interest rates

Macro Thoughts – Summer 2025

/ mtlucasmacro

2025 has been fascinating to watch through a macro lens. The Trump administration is seeking to reshape policy in ways that will reverberate for years to come. Trading relationships, defense priorities, tariffs, fiscal policy, monetary policy, immigration policy and the regulatory landscape are all on the table. Many of these directly impact the markets in which we operate. Last quarter started in the messiest of fashions, ‘Liberation Day’ setting tariffs based on trade deficits rocked the stock market and was swiftly paused in favor of ‘The Art of the Deal’ over the next few months. Stocks recovered, the contours of deals started to take shape and soon we had the One Big Beautiful Bill signed. Tax cuts were extended and investment tax credits were increased. Deficit arguments abound, most of which read like political talking points dressed up as economics. Are we talking about baselines vs current law or current year? Counting tariff revenue? Are we ascribing a growth multiplier? Our take on the macro aggregate is that deficits are not getting materially and hastily slashed so the accounting identity that public deficits become private profits still holds and growth is OK. Under the surface though there are some big changes in the composition of spending, especially when coupled with the new AI Action Plan. There is a broader discussion to be had on the role of the government in setting industrial policy and picking winners that is best saved for a glass of wine. However, they aren’t kidding calling it a ‘Big’ bill (‘Beautiful’ may be a stretch) but take the time to go through it, the answers to the test are in there. Money for defense and a desire to lead in AI.

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As We See It: Macro Thoughts

/ mtlucasmacro

At Mount Lucas we run both discretionary macro and systematic Managed Futures strategies.

  • While macro outlooks are useful for understanding Managed Futures returns, they aren’t very predictive (the “following” part of trend following). However, rule of thumb, they tend to do well when volatility increases in macro markets.
  • Managed Futures picks up a risk premium from hedgers on both sides of the markets, that risk premium shifts with uncertainty.
  • We have a new administration coming in shortly that sees volatility as a feature for negotiating leverage and has big macro policy goals.
  • These policy goals run directly through the macro instruments we trade – bond yields, currencies and commodity markets.
  • Investors need exposure to these macro markets to help diversify traditional investments.

Where do we see sources of volatility relative to the markets we trade?

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As We See It: Yen Intervention Update

/ mtlucasmacro

Around this time last year we wrote here on currency intervention in the Japanese Yen. The TL;DR version.

There is a pretty simple reason we don’t see intervention much anymore – it does not work…Intervention is like trying to hold 100 ping pong balls underwater at the same time – sooner or later one will pop up. As long as the BOJ keeps interest rates artificially low and continues yield curve control, the currency will eventually, intervention or not, get blasted. When the Fed is guiding market yields close to 5% and even the Europeans are raising 75bps a meeting, the policy gaps are untenable. Something has to give.

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As We See It: Yen Intervention

/ mtlucasmacro

The big story in the past week was the massive currency intervention by the Bank of Japan (BOJ). Hard to know exactly how much went through, but reports were in the range of $70bn on Friday alone. FX interventions by major central banks are less frequent than they were years ago. This was the first BOJ buy side intervention since 1998. There is a pretty simple reason we don’t see intervention much anymore – it does not work. Let’s have a quick look at what’s going on.

Against the trend of most other central banks, BOJ policy has been to maintain low interest rates and keep long term yields under 25bps (a policy called yield curve control, YCC), despite rising inflation and a global backdrop of major economy yields rising substantially. They have been the principal buyer of Japanese Bonds, leading to a crash in liquidity. In recent weeks we have seen multi day streaks when the benchmark ten-year bond (the JGB as it’s known) has not traded. Forcing long-term interest rates to below market levels (the 10y swap market has rates around 70bps) has created massive pressure on the currency, and the BOJ has tried to stem the tide.

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As We See It: The UK Bond Debacle

/ mtlucasmacro

Same tune, different words. Every. Single. Time.

Some big pool of money (BPM) would like something for nothing. Large financial institutions (LFI) are happy to help. Heck, they even compete to help the most. As long as X never happens – and of course it never does – we can give you exactly what you want. In the 1980s, pension funds wanted to be long stocks but not the downside tail. Buying puts was too expensive. No problem says LFI! We will give you something called portfolio insurance. Instead of paying implied volatility, you can own an option-like structure at realized volatility. As long as the market does not gap down a lot – which of course it never does – there is plenty of liquidity to execute the hedge. October 1987 put an end to that little fantasy. Then there were those good old sub-prime loans. Some BPM would like some higher yielding debt. No problem says LFI! Each mortgage may be risky, but they are much better behaved when we look at a big basket of them and we’ll spread them out all over the country. As long as house prices never go down, which of course they don’t, and certainly not all over the country, these bonds are golden. We’ve even paid someone to give them a AAA rating! That ended…not well.

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As We See It: CPI

/ mtlucasmacro

The reaction to last week’s CPI print was pretty dramatic. We see a couple of related factors:

  • Given the fall in gas prices, the S&P had bumped off the bottom in anticipation of a soft print. Positioning went from negative to perhaps modestly positive. CPI caught the market on the wrong foot.
  • Gas prices as reported in the CPI did fall as expected, but just about everything else went up (see graph below). Everyone knows gas fell because of releases from the Strategic Petroleum reserve. That policy is the definition of “transitory” (they will need to buy it back, no less). With everything else going up, inflation fears pulled a Lazarus.

Watch rents. Lagging but steady inflation indicator, closely tied to wages.

Source: Bloomberg

The Inflation Supertanker

/ mtlucasmacro

I recently had a conversation with a colleague about the idea that portfolios over the last 40 years have been conditioned for falling interest rates. If that supertanker makes a turn, a lot of money will be on a collision course. He said in 1984 there was an equal and opposite issue … buying bonds for the prior 20 years had been a fool’s errand. The cycle climaxed in June 1984 with a hot GDP, a low inflation print and a collapse in bonds. Even though inflation was low, no one wanted to own them.

I was intrigued and pressed the conversation with our resident bond historian and partner, Paul DeRosa. His response below:

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Pricing Escape Velocity – The Rubber Hits Abbey Road

/ mtlucasmacro

The chart below is fascinating to us, particularly in light of the fairly modest in magnitude, but quite speedy rise in UK yields. The chart shows the difference between futures prices for sterling 3 month LIBOR expiring in September 2022 and 3 years later, in September 2025. They price at 100 minus the interest rate, so a price of 99.5 equates to a 0.5% prevailing rate at expiry. Roughly speaking, individually the contracts can be interpreted as the markets best pricing for interest rates at those points in time, the spread between them gives a look at how the path is priced to get there.

A year ago, rates were priced to be at about zero in September 2022, and not much higher – maybe 1 hike – by September 2025. At a starting point of functionally zero rates – that’s a pretty poor prognosis for 5 years time. Earlier this year, the spread between contracts increased as the nearer maturity contract dropped a little in price – implying higher yields – while the longer maturity contract fell more in price. The spread widened to a high of 78bps in early summer. That’s the market roughly saying things are a bit better economically – over the next few years we will see about a hike per year.

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You Can Eat Or You Can Sleep

/ mtlucasmacro

“You can eat or you can sleep”. The biggest change I have witnessed over the course of the past 3+ decades is the change in investor preference, particularly hedge fund investors, away from positive skew to negative skew… from sleeping to eating. I sleep well. The quote came from a discussion my partner had with another manager who runs a fund that is often aggressively short volatility. He, like all of Wall Street and beyond, have monetized this preference for negative skew – regular returns most of the time, with the occasional blowup. They are eating well.

The preference for negative skew flies in the face of conventional finance theory and behavioral economics. After all, why would people buy lottery tickets? Smarter people than me have worked these ideas over, and it’s a bit of a mess. Let’s just think about 3 possible drivers (I am not bashful about stealing others good ideas). Some of these thoughts are motivated by a great blog post that can be found here: https://www.macroresilience.com/2010/01/13/do-investors-prefer-negative-skewness/

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