In this report, I take a stab at answering the question I teed up in my last one. Does our experience of QE having a very limited effect mean that supply does not matter much and that we can therefore ignore the coming wave of supply implied by the booming federal debt?
The short answer is no because QE did not provide a clean experiment of the importance of supply and because, on theoretical grounds at least, federal supply should matter much more than the Fed’s efforts to mitigate it.
Still, the term premium seems to be more reliably influenced by the inflation backdrop and by underlying economic volatility than by supply. Accordingly, it probably does not make much sense to commit strongly to the idea that the term premium needs to widen a lot, although it will probably widen some, mainly in response to economic developments associated with the late cycle.
The practical implications of this would be, first, to express bearish duration views primarily at the shorter maturities (which is cleaner) and, second, not to let this concern influence equity strategy much. The equity backdrop is complicated enough as it is.
As always, it seems wiser to watch the economy and underlying policy than supply or efforts to manipulate its effects. FH-180321