“The bond market is suggesting much higher r-stars, but I would discount that a bit because they’ve tended not to be reliable.” John Williams, November 2025.
Watch Fed’s Williams Says He’d Discount Bond Market’s Neutral-Rate Estimate – Bloomberg
An absolute classic quote from one of the most esteemed High Priests of Sharpe World, President of the New York Federal Reserve and Vice Chair of the FOMC, John Williams. Ignore reality. Trust the models.
In case you were uncertain about whether Mr. Williams himself has a reliable track record of forecasts and model accuracy, we have the wonderful ability of being able to go back and review any number of his past papers, speeches, interviews, meeting minutes, public comments, etc. Take, as just one of a vast number of examples, the comments from this Bloomberg Television interview in June 2021.
John Williams Says Fed’s Rate Liftoff Is Still Way Off in the Future – Bloomberg
“I do see the very sharp rise in prices we’ve seen in the past few months as mostly temporary, so after inflation being at 3% or so this year, I expect both core and overall inflation rates to come back down next year to around 2%,” John Williams, June 2021.
Based on the below image, things that were notably not reliable in the statement from Mr. Williams were that: a) current year 2021 inflation was not at “3% or so” (June CPI was 5.4% and Core was 4.5%), b) inflation was not “mostly temporary” (it has been above target for 4.5 years, and running), c) inflation did not come anywhere near to coming back down to 2% in 2022 (indeed, it peaked with CPI at 9.1% and Core at 6.6% in 2022). Indeed, as of September 2025, we are still not back down to 2% (Both CPI and Core currently at 3%, a full 1% above target).
Figure 1: US CPI (white) and Core CPI (blue) YoY% Change. June 2021 (green vertical). Sept2109 – Sept2025
Source: Bloomberg, Convex Strategies
The more honest way to consider the implications of this is, as ever, to look at the compounded effects of these annualized changes on the underlying indices. Ouch!
Figure 2: US CPI Index (white) and Core CPI Index (blue) (normalized). 2% Target (red dashed). June 2021 (green vertical). Sept1990 – Sept 2025
Source: Bloomberg, Convex Strategies
Extrapolating those out another 10 years at the current run rates of 3% give a clear indication just how painful the ongoing debasement can be.
Figure 3: US CPI Index (white) and Core CPI Index (blue) (normalized) and Extrapolated 10 years Forward at Current % Change (dashed lines). 2% Target (red dashed). June 2021 (green vertical). Sept 1990 – Sept 2035
Source: Bloomberg, Convex Strategies
Nevertheless, Mr Williams thinks that the bond market has it all wrong. Any pricing inherent in the decisions made by bond market participants is, according to Mr. Williams, incorrectly incorporating assumptions not just about r-stars but, presumably, about future inflation expectations, about future Fed policy actions, about term premium, about fiscal debt and deficit circumstances. The bond market is not reliable because the participants couldn’t possibly know all of these things. Mr. Williams and his models, on the other hand, have perfect foresight.
Except that they don’t, obviously. This comes back to our frequent refrain of the great and mighty central planner’s uncanny ability to consistently claim perfect control of future outcomes, while explaining away current states as being the result of unforeseeable events. Today’s challenges have nothing to do with their past policy efforts to shape the future, or so they assure us.
Mr. Williams shared more of his thoughts on this very topic at a presentation in Amsterdam, captured in another Bloomberg article.
Fed’s Use of Balance Sheet Wasn’t Unconventional: John Williams – Bloomberg
He pushed back on the concept that tools such as forward guidance and balance sheet usage (aka QE) should be considered as unconventional tools.
“By implication, other monetary policy actions that have been used – such as forward guidance and balance sheet policies – are deemed ‘unconventional’, and therefore somewhat suspect…These are not ‘emergency’, ‘crisis’ or ‘break-the-glass’ policies, but those that are well within the long tradition of monetary theory and practice. Of course, how and when to use policies depends on the circumstances and the risks policymakers are facing. But this is a matter of tactics and implementation, not of principle or strategy.” John Williams, October 2025.
We would agree that it is not a matter of principle or strategy, but probably not in the same vein as was intended by Mr. Williams.
Indeed, having only just announced the cessation of what small amount of balance sheet reduction (QT) they have been doing at the October FOMC meeting, Mr. Williams is already preparing to recommence asset purchases!
Fed’s Williams: Fed may soon need to expand balance sheet for liquidity needs | Reuters
“Reserve management purchases will represent the natural next stage of the implementation of the (Federal Open Market Committee’s) ample reserves strategy and in no way represent a change in the underlying stance of monetary policy.” John Williams, November 2025.
Rest assured, Mr. Williams was not a dissenter at the October FOMC meeting where they announced another 25bp cut to the Fed Funds rate, along with the ending of the small ongoing QT. We can update our Déjà vu chart again from last month (Convex Strategies | Risk Update: September 2025 – “Initial Conditions”) and continue to wonder at the uncanny similarities to the magical 1995-1999 era.
Figure 4: GS US Financial Conditions (white), Fed Funds Rate (blue), Nasdaq 100 Index (papaya, log-scaled). LTCM event (green circle). Liberation Day (purple circle). Fed Hiking Cycle June1999-May2000 (white rectangle). Jan1991 – Oct2025
Source: Bloomberg, Convex Strategies
We don’t mean to pick on Mr. Williams, he is no different than any of the shamans of Sharpe World. They are all wonderful examples of the mantra “without accountability, there can be no learning”. Nassim Taleb rephrases it ever so succinctly at the 8:00 mark in this short presentation, “Why the EU Won’t Last Long”.
“Shame is a great regulator.”
“What we have here, in this environment, is decisions separated from their consequences.” Nassim Taleb, November 2025.
As indicated by the title of Nassim’s little presentation, we can’t really talk about “decisions separated from their consequences” without touching on the EU as well.
The seemingly unspecified leader and now grandee of the EU, one Mario Draghi, gave a speech in Spain upon the occasion of receiving an award for International Cooperation. His speech stressed many of the current shortcomings of the current state of affairs in the EU and, as is the common case, advocated for more of what got them to this point. Again, we have one of the principal architects of the current state of play of the EU and the Eurozone projects claiming that present day shortcomings have nothing to do with their efforts to date. The solution is more of what they have been doing. More Europe. More federalism. What Mr. Draghi refers to in his remarks as “pragmatic federalism”.
Draghi pushes ‘pragmatic federalism’ to get Europe out of its predicament – POLITICO
“A new pragmatic federalism is the only viable path, built through coalitions of willing people around shared strategic interests, recognizing that the diverse strengths that exist in Europe do not require all countries to advance at the same pace. All those who wanted to join could do so, while those trying to block progress could no longer hold others back.” Mario Draghi, October 2025.
You could be excused if, like ourselves, you read into that something more along the lines of breaking off from those states that may not want to go along with ever-greater federalism. Mr. “Whatever It Takes” once again affirming what he sees as the ultimate objective of the EU project.
It is our oft stated indicator of a critical state: “If it works, do more. If it doesn’t work, do more.”
The theme of a more coordinated EU has become increasingly prevalent. Here is an article on the European Commission’s plans to propose new legislation to “break down national boundaries and create a deeper EU financial market”.
EU will move to take on Wall Street with major financial reform proposals – POLITICO
One need look no further for the historical nonsense that has been past efforts to construct EU wide financial regulation than the article itself with this little nod to the things that need fixing!
“Existing laws that will be changed include the EU’s flagship financial market rules, known as MiFID and MiFIR; rules for clearinghouses, known as EMIR; rules for investments, known as AIFMD and the UCITS Directive; rules for central securities depositories, known as CSDR; crypto rules, known as MiCA; and the governing regulation of markets watchdog ESMA.”
Anyone familiar with this acronym stew, and sadly we class ourselves as such, will know that a kind description of the morass of regulation would be to term it as veering towards “the lowest common denominator and protectionism”. We are seriously sceptical of the EU plans to regulate themselves into competitiveness.
Along those themes, we refer readers to this wonderful speech from ECB Executive Board Member, Frank Elderson. We don’t know whether to laugh or cry as we read this speech. Mr. Elderson, in his role as Vice-Chair of Supervision at the ECB, is laying out his aspirations for a more unified, and more simplified, regulatory and supervisory regime for the European banking system.
Making supervision simpler: the role of supervisory guides
This note is a worthwhile read, not in that it has any practical future implications but, rather, that it shows the hopelessness of the operational construct of the EU. Committees to review committees and construct regulations to address flawed regulations. He even notes that the ECB has birthed a “High-Level Task Force on Simplification”.
“Lastly, the ECB’s Governing Council created the High-Level Task Force on Simplification to develop proposals for simplifying the European prudential regulatory, supervisory and reporting framework, while still maintaining our strong and resilient banking sector in Europe. The high-level task force plans to deliver its proposals for simplification to the Governing Council by the end of 2025, after which they will be presented to the European Commission.” Frank Elderson, October 2025.
As they say, you could not make it up.
Is the EU fragile? We fall back on our simple metric of endogenous risk. In our forest fire analogy, the red letters represent the, in hindsight, assigned spark that kicked off a blaze. The red circles indicate the built-up endogenous risk of ever greater connectivity of dry brush (leverage), the fingers of fragility, linking one tree to the next, the conflagration/correlation risk.
Figure 5: Endogenous vs Exogenous. EUR FX 9mth 25delta Butterfly. 2007 – Oct2025
Source: Bloomberg, Convex Strategies
As we shall forever do, we refer all regulatory supervisors to the unparalleled speech from Andrew Haldane from 2012 at the Fed’s Jackson Hole Conference, “The Dog and the Frisbee”.
https://www.bis.org/review/r120905a.pdf
“Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex. That configuration spells trouble.” Andrew Haldane, August 2012.
This note ranks right at the very top of things we wish we had written. If you have not read it, we strongly recommend that you do so.
We can zero in on Andy’s key point with the multitude of risk related catchphrases that we use so often: “skin-in-the-game”, “tacit knowledge”, “risk is about vulnerability, not predictability”, “the key to risk is accountability”.
Back in our February 2025 Update – “Rational Accounting Man” Convex Strategies | Risk Update: February 2025 – “Rational Accounting Man”, we linked to this exceptional note from complex system heavyweights Doyne Farmer and Robert Axtell, “Agent-Based Modelling in Economics and Finance: Past, Present, and Future”.
Inside their note they have produced this unmatched comparison between the underlying assumptions of Neoclassical economic models and their own world of Complexity economics.
Figure 6: Neoclassical View vs Complexity View.
We have highlighted in yellow one of the issues that we opine on so often (including in our above comments directed towards Messrs. Williams and Draghi).
“History matters.” Robert Axtell and Doyne Farmer, August 2018.
Please take the time to read down the two columns in the above table, if possible, commit them to memory! The righthand column, “Complexity economics”, is literally everything that we carry on about in these pages. The lefthand column, “Neoclassical conception”, is what we have referenced before as “arrant nonsense”.
“Mainstream economics is replete with ideas that “everyone knows” to be true, but that are actually arrant nonsense.” (Jeremy Rudd Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?)).
We will assign a little bit of positive credit to Bank of Japan Monetary Policy Committee member, and now famous dissenter over the last two meetings (he voted to raise rates while the majority voted to hold steady), Naoki Tamura. Tamura-san prepared this wonderfully comprehensive presentation, clearly making his case that policy rates need to move higher.
https://www.boj.or.jp/en/about/press/koen_2025/data/ko251016a1.pdf
“So far, the Bank has raised the policy interest rate to 0.5 percent, but my view is that the impact of the policy interest rate hikes on Japan’s overall economy has been extremely limited. I believe that the policy interest rate is still far away from the neutral interest rate.” Naoki Tamura, October 2025.
Figure 7: Japan Natural Rate Estimates (left) vs Nominal and Real 1yr Rates (right).
Source: https://www.boj.or.jp/en/about/press/koen_2025/data/ko251016a1.pdf
His very simple point, and one that we have made often, is that the BOJ is running real rates well below any reasonable estimate of the mythical Natural Rate. Instead of pretending that they can (make up) estimate the mythical Natural Rate, it is best to move rates and see how the economy responds. His point, that current rates following on from the rate hikes raising the policy rate to a mere 0.50%, do not appear to be having any restrictive impact on the economy.
Figure 8: USD/JPY FX Rate (white), NKY Index (blue), GS Japan Financial Conditions Index (orange-inverted). 2021 – Oct 2025
Source: Bloomberg
It doesn’t look very restrictive to us either!
All of the above discussed behaviour comes down to the same old thing, trying to prop up the sandpile. Having created so much fire risk, the great fire wardens of the economic sphere see it as their job to prevent fires, not to reduce fire risk. We wrote our own note on Self-Organised Criticality (SOC) way back in August 2021 Convex Strategies | Risk Update: August 2021 – Self-Organised Criticality.
In last month’s “Initial Conditions” note, we referenced some wonderful work by Jean-Philippe Bouchaud (JP) on the “Inelastic Markets Hypothesis”, among other things. Conveniently, JP has also written a wonderful paper on SOC, “The Self-Organized Criticality Paradigm in Economics and Finance”.
https://arxiv.org/pdf/2407.10284
Worth noting that JP credits Doyne Farmer (referenced above on his Agent-Based Modelling paper) for getting him to write this paper.
Again, as is always the case with JP, this is just an exceptional paper, a great balance between common sense and mathematical rigour. We will lay out just a few of the gems from this note, with just quick comments of our own.
“Just as earthquake severity can span orders of magnitude, from hardly detectable tremors to devastating calamities, the probability distribution of price returns exhibit a power-law tail typical of complex systems sitting in the vicinity of a critical point.” Jean-Philippe Bouchaud, September 2024.
Predicting the scale and timing of earthquake-like market dislocations in impossible.
“… it is hard to accept (and quite disturbing indeed) that large events can occur without ‘large causes’ – whereas it is the major epistemological lesson of complexity science in general, and SOC in particular, that tiny perturbations can induce full crisis. A complex system can actually be defined as a system where small perturbations can – but not necessarily do – trigger incommensurate effects.” Jean-Philippe Bouchaud, September 2024.
As our examples of red circles in the above EUR butterfly chart show, risk is endogenous.
“We argue in particular that efficiency and resilience are often incompatible, and that operators, regulators, policy makers should take stock of the unintended consequences that appear when resilience (i.e. tolerance to tail events) is not explicitly included in the welfare function.” Jean-Philippe Bouchaud, September 2024.
Somebody please share this with Messrs. Williams, Draghi, Elderson, et al!
“… most complex optimisation systems are, in a sense, fragile, as the solution to the optimisation problem is highly sensitive to the precise value of the parameters of the specific instance one wants to solve. Small changes of these parameters can completely upend the structure of the optimal state and trigger large scale rearrangements in the context of optimal portfolio construction.” Jean-Philippe Bouchaud, September 2024.
Think the correlation assumptions built into Expected Return/Modern Portfolio Theory optimised portfolio strategies.
“In other words, the better one is able to stabilize the system, the more difficult it becomes to predict its future evolution!” Jean-Philippe Bouchaud, September 2024.
History alone is a poor measure of risk. Future states are fatter tailed than past states. Errors on errors.
How does an investor cope with this complexity in the construction of long-term investment portfolios? First, we suppose, you have to accept that this is how the world operates, that it is, as Per Bak, the father of Self-Organized Criticality named his book on the subject, “How Nature Works”. Then build portfolios that are resilient to the uncertain, to the intractable. Get away from the inherent fragility of optimizing portfolios that are targeted at the mean of expectations. Build portfolios that are resilient to the divergences from the mean, that are convex. As Nassim so clearly put it – “understanding is a poor substitute for convexity”. We like to say that the future can be divided into two spaces; 1) Things we (think we) know, and 2) Things we don’t know. Space #1 is tiny. Space #2 is massive (infinite). First, construct your portfolio to deal with Space #2. Once that is done, feel free to mess about with Space #1.
Our long-espoused philosophy is increasingly gaining traction among some of the world’s most prominent investors. The hottest catchphrase in the industry, at the moment, is what has come to be known as the Total Portfolio Approach (TPA). The folks at CAIA have written this wonderful overview on the topic, “From Vision to Execution: How Investors are Operationalizing the Total Portfolio Approach”.
Vision to Execution: How Investors are Operationalizing the Total Portfolio Approach | CAIA
The authors state as the objective of their well-constructed report “to advance a more holistic and resilient way to build portfolios that can withstand the next wave of change – whatever form it takes.”
They echo our own sentiment from our May 2025 Update – “Just Do It” Convex Strategies | Risk Update: May2025 – “Just Do It” with the statement that “Boards and oversight committees are more likely to support TPA initiatives when they understand the phased, trial-and-error nature of implementation.” As we like to say, you can’t optimize for “Actual Utility”, unlike “Expected Utility” you don’t know what it is upfront, you have to learn by doing it.
Maybe our single favourite comment about TPA in the whole note is this:
“It also offers something rare in our industry: the possibility of true alignment between capital and purpose.”
This gets to our long-held opinion that the key fundamental flaw of the fiduciary industry is that there is not a benchmark/incentive for geometrically compounded capital, which obviously must be the fundamental objective of the capital owner. This sentence gives us a rare breath of hope!
This theme carries on:
“When decision rights are clear and incentives are aligned, a culture of collaboration can thrive.”
“The most challenging but worthy endeavour of TPA is for investment teams to break down silos and focus on the overall portfolio.”
“As we mentioned earlier, these organizations had to rethink their incentive structures.”
As we might put it, following our football/soccer analogy, the objective should be standings at the end of the season, not goals scored per game. The goalkeeper is the most important player to achieve the objective, he/she should not be incentivized on a goal scoring metric.
One of the core issues that they discuss is competition for capital. We can vouch that this is one of the toughest roadblocks for those trying to make the transition. A simple example of said competition can be seen via the results of the GIC/JPMAM research GIC-ThinkSpace-Building-A-Hedge-Fund-Allocation.pdf that we discussed in the “Just Do It” note.
“One common theme among TPA organizations is the evolution of outsourcing relationships into fewer, but deeper, partnerships with GPs. TPA empowers organizations to evaluate managers not in isolation but based on how their strategies interact with total fund exposures and risk factors. In some cases, GPs become knowledge partners and an extension of the investment team as they consider broader market perspectives.”
Anybody that has ever sat through a pitch session of what our intentions are will think this came straight from our own documents.
It is just a wonderful paper. Anybody that would like to discuss it with us, please get in touch.
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