Japan's Structural Shift and Global Bond Markets (with Anna, Guy, Tom)

Eric Lonergan from Calibrate Partners argues that Japan is undergoing a profound structural shift, with nominal GDP up 23% since 2021 and underlying inflation at 2.2-2.8%. This is driving a bear market in global bonds. He believes the BOJ is not doing enough to change this dynamic. He also discusses the challenge for Fed Chair Warsh in balancing the near-term inflationary AI build-out with the longer-term disinflationary potential, warning that talking up a lower discount rate could lead to a stock market bubble.

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Calibrate Partners 1.0
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Eric Lonergan 8.5

Japan's Structural Shift and Global Bond Markets (with Anna, Guy, Tom)

dxy

No direct mention of the dollar. The discussion on Japan's structural shift and potential for further yen weakness could imply a stronger dollar, but this is not explicitly stated.

metals

No direct mention of metals. The focus is on AI and bonds, so no clear directional signal for metals.

ndx

I'm fully anticipating this goes crazy. I wouldn't be surprised if the Nasdaq behaves like Korea.

rut

No direct mention of the Russell 2000. The broader theme of a potential market broadening and AI-driven capex could benefit small caps, but this is speculative.

wti

He describes the oil price shock as a 'near-term, relatively insignificant phenomenon' that will dissipate, implying a downward view on oil prices in the short term.

yields

If the bear market in Japanese bonds persists, global bonds are going to stay in a bear market.

How significant is this move from the BOJ, and do we need hawkish communication from the deputy governor?

Anna
Eric Lonergan

The changes in Japan are profound. It's the most significant structural shift of any major economy since 2021, driving the bear market in global bonds. Nominal GDP is up 23% since 2021, and underlying inflation is 2.2-2.8%. If the bear market in Japanese bonds persists, global bonds will stay in a bear market.

The key thing to look at is nominal GDP in Japan. For 30 years until 2020, it went sideways. Since 2021, it's up 23%.
What is Warsh going to try and do?

Guy
Eric Lonergan

Warsh is going to try and change the narrative on global central banking. The bond market has been trading off the oil price, while the equity market is AI-obsessed. He will argue that the oil price shock is a near-term phenomenon and that the big long-term issue is AI, which will be deflationary.

Every capital expenditure boom driven by technology has ended up being disinflationary because eventually the financing catches up with you.
If the Fed is too early in anticipating that deflation, it will boost the bubble to a point where the shock could be significant. How does Warsh manage that process?

Guy
Eric Lonergan

It's a balancing act. He would probably view it as a victory if he manages to keep the status quo. The danger is if he talks up a lower discount rate and higher terminal growth rate, you will lose your anchor on the S&P and things can go properly crazy.

Most economists would say rates should be going up. That is not going to win him fans.
What takes us from a period where AI is inflationary to one where it is deflationary?

Anna
Eric Lonergan

Ultimately, a recession. There will be a huge CapEx overhang. The good thing about technology-driven bubbles is the rate of depreciation of CapEx is much higher, so it becomes redundant. I'm fully anticipating this goes crazy and goes on for a long time.

I wouldn't be surprised if the Nasdaq behaves like Korea. If you look at the history of bubbles, they are psychological phenomena.
Where does Europe sit in this story?

Anna
Eric Lonergan

The beneficiaries of any technology are the people who use it best, not the inventors. Europe should be thinking about how to make productivity gains. Europe has phenomenal exposure, like ASML, which is a big beneficiary of the SpaceX IPO.

China is providing AI for free via open source. Everybody should use it to make productivity gains.
Do you have any solutions as to how Europe steps up to provide the things it needs to provide, like defense spending?

Tom
Eric Lonergan

Germany has a lot of fiscal space. The real challenge in Europe is political. Germany has an existential threat militarily, a huge energy problem, and its industrial sector has not restructured in response to China. Europe needs to shorten its time horizons and increase its ambition.

Part of the reason for strong profits growth in America is actually because of the budget deficits. People forget this.

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