Animal Spirits Podcast - Talk Your Book: Higher For Longer

Starting point is 00:00:00 Today's Animal Spirits is brought to you by FM Investments. Go to U.S. Treasuryetef.com to learn more about the U.S. Treasury benchmark series of ETS. It's every U.S. government treasury you can think of from three-month T-bills, all the up to 30-year treasuries. So we're talking six-month T-bills, 12-month, two years, three years, five, seven, ten, 20, 30. Got them all, Michael. Every maturity, which is kind of neat. U.S. Treasuryetf.com to learn more about all those different funds.

Starting point is 00:00:26 And we're going to talk in today's show about the duration and the yield of maturity and all these things you're going to learn a lot about bonds. Check out USTREStreasurer ETF.com for more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ridholt's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

Starting point is 00:00:56 Clients of Ridholt's wealth management may maintain positions, in the securities discussed in this podcast. Welcome to Animal Spirits with Michael and Ben. On today's episode, we're talking with Alex Morris, who's been on plenty of times. Alex is the president and chief investment officer of FM investments. One of the things that we did on this episode, which is hope was helpful,

Starting point is 00:01:19 is we explained in relatively plain English because this stuff does get a little bit confusing. All of the different Wall Street jargon around bonds, everything from the 30-day SEC yield to the yield to maturity, to the average coupon, and all that sort of stuff. Bonds are, they're kind of boring, but they're also not very easy to understand for a lot of people. So, yeah, I think we went into a lot of stuff that we tried to put it in plain English.

Starting point is 00:01:50 Alex is a very sharp guy with this stuff. He speaks in a very plain English sort of manner and explains it. And so we talk about all the different places people are putting money. It's really interesting that, I don't know, they have Treasury ETFs for every single maturity you could think of across the yield curve. But what is it, 80% of the money, 75% or so is in three-month T-bills. So hot right now. So I think it's going to be fascinating to see with their lineup of funds how that money shifts over time as rates change. If the Fed does cut, what happens?

Starting point is 00:02:22 How long does that, how sticky is that T-bill money? what's the rate that causes money to come out and go into five years or ten years or two years or whatever it is? I think it's going to be interesting to see. So here's our talk with Alex Morris from FM Investments. Alex, welcome back to the show. Thanks for having me back.

Starting point is 00:02:42 This is, we're becoming regulars together. Before we get into all things, fixed income, I want you to have an opportunity to flux a little bit. I don't know when the first time of you guys were on the show was, I don't know if it's two years ago, year and a half, whatever it is. You guys have had an extraordinary run over the last couple of years. So just tell the audience about that. Well, first of all, I think it's about it. You're right a year and a half ago. And a lot of our success is attributable to both of you. So thank you for helping us get the word out.

Starting point is 00:03:17 Okay, we'll take it. Yeah, look, we find a lot of folks who've told us this and a lot of friends come out of the woodwork who listened to the podcast. So, but 18 months ago, you know, we put out the benchmark series. We couldn't spell ETF. We misspelled it a few times, frankly. And I was no assets then. Now across the series, about 4.8 billion. Wow. A big chunk of that's on the short end of the curve, which is where we expect to see people be right now getting a lot of great yield. And we see folks starting to move elsewhere and use the 10 of them as they're supposed to. Even gave us the opportunity to launch some cool stuff in the IG space and then do some opportunistic income harvesting for folks in an actively

Starting point is 00:03:54 managed one. So, you know, from nothing to rounds to five billion in about 22 months is not so bad, right? Hell of a run. All right. So we in the industry throw out a lot of terms that might be confusing to people that did not study economics or markets. And one of those terms is duration, not to be confused with convexity. Let's talk. Let's talk duration. When people hear that when investors look at a tear sheet and they see whatever, 5.4. What do those numbers mean? What are some things people should be aware of? Where are some of the traps? Riff on this for a little. Sure. Well, let's be honest. It's confusing to folks who studied finance too, right? Bond math is the kind of thing that folks don't particularly like. I was just at a conference giving a talk about rates,

Starting point is 00:04:45 and you have to basically ask people to lock the doors before you start saying convexity and words like that. But duration, when folks look at it, a lot of folks confuse it with maturity. And that's not quite right. It's related to maturity, but you know, you're going to see online that it's called the sensitivity to a price relative to the change in interest rates. But what does that really mean? What it really means is if you look at a bond, right, we forget that it's called fixed income and we care about the income. So it's really just a measure of how much money are you going to get from that bond divided by how much money is that worth in the future to you? And what becomes interesting is the longer a bond has to go and the greater the change in interest rate, the greater the price return.

Starting point is 00:05:28 And what a lot of folks are experiencing now is the phenomenon of, you know, hey, man, where's my dividend? You know, where's my income? Because they've got these low coupon bonds that have a long duration, but they bought them at a relatively low price. And now when interest rates went up, that price went down. but to get their total return, they have to wait until the very end of that bond to get all their money back. And it's difficult for folks, frankly, to try to process those two. What we like to try to tell folks is, you know, we have to say this because we're bond people. It's the first derivative of sensitive interest rates, but it really means is it's sort of like the velocity at which

Starting point is 00:06:07 things are going to change. So if you think of like being in your car, it's how fast you're going, whereas convexity is how quickly you're accelerating to get there. So when we look at duration, we really like to think about, I'm buying an asset that has more time, value to it, and it has more cash flow that I should expect to receive. But there's a greater discount rate now. So if rates come down, you want that added duration, because it's like getting added gearing into the bond for no added risk, right? Particularly in, say, treasuries, there's no real risk that the government isn't going to pay your money back.

Starting point is 00:06:42 So now it's just a question of, if you're willing to hold that bond to the end, how much return should I expect based on what interest rates are going to do between now and then. You mentioned that duration is kind of like maturity, but not really. It's close enough, but the thing is it can change over time. So the duration of U.S. Treasury's was much higher, I assume, when rates were all below 1% for that short period of time. Now that rates are better and higher, that duration has probably gone down. So you can talk about how duration changes based on the change in rates. Yeah, so duration will sort of move inversely to that, right? and I think the key for folks is to remember, when rates go up, you want shorter duration

Starting point is 00:07:22 because you're starting to lose future value there. When rates come down, you want to extend your duration because now you're getting a gearing factor. Some folks like to call it like a bonds leverage, but that's kind of not fair. It's not money you're borrowing. It's just the impact to how much money you should expect to get versus what the interest rate was at that time. I mean, the irony for all bonds is if you just wait to the very end, you're going to get paid par value back, right, unless something goes terribly wrong, which isn't really a risk with treasuries. So now it's if you're going to play that rate change and you're going to hold a 10-year bond for two or three years, you really care what that duration is, what the rate changes, because if

Starting point is 00:08:01 rates go down 200 basis points, you're going to make a lot of money. And if you're going to make a lot of money with the same risk of default, you want as much of that gearing as possible. So you want to go as far out on the curve and get as much duration as you can. The converse is, if rates don't go down, prices don't work in your favor or if rates go up, they work against you with that same gearing. And that's where duration gets risky. Talk about the differences between duration of an individual bond versus the duration of a fund of bonds. Does that, that sounds terrible coming to my mouth, a bond fund. I was going to ask about this too, because one of the things that we always hear from investors is I don't care for interest rates rise because I'm going

Starting point is 00:08:40 to hold my individual bonds to maturity. So it doesn't impact me at all. And I always say, No, that's ridiculous. A fund, an ETF for a mutual fund that holds bonds is just a fund that holds individual bonds. But they just may buy and sell them to keep a maturity or whatever, but it's no different. It's just a different way of thinking about your payback, correct? Yeah, so if you were to buy a single bond, like you just went out and bought a 10-year bond from treasury direct.gov, you know, if it's working that day and if you can work out how to make it all happen. Really is like a 1997 website still, isn't it? It really is.

Starting point is 00:09:15 I mean, it does what it looks like. Some browsers, it kind of occasionally asks me if I have Internet Explorer still to load this page. But if you did that and just put it in the back of your desk drawer, right, and just let it collect dust, you're going to get your $100 back. So it's sort of like saying, hey, I bought a share of meta today, and I don't care, I'm not going to look at its value for 30 years. That's all I care about. I'm just running that risk. So, sure. But bond funds, bond managers, you don't pay us to just buy a bunch of bonds and wait for them to go to zero.

Starting point is 00:09:42 you pay for us to run a strategy. That strategy usually targets an index, and that index has some set duration metric. And either we're going to go long or short relative to that index to try to gain excess return over the index. So bond funds by their nature are constantly buying and selling things. So you care what your bond manager is doing because of that. But if you literally just bought one bond, you only care about is the issue we're going to pay me the money back in the future, be done with it. But bond funds by hundreds of or sometimes thousands of bonds, and now you care what that average duration looks like. Because when rights move, if your whole fund is on average above duration and rates come down,

Starting point is 00:10:25 you're going to make a lot more money than the benchmark. If you're on the wrong side of that, it hurts. The way that I always taught duration was it measures the price sensitivity to a 1% up or down move in rates. However, that is the textbook. That's like the textbook answer because it's assuming that every part of the curve moves upward down 1% together. And in real life, that's not how interest rates work.

Starting point is 00:10:55 No, and if you look at the curve today, right, you're going to hear all about inversion and whatnot, which if you started in finance two, three years ago, you've only ever known this. So you don't know what a normal interest rate environment looks like, as it were, with normal and air quotes there. But the curve moves in very different ways, right? It doesn't move in unison, and how that, how one end of the curve moves relative to the other is often seen as a harbinger of potential recession, you know, inbound in some number of

Starting point is 00:11:23 months, or conversely, recovery from that. And like if you own a short-duration asset, like T-bill, which has, you know, 90 days on it, so a quarter of a year, it's a very different impact, and that rate moves relative to the Fed funds rate versus the 10 year, something like U10, which is trading on very different factors, right? The market is controlling what the value of that bond is worth, not the Fed, ultimately. And you can imagine what the market does and what the Fed does are two completely separate things.

Starting point is 00:11:52 They have different purposes, different buyers for those securities necessarily, right? So they're not linked. Where that 1% change makes a lot of sense, you know, you hear options traders talk about the rule of 16 or, you know, if you're trying to figure out the doubling time, it's the rule with 72. They don't like to tell it's actually the rule of 69.3. That's just a little more difficult to do the math on. Don't tell Michael that. He's going to use that going forward. We can go through the logarithm for it if you're really excited. But the point of it is it's hard to look at it and say, here's the 1% because these are curves, right? There's some actual

Starting point is 00:12:26 exponential value to these things. So when folks try to look at these linear approximations, they say, oh, well, it's close enough. Yeah, when rates were also pretty much zero, it was flat at zero. But now that rates are material, you really do need to pay attention. And it's a great, like, if you're an investor today and you hear, oh, when should I increase duration, you know, the first thing to remember is right now you want to stay in like T-bill. You want to hang out, earn your 5.4% until you're ready to do something. And when you're ready, you should make that, you should pull the trigger a little early. The way the math works out, the way the market reacts the duration, you're not penalized for showing up to that trade when rates are high by a few

Starting point is 00:13:05 months, right? So if you thought the first rate cut was going to happen in December, you know, you can start making that trade as early as the autumn. But the problem with it is the market corrects that very quickly. So you kind of penalize for showing up just on time and you're really hit if you show up late. Well, that's why I think your suite of ETFs is going to be an interesting tell to the markets in terms of of AUM. So you said that the majority of your AEM or bulk of it is in T-bill, right, in the 90-day, three-month T-bill? Yep, you're about $3.5 billion there. Right, because you're getting paid over 5% there and you have little to no interest rate risk.

Starting point is 00:13:42 Basically, you're not going to see much volatility at all, even if rates move, right? It's very stable. And since the Fed hasn't cut rates, people are thinking, geez, I can continue to get this. People were worried that there's going to be five or six rate cuts before the start of the year, and that would mean lower T bill income, right? So it is interesting because for the last 18 to 24 months, other investors have been positioning in longer-term bonds, hoping that, well, we're going to get a recession or something is going to happen where rates are going to fall, and I'm going to pick up that

Starting point is 00:14:14 duration. So do you think that investors will be able to get ahead of that kind of thing? Or do you think it happens on a lag where rates fall and then people rush in? Well, certainly we see historically rates fall and where any market event happens and folks pile in after the fact, right? It's time in the markets is an impossible act. And this way I like to tell folks, right, it's time in markets, not timing the markets. But in this case, I think investors are wise to collect that five-four until they're ready. You're going to get some signal from the Fed, right? The Fed made pretty clear they were intending to cut rates, but they never said five or six cuts. You know, the market said that. It got a little jumpy. And I love the Fed Fund futures market. It's one of my favorite

Starting point is 00:14:57 statistics because it's always wrong. Like, it has almost never been right. It should have statistically, by pure chance, been right by now and still hasn't. So, you know, folks get very focused on that and do all this Fed speak. You know, the one bit of Fed speak that I think makes sense is we've talked about higher for longer, and we've started changing that narrative, folks, for it's longer for higher. Like, this is a new normal. And when the rates come, there's no guarantee, cuts come. There's no guarantee this is going to be 50 basis points three times in a row, you know, religiously every month. These could be small hikes. They could pause at some point. as they have to deal with potential rebounding inflation.

Starting point is 00:15:34 So folks are smart to start making that transition. There's nothing wrong now by being further out on the curve, like a U2 or U-Trace or two or three or even five years out, because you're making such a high current coupon that as you roll to the next current issue in our products, you're getting that insurance value, basically. Hey, I'm getting a really high current coupon that I'm pretty happy with, and I'm rolling to the new issue.

Starting point is 00:15:59 so if the cut comes, and I wasn't ready, I'm going to have my duration being extended throughout that cutting cycle, which is exactly what you want to do, right? You want to buy the longest duration as the rate set comes down. So by sitting in our products while you're waiting, you're collecting a nice income. If you want to maximize that income, go to T-bill. If you just say, look, I know rate cuts are coming in the next six rate months. I don't want to time the market. I just want some sensitivity. You can sit at two, three, five, seven, ten years out and just wait. and when it comes, the product is going to give you that return because rates will come down, price will go up, and you'll be rewarded.

Starting point is 00:16:34 All the while, you're still collecting 4 plus percent on the coupon, so a 4 plus percent dividend, which is pretty material. I mean, if we won the clockback three years, 4% was a dream. You know, that was like a fantasy for folks, because we hadn't seen that in a decade. Now, you can find that across the entire yield curve. You just have to decide how much price volatility you are willing to stomach between now and then.

Starting point is 00:16:56 and then when it happens, how much return you should expect. But because the UTFs are liquid, you can change your mind along the way and you're able to move in and out pretty quickly. So which of yours products right now has the most money in it? T bill, by far. And T bill is that three month or six months? Three months. Okay.

Starting point is 00:17:15 So the reason why people are so comfortable sitting at the very short end of the curve is because it offers one of the highest yields out there. What should these people be thinking about, though, that they might be. may not, what are some of the risks, I guess it's called reinvestment risk. What does that mean and why is that important? Yeah, so reinvestment risk, and particularly in the bond world, this theory, if I get cash flow today as opposed to, say, an equity where I don't, I just get long-term appreciation, am I able to put that money into a security that's going to pay me just as much money, right? Or am I getting cash flow that I can never get the same return on?

Starting point is 00:17:52 For the short term, and that longer for hire regime, there's not a real risk of that reinvestment risk going much down, right? Like you're going to get 5% or more. You can reinvest it and continue to get 5% or more. So on a short-term basis, I don't think there's any real fear that investors should have. We hear a lot of folks who are using T-Bill and the 6-month, which is X-Bill, for cash alternatives, and then folks, both the cash that they'll keep in their portfolios forever, and then strategic short-term cash, they don't know where to be positioning. Our advice to folks have been, if you like that return and you're uncertain, stay there. It's a great place to be. You're going to see us, though, start talking

Starting point is 00:18:32 more about winding into that duration, so moving further out the curve into two, five, 10-year products, because we know eventually that rate cut is likely to come. The Fed's made pretty clear that something needs to happen. Inflation is largely kind of static, and at some point they'll need to do something, and we want to be ready for that. In the interim, we're happy to collect that coupon rate, but we accept that as if you look at the 10-year, 10-year yields have dropped 15 basis points in the last week or two when we're talking about this. And that has a impact to the price of U-10. And we're okay with that. Some investors may not be. And if they just like to see that stability to your point, they don't want interest rate risk, then they should be in T-bill

Starting point is 00:19:13 or X-bill where they have virtually none. And they're going to still collect a really healthy coupon in the interim, which is great. The psychology of bond bear markets, Ben and I were talking about this is interesting because bonds are still very much underwater, right? I'm just like an index, for example, if you're an index fundholder of bonds, you're still very much underwater. And if you consider, and that's, I'm talking nominal. Right. Inclusive of the interest payments. If you, if you tack on inflation, it's, it's obviously way worse. Do you think the simple explanation for why people just behave differently in bonds and stocks, and there's a few reasons, but you're still getting in the income.

Starting point is 00:19:50 Like, in other words, I think that for a lot of investors, are less anchored to maybe the market value than they would be to equities as long as those income payments are still coming in. And if the income payments are flooding higher, all the better still. I think that's right. I mean, if you think about it, it's almost like the 90-10 rule and then the 1090 rule here, right? Bond investors are all about income and some are less sensitive to the price, particularly

Starting point is 00:20:13 those who have a portfolio where they know they've got liabilities or they're going to hold that bond to the end. It's just give me the income and make sure the issue. who is going to pay me back. Equity investor is the exact opposite. Very few people really talk about dividends nowadays, right? We hear it about dividend growers, but it's 2, 3 percent. Most folks are inequities for the capital appreciation, right? The thing that's quoted every day about Google, about Apple, isn't its dividend amount. It's its price. Right, right. That's what we talk about. So you have to kind of think where you're going to be. That doesn't mean you can't

Starting point is 00:20:46 lose money as a bond investor. You can get some really high current income. You can reinvest it, but if you're constantly reinvesting in bonds that are losing value, you're still losing principal value. And some folks have been fairly well burned by that. I think the way to kind of tie all of that in inflation together, though, is, you know, what happened to tips over the last two or three years, right? Tips were like, hey, I'm supposed to buy this thing, and it protects me against inflation. It's right in the name, right? Treasury, inflation protected security. There it is. How did I lose money when inflation went up in tips? And the answer was, our friend, duration. tip funds had duration that was two, three, or more years out. So although the tips actually

Starting point is 00:21:27 did protect you against inflation, the thing that the Fed does to fight inflation, which is hike interest rates, multiplied by your duration effect, took away all of your inflation protection and you lost principal value. So you kind of see all that coming together, like that thing that seemed like the really smart thing to do, let the government ensure you against inflation hurt you because you bought something that had some duration in it. And the thing the government did to protect the economy against inflation injured you personally more than the protection they provided you against that exact inflation. It kind of comes full circle to what we started talking about as duration is.

Starting point is 00:22:03 I think a lot of people who own tips probably didn't realize that the duration piece was going to override the inflation piece, and these were going to act more like bonds than the inflation protection. Exactly. And I talked to a lot of investors who are like, we talk about tips and why now is a great time to be thinking about tips. Oh, my God, I never want to buy a tip ever again. Like, it just injured me so much.

Starting point is 00:22:21 Like, well, but it's because you kind of bought the wrong ones. You really bought a long-duration bond. It happened to have this other feature, just like a bond being callable, just like a bullet. Like, all these other features, there's just one of them. That wasn't the one, though, that was driving the market price. And your Tips Fund wasn't holding it to maturity. It was marking it to market every day. You saw red, ink, got scared and sold.

Starting point is 00:22:44 But if that fund held it to maturity, you'd actually be fine. you just didn't have the horizon to do that. Neither did the fund manager. So you took a real loss. That's a good point because I think these are really hard securities to understand. We've been talking a lot of hard to understand stuff. But in 2021, you had like a negative 2% real yield on like a five year tips. Today it's what, over 2% probably. So to your point, that's about 2 and a half. I've always been taught the rule of thumb that like 2% above 2 to 3% that's that's a pretty good signal for tips being a pretty darn good buy or good entry point, right? You're getting a 2% yield plus inflation. So if inflation is three or four percent, we're talking five or six percent yields, right?

Starting point is 00:23:25 That's a pretty good deal. Yeah, if you bought a mid-duration five-year plus sort of tip today and you felt that inflation was going to stay somewhat persistent, but the Fed was going to cut rates anyway, you've got a few ways to win there. It's all going to work for you. The downside to investors two, three years ago, those who called inflation correctly, in particular, was they got the right call. they got the right feature of the security, they just got injured because they got the duration

Starting point is 00:23:51 metric wrong. And that duration, you know, I said it's not linear. It compounds on itself. And it just, it compounded on itself faster than the inflation protection actually could matter. And as a result, folks were kind of burned by the thing they thought was supposed to protect them. And again, it wasn't that it didn't work. It did exactly what it was supposed to do. It just had too much duration. So if you're worried about short-term inflation, you want a tip, but you want a short-term tip. And that's where I think folks get a little confused, like, oh, I thought I just bought this thing and it just protected me against inflation in the market and all would be wonderful. And if that were true. While we're demystifying some of the financial jargon, when investors go to a site

Starting point is 00:24:32 yours or others, and they're looking at the different terms, the duration, yield to maturity, 30-day SEC yield. So actually, let's stop there. So what are the differences between the yield to maturity versus the 30-day SEC yield. Sure. So yield to maturity is what you would get if you held that bond theoretically to maturity, right? This is the sum of all the cash flows, you know, the return and price and then getting your full par value back, right? So, and depending upon where you are and the, you know, what price it was bought at is going

Starting point is 00:25:04 to impact your individual yield to maturity. When you see a quote on a website, that's just the closing price from last night. The 30D SEC yield from a fund, like T-Bill or U2 or U-10, is how much money we've actually distributed to you in the last 30 days, right? Or if we took today and multiplied by 30, how much you'd actually expect to get as a dividend yield from the fund today. And, well, that's how much the income the fund has had and can distribute. You'll see the distribution amounts differ slightly from the SEC yield because one, we don't

Starting point is 00:25:40 recalculate our dividend yield every day, right? It's, you know, we just, that's the amount of money we paid out once in a while. And because mutual fund accounting is fun and likes to keep people employed, there's some things that go into the SEC yield that don't necessarily go into the dividend we would pay out. But more or less, they should be pretty darn close. And in T-Bill, U2, U-10, they're generally within some number of basis points, rounding errors from each other. Some funds, you'll see, are paying out substantially more than their SEC yield. So a lot of like options funds do that. And some of it is they're paying you out principle that you had invested. It's a whole host of other things that do. So when you see a big, big difference between the two,

Starting point is 00:26:18 you should start asking some questions. So what do you think bonded makes sense for bond investors to look at? Or does it make, is that contingent on how long they're going to hold it for? Bond investors who are going to buy a fund should look at how close are those two. And if they're close enough, then don't be too worried. If they're, you know, they start getting 100 basis points away from each other, it's time to start asking some questions. There's some very, very real and good answers as to why the two of them might reasonably be dislocated. But if that's true for a long period of time, then you really need to ask some questions. But the investors really need to ask themselves, what's the total return I'm going to get? That's the distribution yield I get.

Starting point is 00:26:54 And if I look at what happened over the last two or three months of a fund and I, you know, just plug it into Yahoo Finance. Off you go. It'll tell you what your actual total return is. And that's what you should worry about. If you're looking for income from a fund, pure income, you should ask, what is it holding? And what are the coupon rates? Because the yield on a fund, right, includes buys and sells of security. So you could see a SEC yield from an actively managed fund that's high because it just sold a lot of things that were worth a lot of money, but can't reinvest them into things that are going to pay you again in the future, or at least not for a long time. If you're looking for pure income, you like to look at the

Starting point is 00:27:33 average coupon of that fund. That's how much money's actually going to come in, that that manager can distribute to you as cash flow or can reinvest. And that's why, you know, like when you look at the benchmark, you're going to see the yields and the distribution yields are pretty close because all the income we get, we pay out. The higher the coupon, the higher the dividend rate. It's a simple pass-through equation. And that's what I think investors are really starting to focus on is the income part of fixed income because it's back. It was gone for so long, but now it's back. We're so back. If rates stay higher for logging that we had thought a year ago, earlier this year, is it a stretch to say that we might be entering somewhat of the golden

Starting point is 00:28:14 age for fixed-to-come investors? Well, you know, I'm afraid if I say yes, you know, in like two years, we're going to hear the edited out of like Morris totally stuff this one up. But I think it's fair to say that, as we say in the longer for hire right side, that there's going to be a period where bonds are going to have material returns again. And, you know, the period we were in the last, say, 15 years, that was the exception. There never really been a period where bonds were just so lethargic, where, you know, you were better off, you would make more money just, you know, buying an equity that had

Starting point is 00:28:51 a lot of other risk and no actual principle. And that even worse, folks were, companies were issuing bonds so they could buy back their own equity. It was like this weird Goldilocks world we were in that couldn't be sustained. Ultimately, bond investors getting money is a good thing. It kind of slows down the pace at which you can make super risky investments, right? So it's probably, maybe put the other way, who is this bad for? This is bad for folks on the super far venture end of the space where because folks wanted a material return over equities, they were willing to make increasingly risky investments, right? It's probably bad for companies that were living on really cheap debt and didn't have a really good business model or didn't have ample cash reserves. So they're going to struggle. They'll hopefully be acquired. Some will probably go bankrupt.

Starting point is 00:29:39 But for investors, the good news is if you are looking for an actual coupon rate where you know every month you're about to get some amount of reasonable income, this is a great time for you. And there's no reason to look back and it's a great time to hop in. And because you're worried about that income side of it, I wouldn't worry too much about rates going way, way up from here. So you don't have the same risk you had two years ago, where you just knew rates. How about this for someone it's bad for?

Starting point is 00:30:05 Is this bad for the U.S. government? Because a lot of people keep asking us, like, you know, we've added trillions of dollars in debt. And I think one of the things people don't really realize is that, like, that liability to the government is an asset for someone else, right? And so the government, yes, they're paying higher interest expenses, but the investors on the other side are earning higher yields. Are you in, I think one of the ways people see this, like, manifesting into a crisis is, well, at a certain point, the bond investors are going to balk and they're going to. not going to be able to take up all the supply the government is putting out. Are you surprised that increasing this supply so much and there's still been investors jumping in to take it? I think I'm a little surprised at how enthusiastic investors have been, right? Because the Fed offers

Starting point is 00:30:50 its overnight rate, fair enough. And the Treasury is stuck to whatever the market wants to accept. And the market could start saying no, in which case you'd see rates go way, way up on the long into the curve. And we just haven't seen six, seven, eight, nine, ten percent. Some of these numbers that were, you know, possible. You talk to investors from the early 80s, they remember buying 30-year treasuries with an 18 percent coupon payment on them. So those things can't happen. Bond vigilantes are weak. That's right. So it could happen. It hasn't. But you're right. Look, it could be catastrophic for the government that they get stuck in this loop. They have a high interest payment, which means they need to put out more debt to make it work, which means they need

Starting point is 00:31:30 more debt to pay off their old interest, right? You can just see how that cycle hurts. This is a theoretical exercise, but if they really wanted to control this debt, couldn't the Fed just say, well, we're going to just fund it all with T-bills, and we control that rate? They could. Eventually, though, the Treasury offers the debt, and the market would say, nope, I don't care what the Fed's doing. Like, that arbitrage through the banking system just may come to a crashing halt. And something interesting happened today, which is the Fed, for the first time and a long time, had no bid on its overnight repo, which is sort of a sign that short-term liquidity... Is that bad? It sounds bad.

Starting point is 00:32:07 Well, it's a sign that short-term liquidity is actually pretty healthy, but no one needs to go to the Fed to get short-term lending liquidity. Like, Fed repo rates go way, way up when there's a short-term shock. Like when the currency devaluation in Europe and a lot of, you know, folks need to buy oil, but in dollars, they didn't have enough dollars to exchange euros for, the Fed steps in through the repo facility and fixes. First time we've ever heard repo right mentioned, it's a good thing. Yeah, it's, it's weird. Like, you're getting all this sort of conflicting signs in the economy, but if you took

Starting point is 00:32:37 the average and just filtered out some of the noise and some of the politics of it, it's kind of working. Like, there are a lot of potential cracks, right? Folks have this, like, odd fetish of figuring out how the world's going to end tomorrow and then doing absolutely nothing about it. So if you put that aside for a moment, the actual underpinnings are pretty, good. Yes, we have this very, very prescient issue of, like, what happens if the interest expense just gets so big we can't even afford to pay it off? And that's where default

Starting point is 00:33:07 and all such other scary things start to happen. And it is getting worse, for sure. But it getting worse is compounded by the fact that we're issuing a lot of debt. It's issuing a lot of debt that's the problem. It's not how much an interest we're going to pay. It's that we're just spending way, way more than we have income for. And we all know in our personal lives, that can work for a little while until it doesn't. And the problem is it should have stopped working a long time ago, but it just keeps seeming to work. And so the government has no incentive to stop, right? There's never been... In the meantime, baby boomers get 5% T-bill yields. Exactly. Kind of making inflation worse, right? Because now more money sits there. They have more

Starting point is 00:33:47 money to spend. They spend more money. If you own a house today and you want to move, you can't afford the same house that you're going to move to if you have a mortgage because your mortgage will triple. If you're sitting at two and a half, three and a half percent, that mortgage is going to be seven percent today. Your net payments might double, might triple. And it's kind of like, folks are like, why do we have a housing crisis? Because no one can afford to move. And there's no incentive because the few folks who are willing to buy are buying limited supply. They're driving the price way up. So it makes it even harder to do that sort of mobility that we used to really enjoy. Folks move from city to city.

Starting point is 00:34:22 It was easy to do that. Now, like for like, you'd have to earn a lot more money to afford it because you're just paying it all back to the bank. So you get these weird factors. Before we let you go, just remind listeners, how exactly do your products work in terms of their sensitivity to interest rates? What exactly, if you're buying U10, what exactly are you buying and what are the direction of interest rates due to the price and total return?

Starting point is 00:34:48 So in U10, you're buying the on the run. tenure. So the most recent issued by the government, they issue it once a quarter, every quarter we sell the one we own and we buy the new one. So you're constantly sitting at that same maturity level. So kind of, you know, from bond to bond, similar duration. And as interest rates go down, you want to be extending duration, we do that automatically for you. In the interim, as we do that role, we harvest the coupon income that we would receive on the bond and we pay that out to you as a dividend. So you get income today, rates come down, you get a lot of total return on the backside. All right. If people want to learn more about the benchmark series

Starting point is 00:35:26 ETFs, where do we send them? U.S. Treasuryetf.com. All right, Alex, thanks again. Thanks, guys. Okay, thanks to Alex. Remember if you want to check out the U.S. Benchmarked Series of ETS, go to us usustreasureretef.com. Email us, Animal Spirits, at the compound news.com.

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Animal Spirits Podcast - Talk Your Book: Higher For Longer

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