Lacy Hunt Turns Bearish Bonds: Studying His Reversal

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Economist Lacy Hunt has been a bond bull longer than most money managers have been in the business. Recently, he made a surprising U-turn on his bullish stance. The following paragraph opens his Second Quarter Review and Outlook . The structural backdrop for U.S. inflation increasingly suggests that the long-run equilibrium range is migrating from roughly1.5–3.5% toward 3.5–4.5%, with a notable risk of episodes of inflation above 5%. An important core reason is the steady erosion of the disinflationary architecture that dominated the 1990–2020 period, even as various cyclical pressures also play a role. For nearly four decades, Lacy Hunt has been pounding the table for lower yields. As chief economist of Hoisington Investment Management, Hunt bought long-term bonds, betting that globalization and excessive debt impede economic growth, keeping a lid on inflation and interest rates. Despite the extraordinary monetary efforts to stem the 2008 financial crisis, the decade of extremely loose monetary policy following the crisis and even through the pandemic-related surge in the money supply and high inflation, Hunt held his deflationist line. So, when Lacy Hunt and his partner Van Hoisington posted their Second Quarter Review and Outlook titled “ Capital Scarcity and the End of Globalization’s Disinflationary Era ,” heads turned. Backing their words with action, Hoisington Investment Management, managed by Hunt and Hoisington, sharply reduced their clients’ bond duration and put the proceeds in Treasury bills. That reversal of such long-held opinions deserves serious attention. We provide a summary of their new views and some counterpoints to help you assess their new stance. Our objective in this article is not to support Lacy Hunt or rebut his work, but to present his case and accompanying data to help you better assess his warning. Lacy Hunt’s basic bond bullish thesis for the last thirty-plus years rested on the core economic framework that economic output is a function of labor, capital, technology, and resources. Thus, anticipating changes to those four factors is paramount to forecasting output and inflation. Hunt argues that the collapse of the Iron Curtain and China’s entry into global trade, along with economic globalization involving many other countries, introduced “ One of the largest positive supply shocks in modern economic history.” Hundreds of millions of low-cost workers entered the global economy, with manufacturing concentrating in the regions that could do so most cost efficiently. Simply, those countries that could produce at the cheapest costs did so to the benefit of the global economy. From the US perspective, outsourcing production resulted in cheaper goods. also, with enhanced global trade, global capital flows rose, and resources became more abundant. Further, because of the dollar’s reserve status, steadily increasing global trade boosted demand for US dollars and dollar investments like US Treasury debt. Hunt claims that the macroeconomic environment of the last 30 to 40 years helped explain why increasing debt levels were disinflationary. Per Hunt: Diverted income away from consumption, restraining aggregate demand growth, while expanding global productive capacity absorbed liquidity and credit expansion without generating broad pricing pressure. Further to his case, monetary velocity fell. Velocity calculates how often a dollar circulates through the economy. Inflation is a function of the supply of money and, often overlooked, the velocity of money. For the better part of the last 40 years, velocity moved lower as money was increasingly parked in financial assets rather than investments in plant and equipment or consumption. Corporate executives increasingly favored financial engineering, like stock buybacks, over capital investments. This inflated financial asset prices while doing little for the economy’s underlying productive capacity. Hunt’s new stance appears to be predominantly based on three factors. First, in his opinion, globalization is reversing. Tariffs, reshoring and friendshoring, alongside security-related trade protectionism, replace the “ lowest-cost producer ” model with a more expensive “ secure and resilient producer ” model. Second, labor supply growth is slowing. The combination of lower birth rates, an aging population, and reduced immigration is decreasing th