The Bond Bull is Back
Featuring Dr. Komal Sri-Kumar
Published on: May 29th, 2019 • Duration: 18 minutesDr. Komal Sri-Kumar, president of Sri-Kumar Global Strategies, returns to Real Vision to update his bullish bet on bonds from last year. Sri correctly forecasted that trade wars, slowing growth and low inflation would ultimately lead to lower yields and falling stock prices. He now reviews where he thinks the U.S. 10-year Treasury yield is headed next, in this interview with Jake Merl. Filmed on May 24, 2019.
JAKE MERL: Welcome to Trade Ideas. I'm Jake Merl, sitting down with Komal Sri-Kumar of Sri-Kumar Global Strategies. Sri, great to have you back on the show.
KOMAL SRI-KUMAR Good to be back. Thank you for having me.
JAKE MERL: So, you've been on Real Vision a few different times over the past year explaining why the US 10-Year should be yielding below 2.5%. You said slowing global growth following inflation and trade wars will lead to a safe haven trade in treasuries. Your first few trades did get stopped out. It did take a little while for this thesis to play out. But you pretty much nailed the narrative. Can you please review your thesis on bonds? And what led you to making this call?
KOMAL SRI-KUMAR: The thesis, Jake is very similar to what you said, namely, trade wars are going to be good for US Treasuries, and then low inflation is going to be very good for it as well. And the expectation of low economic growth is also a positive. Think about what a nominal bond yield is. It is a summation of your expectations on inflation and what you think is going to happen to growth. If real growth is going to be very high, you will be prepared to pay a very high interest rate, and I will demand a high interest rate to lend to you. And that is not only with respect to the private sector individuals, but with the US Treasury as well.
And I took the position that despite the Trump tax cuts around Christmas of 2017, yes, you will have a few quarters of growth pickup. But that's a sugar high. Just because you have a sugar high and your energy level goes up, that doesn't mean you'll become an individual with permanently high energy for the rest of your life. Similarly, here, I thought it would happen to two or three quarters and then fall off. Sure enough, that seems to be happening right now.
Second, the Fed has been saying to us for 10 years, last decade, Jake, that inflation is going to go up to the 2% target. And I have said on your program, no, that's not going to happen. And the reason is fiscal deficits alone will not do it. Quantitative easing that we had will not do it. We have all other reasons such as the population getting too old in the United States, we have fewer young people coming in as immigrants with skill as well as purchasing power.
And we have the situation where the quantitative easing really impoverished the low wage and medium wage worker, because unless you were in the stock market, you were left behind in the society in the last 10 years. And those are the people, the low-income people are the ones who consume and they're now too frightened to consume. Those were the reasons and the macro has played on, played out quite well so far.
JAKE MERL: And just to play devil's advocate here, we are seeing this huge increase in the supply of treasuries. And we're seeing a lack of demand from abroad, from foreigners. Does that worry you at all?
KOMAL SRI-KUMAR: It does not. I see what the net impact is. And if you look at what happened, the 10-Year Yield went below 2.29. And it's the lowest since 2017. Yes, the US fiscal deficit has increased. And that is not a good thing. And therefore, they have to issue more treasuries. But look what the market is saying despite that the yield is going down. And the reason for that is that there is an immense amount of global demand that is coming from different sources.
Even the threat that the Chinese may sell some of their treasuries as a retaliatory measure in the trade war has not caused the yields to go up. So, the private German, the private French person and the private Asian investor is going to say I'm going to seek refuge in US Treasuries. So, it basically it looks like a bulletproof situation for US Treasuries right now.
JAKE MERL: So, last time you were here in December, you said that recession was in the cards for 2019 unless the Fed paused on its rate hike cycle. And it looks like that's the case. We've seen the Powell pivot, from hawkish to dovish. So, given what's going on, what's your current view of global growth, global inflation? And what's your view for your recession call for this year?
KOMAL SRI-KUMAR: That's a timely question, Jake. When I said that in December, we had Fed Chairman Jerome Powell telling us all, not only was he hiking on December 19th, but he was going to increase rates two more times in 2019. And he was going to let the falloff in the Fed's balance sheet to be, as he put it, to use his words, automatic pilot. The markets just was just very frightened by those statements, and the market cratered in the second half of December.
We all know that the Fed is supposed to be, supposed to be, looking only at growth and inflation and not try to protect the equity investor. But I've always said the Fed is not an independent body. And it does care about equities. And when equities go down, the Fed steps in and protects your back. That's what happened with the pivot on January 4th.
So, going to your question, my expectation had been for the recession to begin in the second half of 2019. Now, I think we are talking about closer to the middle to second half of 2020, perhaps just about the time the presidential elections are being held. Because what you have today is an increasing amount of trade war on the one hand, which in turn is going to be negative for the economy. At the same time, you have the Fed, which is probably going to step in and I think even cut rates before its June 18th, 19th meeting, if we have a short falloff in equities.
So, what dominates? Does the Fed move caused the recession to be postponed? Or do you have the trade war that accelerates it? And I'm saying the net impact is going to be the Fed protects you for some time from a recession. And then the Fed can't do anymore, because the valuations have increased, and it becomes time to have a recession.
JAKE MERL: So, how do you see the trade war unfolding? Do you think we're actually going to get a deal?
KOMAL SRI-KUMAR: I don't see a deal coming through anytime fast. I think both sides- the Chinese side and the American side, has enough reasons to keep continuing with the trade war. On the US side, President Trump believes that his base finds it very attractive to attack the Chinese. And also, he has had support from across the aisle with Senate Minority Leader Chuck Schumer, suggesting that he not give up and keep attacking the Chinese. So, that means there is overall support for doing that.
On the Chinese side, the President has asked for as he called it, the Long March, he said three days ago, that is taken to be a code word for essentially get prepared, my fellow Chinese citizens for a long cold war on the trade front. So, I think that is something that is going to continue to happen. And for the Chinese in particular, and something I know from several trips to their country, is they are very conscious of saving face. You cannot have the Chinese president just concede and give up to the American side and the American demands. So, even though the Chinese economy is suffering, and we see that from a number of macroeconomic statistics, it still means that politically, they cannot give up.
So, what does that mean? The trade war is going to go on with ratcheting up of tariffs for one. Second, it is also mutating, it is changing. We saw a few days ago that there was an order by President Trump that US companies do not sell equipment to Huawei, which is a giant Chinese telecommunications company. And just as about a few days later, we had Hikvision, which is a video surveillance firm in China. And the reports are that there may be restrictions on them as well.
So, one you have tariffs. Two, you have specific action against specific companies. And third, as part of the mutation, you may have restrictions on specific Chinese individuals who are suspected of leading some of the efforts for spying or for surveillance. When all of that happens, expect the Chinese also to retaliate in some fashion to each of the moves, which is why I think it's not going to be a short-lived situation. It's something that may well go on at least to the 2020 presidential elections.
JAKE MERL: So, with all this in mind, do you think the trade wars and Trump's policies are negative for stocks and positive for bonds? Is that right?
KOMAL SRI-KUMAR: That is exactly right. I think, look for more defensive instruments to go on that way. And to do that, Jake, I look not only at what's happening with US Treasuries, but the European no-risk investment was this a German bund. And the 10-Year German Bund recently went to minus 13 points, you get a fabulous return of negative 13 basis points, which means when you buy 100 euros worth of German paper, the German government promises to pay you less than hundred euros. And that's why do you do that? Because you're scared, because you're risk averse. And that also is suggesting to me that risk aversion is not just a US phenomenon, it's become global.
JAKE MERL: So, we're currently trading around 2.3% on the 10-Year, and around current levels, would you be looking to go long here? Or would you be looking for a better entry?
KOMAL SRI-KUMAR: I think you cannot look for a precise entry point. I am not a market timer. And I don't think investors should be timing the market. But at about 230, I would say the next stop- I used to say the next stop is 225. But we went below 229 already. So, I'm actually looking for about 210, to where it is. So, you do look for a good profit to come from being in it. But I think it is not going to happen smoothly. You may stick around in between, say 228 and 235 for some time. And then something is going to happen on the trade front. And as happened on May 23rd, you're going to see a nine-basis point drop on a single day. That's what I expect.
So, the 210 may come any time within the next six to nine months. So, you do want to take a long position in it, but not be a market timer.
JAKE MERL: So, Sri, last time you were here in December, you said you were looking for the yield curve to invert. And we've seen parts of the curve invert over the past few months. But what are you looking at going forward?
KOMAL SRI-KUMAR: What we found, Jake, as you correctly said, is that the front end of the curve has inverted, namely, the 3-Month to the 10-Year or in the case of the 5- Year, the short in five years and less they have inverted. But the two to 10, which a number of people in the market view very carefully, has gone to as low as positive eight basis points. But it is really not inverted. You have not had a negative one. I don't expect any more a negative move in the short-term. And the reason is the Fed pivot.
Remember what the two to 10 is telling you. The 2-Year and the 10-Year are having a race downward in terms of yields, that's exactly what it is. And if you said that a 10-Year going down is suggestive of risk aversion and the recession coming on, the 2-Year is also going down just as fast or faster. That means the market is saying the Fed is not going to increase interest rates, it may even cut interest rates. So, the reason why it hasn't inverted is because the 2- Year and the 10-Year are waiting for the Fed to take some action and when the Fed action is no longer effective.
And I told you earlier on that that happens by the middle of 2020. So, you probably have another six or nine months to go before the two to 10 inverts. And then, beware, better be on guard. So, all signals are pointing toward a recession. But it's not yet.
JAKE MERL: So, what would you say is the biggest risk to your bullish bet on bonds?
KOMAL SRI-KUMAR: There are several risks to the forecast. The trade war comes to an end unexpectedly. Then we also have some form of immigration reform, which is very positive in terms of demand. And you're doing that not through fiscal policy and monetary policy, but structurally deregulation, pro-business policies, promotes investments and equities rise in which case, it will be time to say you shouldn't be defensive anymore. And it's time to shift over from high-grade fixed income securities over to equities.
So, those are two or three different risks to the forecast that you could have, which can cause the 10-Year Yield, for example, to rise rather than fall. But I mentioned them as risk because you asked me, but I think they are improbable because I also have to look at the probability that the trade wars would come to an end. And I don't see that happening anytime soon.
What you see on the other hand, Jake, is President Trump has postponed the tariffs on European Auto tariffs for 180 days. And he has reached agreement with Canada and Mexico, on what is known as USMCA or sometimes as NAFTA2. That still has to be approved by Congress. But at the White House level, there is peace now at least temporarily with the Europeans and with Canada, and Mexico. All guns are pointing toward the China trade war.
And so, once that is done, you're not home free and yields don't start to go up on treasuries, then it's time to shift focus toward Europe, and try to find out what is wrong in the Canadian or Mexican relationships with the United States. That's where I think the market doesn't fully incorporate or discount those developments. It thinks that there may be an agreement with China eventually. But if it is, there is no certainty that the promises will be kept.
President Trump has up again a past where he made an accord with the Chinese and then he pulled back. That could happen again. There is no certainty that anything will be long lasting. And also, if he reaches even a temporary accord with the Chinese, he needs to keep going with an attack on Europeans. Remember that the Midwest, which is part of the Trump base, has workers whose wages have gone down, whose employment has been lost. As a result, he thinks because of imported vehicles coming from there, and therefore, he has to keep the fight on.
So, politics is going to interact very much with economic reality. And the net impact is going to be negative for I think the markets. So, that's why the risk that you talk about of yields rising, I don't consider it to be significant.
JAKE MERL: Sri, that was great. Thanks so much for joining.
KOMAL SRI-KUMAR: Thank you very much, Jake.
JAKE MERL: So, Sri is bullish on treasuries. Specifically, he likes buying the 10-Year Treasury at current levels and thinks the yield could hit 210 over the next six to nine months. That was Komal Sri-Kumar of Sri-Kumar Global Strategies and for Real Vision, I'm Jake Merl.