some call it secular stagnation - we like transitional divide) - even proportional and commensurate with the previous trough, is illogical even along the irrational continuum we often find ourselves walking out on.
The underlying takeaway for us, is that participant expectations - as well as most members of the FOMC, have found themselves significantly ahead of reality when it comes to the prospect of rate hikes. This has been one of the main drivers of the dollar's moonshot over the past eight months, which has been motivated by persistent expectations of a more traditional tightening regime normalizing policy (as it has in recent past), while the rest of the world opens their monetary spigots. Over the past two years, by the FOMC's own telegraphed forecasts to the market, they have speculated that short-term rates would rise above ZIRP to around three percent by 2017. In our opinion, this outcome remains exceedingly optimistic when you consider the long-term yield cycle and what we can glean about the trough from the previous cycle.
In many ways - although the Fed likely had good intentions at the time and was dealt a very difficult hand to play, their increasingly transparent policy approach with the market appears to have severely limited their capacity to act - as misplaced as it may be these days. With the majority of the worlds largest central banks continuing to ease aggressively, while rate hike expectations in the U.S. remain steadfast, the dollar has reached a level in such a short period of time that it now limits the Fed's ability to tighten without causing serious dislocations and distortions around the world - that would inevitably reach back with known and unknown consequence in the U.S. Although the consensus opinion in the market is that the dollar is on a secular updraft that could continue for years, considering the strong ties of globalization that bond us with the world and proportions and profile of the long-term yield/growth/debt cycles - in our opinion, those expectations are as misplaced as looking for a secular rise in yields today.
As mentioned in previous notes, we expect the dollar to once again modulate and follow last years move in yields back down into the trough of its long-term range, as expectations come in with regards to the magnitude and timing of potential rate hikes and as markets slowly transition and stumble their way across the transitional divide to the next growth cycle. Despite it's current disposition - and contrary to popular opinion in the market these days, we expect lower for longer will eventually apply to the world's primary reserve currency as well. If not, the Fed's haunting specter over the past two decades - that of deflation, will eventually drift over onto our shores. That said, we suspect it will be more of a push and pull with cyclical inflationary and disinflationary moves across the transitional divide, with the markets currently situated for another reflationary upturn.
To a large degree this relies on the trend of the two largest reserve currencies in the world (dollar/euro), which from a long-term performance perspective of its proxy (U.S. dollar index) - is almost as stretched as it was at its secular peak in February 1985.