The Massive Bond Short | “Recession Denier” Jonny Matthews (ex-Brevan Howard) On The Duration Bubble, Correlation Trades, and Variance Swaps

Episode Summary

Executive Summary: Johnny Matthews argues the macro regime has shifted to structurally higher inflation, deficits, and bond yields, making long-duration shorts less attractive now than in 2022. He remains constructive on TIPS and relatively cautious on equities and FX, while seeing Europe and China as weaker and Japan as still trapped in policy conflict. He emphasizes that macro views must lead trading structure, not vice versa.

Main Topics: Career background and macro research process (Priority: 5/5): Matthews reviews his path from Salomon Brothers to Citigroup and Brevan Howard, then explains how writing daily macro notes improved his research discipline, reduced noise trading, and strengthened longer-term positioning. Why the bond short worked and why it is less attractive now (Priority: 5/5): He outlines the post-pandemic inflation and stimulus backdrop that made short duration a strong 2022 trade, but says much of the easy downside in Treasuries is gone and risk-reward is now less compelling. Supply-demand for Treasuries and structural deficits (Priority: 4/5): The discussion covers whether Treasury supply, fiscal deficits, and changing buyer demand are pushing yields higher. Matthews argues deficits are unusually large late in the cycle and may keep bond supply elevated. U.S. growth, labor market, and recession debate (Priority: 5/5): Matthews rejects near-term recession calls, citing resilient payrolls, low claims, strong household balance sheets, and still-high labor demand, while acknowledging growth is slowing and some data are softening. Asset allocation views: bonds, TIPS, equities, and volatility (Priority: 4/5): He prefers TIPS over nominal Treasuries for long-term exposure, sees low equity risk premium versus cash rates, and says opportunities are limited, leaving him with one of his flattest books in years. Europe, the U.K., China, and Japan as contrasting macro stories (Priority: 4/5): He describes Europe and the U.K. as weak due to rate sensitivity and slower growth, sees China as weighed down by property deleveraging and governance issues, and views Japan as a difficult but still managed policy case. Derivatives, correlations, and lessons from crises (Priority: 3/5): Matthews explains how options, vol, and correlation trades require the correct macro call first; in crises, historical relationships can break down, making complex relative-value trades dangerous.

Key Arguments: The post-pandemic mix of fiscal stimulus, monetary stimulus, and revenge spending made shorting duration in early 2022 a high-conviction trade. The 10-year Treasury moving from about 1.5% to near 5% vindicated the bond short, but current yields make further shorting less attractive on risk-reward grounds. Structural U.S. fiscal deficits and higher Treasury issuance likely support a higher long-term yield regime. Matthews does not believe an inverted yield curve alone reliably predicts recession; labor market resilience and household wealth matter more. U.S. growth is slowing, but still not signaling recession; claims, payrolls, and spending remain supportive. TIPS are attractive because they provide real yield plus inflation compensation in a world where services inflation may stay sticky. Equity valuations look expensive relative to risk-free rates, but strong earnings and liquidity mean he does not expect an immediate market meltdown. Europe is weaker than the U.S. because its mortgage market transmits rate hikes faster; the U.K. and continent are already feeling pain. China is a value trap to him because property-sector stress, weak governance, and uncertain restructuring outweigh cheap valuations. Japan remains constrained by demographics and policy conflict between the BOJ and Ministry of Finance, making yen and JGB trades difficult and dangerous. Macro views should drive trade structure; options and volatility can improve payoff, but they cannot rescue a wrong thesis.

Data Points: Career at Salomon Brothers/Citigroup: 11 years - Matthews spent 11 years there as a trader before moving to Brevan Howard. Assets managed at Brevan Howard: Several hundred million dollars - He described managing a diversified macro portfolio as a portfolio manager and partner. Initial inflation level in early 2022: Above 7% - He said inflation had already moved past 7% as he initiated the short-duration trade. 10-year Treasury yield when trade began: About 1.5% - He noted this compared with inflation above 7%, making the short attractive. 10-year Treasury yield recent high: Touched 5% - He said the yield recently reached 5% and could still possibly go to 5.5%. 10-year Treasury yield current level: About 4.75% - He said this level offered better value for buyers than for shorts. TIPS real yield: Around 2.3% - He described real yields as a solid investment opportunity. Peak TIPS real yield: Almost 2.5% - He referenced the recent peak in real yields. Core services inflation in the U.S.: About 5.7% - He cited this as evidence inflation may stay sticky even as headline inflation falls. Initial jobless claims: 217,000 - He used the latest reading to argue claims remain very low. Continuing claims: Highest since July - He said continuing claims have been inching higher, suggesting slower re-employment. Vacancies to unemployed ratio in the U.S.: About 1.5x - He cited JOLTS data to show labor demand still exceeds supply. Household wealth in the U.S.: About $170 trillion+ - He used this to support the view that households can keep spending. Cumulative excess savings: Over $1 trillion - After national accounts revisions, he said excess savings were estimated above this level. Previous estimate of excess savings: About $500 billion - He contrasted the revised figure with the prior calculation. U.S. debt-to-GDP: About 130% down to near 120% - He argued high nominal GDP growth helped reduce the ratio. Average outstanding U.S. mortgage rate: 3.6% - He said this low locked-in rate limits the transmission of Fed hikes to households. Current new 30-year mortgage rate: Close to 8% - He said new borrowers face much higher financing costs. FTSE earnings exposure: About 90% from outside the UK - He used this to argue country-level equity indices are not tightly tied to domestic growth. Japan unemployment rate: About 2.6% - He cited this as evidence Japan has limited labor supply. UK inflation peak: Over 10% - He highlighted how high UK inflation had been relative to the Bank of England's slow response. BOE policy rate move: From 10 bps to 25 bps initially - He criticized the Bank of England's early caution in tightening. Portfolio performance in 2022: Close to 100% - He said his little portfolio made almost 100% in the year when bond shorts worked well. Portfolio performance this year: Slightly ahead - He described this year as much tougher with fewer obvious opportunities. Starting leverage in 2022: 5x - He said the portfolio was leveraged five times at the start of 2022 to short duration.

Pivotal Quotes: "I've got to be honest with you. I just had no doubt in my mind these yields were going up." — Johnny Matthews: Explaining the conviction behind the 2022 Treasury short. "I think we've entered a structural era of, I won't say permanently, but much higher rates, higher inflation, higher deficits, and higher long-term bond yields." — Johnny Matthews: His core macro thesis on the post-pandemic regime shift. "You've got to get the big picture macro view correct because otherwise, this tinkering at the edges won't count for anything." — Johnny Matthews: His view on trading structure, volatility, and relative value.

Implications: Listeners should expect a slower-growth but not yet recessionary U.S., structurally higher rates, and a preference for inflation-linked or real-yield assets. The tougher trades are now in FX, Europe, China, and complex relative value.