Why Bond Market Veteran Andy Constan Believes In 'Higherer For Longerer'

Andy Constan is the founder, CEO and CIO of Damped Spring Advisors – a financial research company that publishes bi-monthly reports regarding current and future market expectations.

In his 35-year-long career, Constan worked for top-tier investment firms, including Salomon Brothers – the most famous bond trading house in history. During his 16 years at Salomon, he notably led global equity derivatives sales, trading, and structured products. He also worked for Bridgewater Associates, the world’s largest hedge fund.

Constan will join other financial industry veterans at Benzinga's Fintech Deal Day event in NYC on Nov. 13, where he will speak on the topic of "Navigating Volatile Markets: Strategies for Uncertain Times."

The Current Market is a Drama in Five Acts

In a recent Damped Spring Advisors report, Constan voiced his opinion about the current state of the economy, continuing on the foundations he started quarters ago – dubbing it "Higherer for Longerer."

Comparing the market environment as a screenplay in five acts, Constan laid out a scenario.

In the first act, continuing rate hikes don’t achieve the inflation target for two reasons.

The first one is because buoyant asset prices provide increased wealth for consumers and embolden corporations to hoard workers instead of cutting payrolls. Furthermore, the labor market then remains far too tight, leading to continued strong nominal spending based on wage growth.

In the second act, bond yields rise, and Constan argued it is not due to U.S. Banks selling bonds.

"US Banks have been aggressive sellers since QT was announced. Over the last year, they have sold 500BN of bonds and agency securities. However, in the last two months, they have sold very little," he wrote.

Instead, he believes that without a major catalyst from the biggest bond market participants, the long-term market will drift to higher yields dragged by the ongoing hikes by the Fed.

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Constan sees 4 potential catalysts that could impact the bond market: more quantitative tightening – including outright sales by the Fed, defensive moves by China and Japan to impact the currency weakness, regulatory requirements forcing banks to deleverage, or a shift from bills to bond issuance by the Treasury.

For the third act, Constan believes that the equity multiples contract. He argues that equities become vulnerable to changes in 30-year bond yields as their rise results in a multiple compression. He also believes we entered this act earlier this month.

He expects this act to result in a risk premium expansion and increased portfolio volatility driven by falling diversification benefits and rising single asset volatilities.

In act four, fiscal tightening starts impacting demand and, consequently, earnings contract. Constan envisions act four as both long and painful. By its start, unemployment has yet to react to the fall in asset prices, but by its end, the depths of its despair become visible.

The prior cycle shows typical earnings fall by 20-30%. As earnings decline and risk premium expands, equity markets suffer substantial weakness. This situation fuels a negative cycle of job losses, leading to demand destruction and further job losses.

Finally, act five results in a recession. While Constan admits that the recession’s severity remains unknown, he provides a handful of questions for market participants as food for thought.

1. Has adequate liquidity come out of the financial system? In particular, have RRP + Bank reserves fallen to a point where QE is even an option?
2. As economic activity falls, tax receipts fall, and deficits rise. Will the government spend less or more, tax less or more?
3. Will the cyclical shift to deglobalization become secular?
4. Is zero interest rate policy a politically viable option for the Fed and the world's central banks?
5. What of AI and its potential deflationary force?

To hear Constan and other industry veterans discuss the latest market developments, check out Benzinga's Fintech Deal Day event in NYC on Nov. 13. Tickets are flying — get yours!

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