Brij Khurana, Fixed Income Portfolio Manager, Wellington

Brij Khurana · Wellington Management

QE pushed yields higher by raising debt-monetization fears, which drove investors into stocks rather than bonds.

The conventional balance-sheet channel says QE lowers yields, but the opposite happened: heavier QE coincided with higher yields. Markets see a much larger Fed balance sheet as a less responsible central bank and fear eventual debt monetization. Investors then buy reflationary hedges such as stocks and sell bonds, which pushes yields up. Stocks rose after QE not because discount rates fell, but because discount rates rose as money moved into equities.

“when markets see a much larger balance sheet, they get very worried about the potential for debt monetization to take place at some point.”at 10:41

Brij Khurana · Wellington Management

Recent yield rises reflect Fed repricing and AI-driven real growth, not Treasury supply or inflation expectations.

He rejects the view that Treasury supply drives the recent rise in yields. Inflation expectations are very low and assume the Fed will regain credibility by returning to 2%. Most of the move is a repricing of the Fed's path plus a real growth story coming from AI. The 2-year-forward curve has already inverted, which he reads as the market expecting tight policy if the Fed follows through.

“the rise in yields recently has been a repricing of the Fed, that it's not about treasury supply as much people want to think it is. It's not about inflation expectations. ... So most of it has been a Fed repricing and real growth story emanating out of AI.”at 21:19

Brij Khurana · Wellington Management

The 10-year-10-year yield near 6.2% is about 100bp above fair value of roughly 5-5.25%.

The 10-year-10-year yield should roughly track nominal growth, and it did in the 1990s and 2000s. Forward estimates for US nominal growth look about 100bp too high. Real population growth is about 0.5% and productivity about 1%, so long-run real growth is about 1.5%. Add 2.5% inflation and the result is about 4%. Higher debt than in the 1990s adds roughly 100bp of term premium, giving a fair 10-year-10-year yield of about 5-5.25%. Forward yields sit about 100bp above that, so both the two-year-to-ten-year and the long end price in a lot.

“Right now, I think it's close to around 6.2% or something like that if you look at the ten year ten year rate in The US, which is really, really high.”at 22:47

Brij Khurana · Wellington Management

TIPS are cheap: breakevens near 2.3% and real yields near historic highs; top pick for long horizons.

Inflation risk is higher now than in recent decades, yet breakevens sit at about 2.3% across the whole curve. That leaves little inflation risk premium in inflation-linked bonds. Real yields are close to their highest levels since the asset class was created in the 1990s, when investors demanded a large liquidity premium. For investors with a long horizon who want to protect capital, inflation-linked bonds should be near the top of the list. If growth slows, breakevens would fall further, and nominal bonds would do better. Still, given current real yields and the risk that inflation keeps running above what is priced in, TIPS are a safer play than other assets. The asset class is under-owned, and TIPS trade like credit when investors don't want that. That makes them carry better than credit with better liquidity.

“And so there isn't a lot of inflation risk premia in inflation linked bonds and you're at real rate levels that are basically the highest level except for when the asset class was first created in the nineties”at 46:46

Brij Khurana · Wellington Management

More optimistic on UK bonds: cleaner positioning and long-end issuance cuts ahead of the US.

The 2022 gilt crisis was driven by pension-fund unwinds, and UK bond positioning is much cleaner now. The UK has cut long-end issuance substantially, around six to twelve months ahead of the US, and is trying to bring the weighted average maturity down sharply. Japan has done the same. Unlike the US, which lets QT run off, the UK was actively selling gilts under its QT programme, and that is no longer happening to the same degree. Khurana also argues that even left-leaning UK governments are highly attentive to bond market reactions, unlike the US, which keeps spending regardless of yield levels. The UK fiscal position is still weak, but the government is listening to the bond market. This gives more reason for optimism on UK bonds than in recent years, especially at the back end of the curve.

“what they've done with their bond market is almost six to twelve months ahead of The US in terms of they've cut long end issuance substantially”at 42:44

Brij Khurana · Wellington Management

France's wide Bund spread is justified by weaker debt dynamics; the 2011 Italy comparison is wrong.

The French-German spread is at its widest since 2012, and it is above its 2011 level. Khurana says that is justified. In 2011 France had much better debt metrics and was seen as the safe haven versus Italy and Greece. Over the past 10 to 15 years, Italy and Greece deleveraged through harsh domestic deflation, while France ran a credit boom with robust bank lending and dramatic government borrowing. Comparing France to Italy in 2011 is unreasonable because then the question was whether Italy would leave the eurozone, and that is not plausible for France. The ECB has many more mechanisms to buy French debt. Part of the wider spread is also a higher-beta rate story in Europe. Political risk over the next few years adds to the picture. Khurana warns that investors should still price in some tail-risk scenarios.

“I don't think that's possible for France. There are a lot more mechanisms in place for the ECB to buy French debt.”at 45:13

Brij Khurana · Wellington Management

Fed policy-rate targets barely drive investment; low rates caused over-easing and financialization that cut potential growth.

Neo-Keynesian and general equilibrium models that the Fed relies on assume lower rates lift investment, but the investment the Fed targets has not tracked interest rates. Since the 2000-01 internet bust, non-residential investment has run its own cycle. Post-GFC, bank losses blunted any stimulus from low rates, and today's high rates show almost no correlation with AI capex. Central bankers who miss their inflation target keep cutting rates too low, and negative real rates encourage financialization. That financialization, he argues, has reduced the economy's potential growth rate by pulling focus from the real economy.

“the things that they were targeting with interest rates actually were not highly correlated with interest rates themselves. And the most common thing is investment.”at 4:56

Brij Khurana · Wellington Management

US inflation is now wealth-driven sticky services, not supply shocks or wages, so policy rates are a weak tool.

The supply shock from COVID is in the rearview mirror. Core CPI excluding shelter has run near 2% for three years, and wages are not the source of inflation according to the Indeed wage tracker. The unemployment rate is low only because labor supply and demand are both weak, so the labor market is in balance. What remains is residual fiscal-spending inflation in relative prices (used versus new cars) and a wealth effect in shelter, medical care, restaurants and travel. That sticky services inflation is tied to asset prices, which have run well ahead of nominal GDP, so the Fed's policy rate is the wrong tool and other tools should address it.

“It is mainly wealth driven at this point, at least in The US.”at 12:26

Brij Khurana · Wellington Management

Asset-rich boomers' stock-heavy wealth drives inflation; real wage growth is the better policy outcome.

Baby boomers control roughly 50-60% of US wealth and hold 70-75% of their assets in stocks, so the wealth distribution is generational as well as income-based. Country-level wealth in stocks has overtaken real estate for the first time historically. Wages as a share of GDP have fallen, and this asset-price-driven distribution is driving a lot of the inflation. The most desirable policy outcome, he argues, is real wage growth that lets the economy grow into its current level of asset prices.

“It's not only an income distribution story, it's a generational distribution story in the sense that the baby boom population controls close to 50 to 60% of the wealth in the country.”at 15:19

Brij Khurana · Wellington Management

US nominal growth has likely peaked as the oil shock erodes real wages and past rate cuts and commodity relief fade.

Two positive drivers for growth, lower policy rates over the past year and a half and low commodity prices, are reversing. The oil price shock is eating into real wages, and real wages excluding transfers are falling year over year, which is rare outside recessions. Consumer balance sheets are weaker than in 2022-23, when inflation hit 8%. Fiscal support has been front-loaded by the one big beautiful bill, so nominal growth has likely peaked over the past year, even though markets are optimistic it will continue.

“The oil price shock is now, I think, really eating into real wages. If you look at real wages, ex transfers, they're growing at a negative level year over year, which is very rare outside of recession.”at 18:47

Brij Khurana · Wellington Management

Divided government after November could be a bond-market catalyst as markets price in less fiscal stimulus.

Fiscal spending has been front-loaded by the one big beautiful bill, mostly in the first half of this year. A divided government after the November midterms has historically marked inflection points for bond markets. Markets are quick to price in less stimulus than the economy has had historically, which could move yields. He calls November a possible important catalyst.

“But if we do get divided government come November, that has historically been very important inflections for bond markets where the market's quick to price in less stimulus than we've had historically.”at 19:02

Brij Khurana · Wellington Management

Bank loans to private-credit lenders rose about $1 trillion; the Fed should raise capital ratios on them, not cut them.

Loans to non-depository financial institutions (NDFIs) have risen by close to $1 trillion over the last six or seven years, so banks are effectively lending to private credit. Private credit then lends in more innovative or questionable ways. Banks do this because capital rules treat these loans favorably versus corporate lending. He expects the Fed to lower capital ratios on them, but argues the Fed should raise them to bring this lending back under bank oversight, since some financing deals look more questionable than in recent years.

“if you look at loans to non depository financial institutions, NDFIs, that has increased by close to a trillion dollars of new loans in the last six or seven years.”at 27:24

Brij Khurana · Wellington Management

Hyperscalers' record debt-funded AI capex crowds out other borrowers; some chip financing deals look circular.

Hyperscalers are issuing record investment-grade debt and do not care whether they borrow at 6-8%, because they expect AI returns of 30-40%. Bondholders bear the cost, since 200bp on long-duration bonds means large losses, and the borrowing pressures other corporate issuers. Some chip financing deals look circular, which echoes the lending before the GFC. Lending is also flowing outside banks, which raises risk that is not visible in the banking system.

“But their belief is that the return on investment on AI, they don't care if they're borrowing at 6%, 7%, 8%. ... It is definitely putting pressure on borrowing for other corporate issuers.”at 30:16

Brij Khurana · Wellington Management

Markets pricing rate hikes in Europe, Australia and New Zealand would be a central bank mistake given weak data.

Markets price about 80 basis points of hikes in Europe and 85-100 basis points in Australia and New Zealand, a coordinated global tightening. He compares this to the ECB's 2008 hike, which he calls a quintessential central bank mistake. In Australia and New Zealand the economic data is weak and unemployment is rising. Inflation there is temporarily sticky, but it is supply-driven, as oil prices are everywhere, so hiking into it would not be justified.

“That was a quintessential central bank mistake, when should you not hike? And I think the economic data in countries like Australia and New Zealand is not good and unemployment's rising”at 33:17

Brij Khurana · Wellington Management

Variable-rate mortgage markets such as Australia's offer better hedged-to-dollar yields than Treasuries or corporates.

An unconstrained global mandate lets him look abroad for markets where consumption responds quickly to rates. Variable-rate mortgage markets pass policy changes through to spending much faster than the US, where most borrowers locked in low fixed rates. Their federal balance sheets look stronger than the US's, and their curves are steep. Even after hedging back to dollars, these markets offer better yields than Treasuries or corporate bonds. Hikes there would also destroy growth faster, which could rally the back end.

“We have the luxury now of being able to look abroad, find countries which might have variable rate mortgage markets where the pass through to consumption is very, very quick compared to The US”at 33:41

Brij Khurana · Wellington Management

EM local-currency bonds are in an early structural bull market, with high real yields and cheap currencies.

EM inflation is supply-driven, and EM economies never saw the fiscal stimulus the developed world did. Policy rates sit at about 4-8% in real terms, and many currencies look cheap on a real exchange-rate basis. EM local bonds rose almost 18% last year and are still higher this year, while fixed income overall is flat to negative. A run of market-friendly political changes (Argentina, Colombia, Hungary, Chile, with Brazil's election ahead) points to less fiscal spending. Investors remain lightly allocated, so the asset class is still early in its bull market.

“The other area where I think there's just a positive structural inflection is emerging market local bonds.”at 33:54

Brij Khurana · Wellington Management

China's bond yields look too low; market pricing a balance sheet recession after housing bust.

China's five-year government bond yield is about 1.5%, very low even against traditional safe-haven markets like Switzerland. That is puzzling given healthy nominal growth and a large export-led boom. Khurana says the bond market's behaviour resembles the US and Europe after the GFC, when a country sat in a balance sheet recession. China's closed financial system hides this, but housing prices have fallen sharply, housing was households' largest asset, and that decline is embedded in the banking system. Authorities are finding it hard to stimulate household consumption, a hallmark of a balance sheet recession. Khurana reads the bond market as pricing a long deleveraging after a housing bust, which is why yields are low even though growth looks strong.

“I think yields there are very low. If you look at five year rates, they're at one and a half percent.”at 36:51

Brij Khurana · Wellington Management

Yen carry trade now flows into US stocks, making yen moves matter more for equities than bonds.

The classic yen carry trade meant shorting the yen to buy high-yielding emerging markets, but that is no longer the pattern. Japanese investors have not been buying US Treasuries much, and their foreign Treasury holdings have fallen relative to US debt. The money has gone into US stocks. In the August 2024 yen carry unwind, emerging markets held up fine, while the unwind was far more correlated with US stocks than with anything else. So the yen matters more for stocks now than for bonds. Japanese investors hold US assets largely unhedged, so they gained from both rising US stocks and a weaker yen. That left less demand for yen assets. Bessent's aim, in Khurana's reading, is to stabilise the yen so the trade is no longer one-way, which would make hedging cheaper and could bring capital back to Japanese bonds and lift yields.

“it matters, I think, more for stocks now than it does for bonds.”at 40:13

Brij Khurana · Wellington Management

US keeps spending regardless of yields and ignores deficits, unlike the UK's bond-market-sensitive government.

The US deficit is around 6% of GDP, with roughly $2 trillion deficits, and the US does not seem worried about it. Khurana argues the US keeps spending regardless of where yields are, so the bond market gets no fiscal discipline. The UK's fiscal situation is weak, but even left-leaning UK governments are receptive to the bond market. Khurana sees this as a positive for UK bonds compared with the US, where the Treasury keeps spending without heeding bond market signals.

“And I think also in The US at least, we don't worry about 6% deficits. We don't worry about $2,000,000,000,000 deficits.”at 43:22