The Deeper Dive: As Bonds Go Critical, I Go Critical on Yellen's Treasury Defense
And Janet Yellen came so close to saying something smart when she said something incredibly vacuous.
I’ve been spending a lot of time in the past two weeks talking about the bust that is happening in bonds because the US bond market has the power to break the entire world when it goes down. It is also where all the action that matters most is happening right now in such a pronounced that it pressed the US treasurer today to come up with a defense for what is happening in bonds that praises her boss’s deficit-funded economy and keeps her pals at the Fed out of it.
The bond market may seem boring because it is more complex than stocks, so eyes glaze over; BUT it is the atomic bomb of markets if it goes critical, and it is now going critical, causing treasurers to try to divert attention by construing the problem as a cause célèbre for Biden. And celebrate his contribution to global collapse, he gladly did today when he saw the GDP report he created.
(For that reason, I’m sharing part of this week’s “Deeper Dive” with everyone for free, which will also give you a taste of what “Deeper Dives” hold.)
The atomic debt bomb
As I’ve been arguing, the recession that is coming (or second dip into recession after last year’s “technical recession”) is NOT coming due to all the cracks in the economy that I laid out in detail in last week’s “Deeper Dive.” (See: “The Deeper Dive: The US Economy is Robust Like a Dying Elephant.”) It’s coming from the Big Bond Bust.
However, the cracks assure the economy is already fragile and weak in many ways that the mainstream financial media continues to fail to give the reasonable concern that is merited. Those cracks continue to widen and spread, and should be recognized much more than they are. The Big Bond Bust will hit that fractured mess I described like a wrecking ball. So, the cracks are important, and they certainly tell us that all is not well; but US Treasury bonds are everything in this bust-up. As even Treasury Secretary Yellen inadvertently admits, US Treasuries are busting up economies all around the world.
The overall bond market is even bigger than the stock market and more central to everything financial in the US and the world:
You might think the stock market is huge, but the bond market is even bigger. According to the Securities Industry and Financial Markets Association (SIFMA), the global bond market was worth $126.9 trillion at the end of 2021, compared to the $124.4 trillion global equity market cap. The gap between the two has likely widened in 2022 as stock prices have fallen.
Wikipedia claims (and I’m not sure how accurate it is,
The global credit market in aggregate is about three times the size of the global equity market
The truth probably lies somewhere between those two assessments of size, but the difference in scale is even more true if you look at the US bond market compared to the US stock market because the US bond market is largely the mechanism by dollars are traded between nations to make the dollar function as the global trade currency. Therefore, the US bond market is exceptionally broad and deep and influential over all economies because of how US Treasuries are used as the “currency” of global trade. That means the impact of the US Treasury market on global finance is also exceptional.
The bond market, a marketplace dealing in debt securities, significantly impacts global economic landscapes. It offers governments and corporations the much-needed capital, provides investors with diverse investment options, and plays an integral role in maintaining the financial system's stability. Understanding its mechanisms and potential is crucial for anyone involved in the financial world….
You might not know it, but the Bond Market is about twice the size of the Stock Market. [Seems everyone has a different idea of the scale comparison, but they all agree it is bigger!]
It’s true; in the US and internationally, the bond market, which includes municipal bonds, corporate bonds, government bonds, v, etc, has almost twice the amount invested in it than the Stock Market.
I’m speaking particularly of the US Treasury market where dollars are traded between nations, but the rest of the US corporate bond market trades off of the rates established by “no-risk” Treasuries as the pricing threshold with corporate bonds adjusted upward from those no-risk government bonds to account for greater risk by offering greater rewards.
A good article in the news headlines below today from USA Today, titled “Bad sign for sizzling US economy? How recent Treasury yields could spell trouble,” finally explains the risks from bonds that have caused me to start sounding the alarm that trouble is nye. I laid out years ago for my patrons why this would become a serious problem in the Everything Bubble Bust, but now it is happening in its infancy. You can see the pressure building and expanding daily, doing what all the other problems combined could not do:
Neither soaring inflation, nor high interest rates nor the resumption of student loan payments have put much of a dent in the seemingly unruffled U.S. economy.
Yet a recent jump in 10-year Treasury yields could be a tipping point, helping douse a remarkable growth spurt and possibly nudging the nation into a mild recession next year, some forecasters say.
“Mild,” of course. You cannot expect mainstream financial writers to go where I would badly go. They hedge their wording to sound reasonable to their colleagues, lest they be accused of being “Chicken Little” economists, but I think they are being little chicken economists.
I would say it will be far more than mild because they grossly underestimate the cracks throughout the US economy that I’ve laid out with clear data in my “Deeper Dives,” including particularly misunderstanding the damaged labor market, and they underestimate the level to which the global economy is cracked and ready to crumble and how those two spheres of influence will reverberate with each other and amplify each other. But they are right about the potency of the bond bust to be the epicenter or tipping point of economic trouble in the US … and the world (as Janet Yellen almost realized by accident, which we’ll get to).
Yesterday, we read,
The government on Thursday is expected to report that the economy grew at a robust 4.5% annual rate in the July to September quarter, fueled by strong consumer spending, according to economists surveyed by Bloomberg…. But growth is expected to slow to 0.7% in the current quarter and 1.1% for all of next year, says a survey by Wolters Kluwer Blue Chip Economic Indicators.
But today, we discovered,
The U.S. GDP grew at 5% last quarter, better than expected, and President Joe Biden said it was evidence that his economic policies are working.
“I never believed we would need a recession to bring inflation down – and today we saw again that the American economy continues to grow even as inflation has come down,” Biden said in a statement on the new data. “It is a testament to the resilience of American consumers and American workers, supported by Bidenomics.”
Notice everyone keeps parroting the word “resilience.”
For months, Biden has traveled the country giving speeches on his economic agenda, dubbed “Bidenomics,” and the booming economy. Yet polling shows Americans overall are still uncertain that the economy is truly strong.
Of course, they aren’t buying it. They live in it. He doesn’t.
I don’t trust the GDP data either, given how many other major metrics completely contradict it as I’ve laid out in these editorials and even in more detail in my “Deeper Dives,” but the writer in the first quote is, at least, acknowledging something Biden has no capacity to see — that growth is already going down significantly, and that is before the big bond bomb goes off in the middle of it all. That writer goes on to say,
The economy also faces the effects of the renewed student loan repayments, a United Auto Workers strike, the possibility of a government shutdown and the cumulative effects of the Federal Reserve's short-term rate hikes.
And those are only a few of the many cracks I’ve laid out in this economy that is now resting on a financial atom bomb.
The 10-year bond topped 5% last week for the first time since 2007 – up from 3.2% in early April and 4.6% on October 9 -- hammering the stock market and casting a veneer of gloom across the outlook. That’s because the 10-year note serves as a benchmark that has ripple effects on other types of consumer and business loans.
It has the power to break it all. For example,
Higher long-term rates could push 30-year mortgage rates past 8%, further hobbling the housing market. Loftier rates also could discourage business investment, and hamper U.S. exports, among other impacts.
What “going critical” means, however, is that the rates are now setting themselves. The Fed losing some control over those rates due to the Federal government’s determination to blow deficit balloons up that are filled with hydrogen gas and are the size of the Hindenburg and the Fed’s need to stay out of financing that in order to fight inflation.
“It’s bad news for the economy,” says economist Matt Colyar of Moody’s Analytics. “It’s a major headwind.”
And that is, in my opinion, putting it mildly.
A more politely couched way of saying the Fed is losing control over bond interest is…
Federal Reserve Chair Jerome Powell stanched the bleeding last week by saying the bond’s rise is doing some of the Fed’s inflation-fighting work, making it less likely the central bank will have to raise short-term interest rates again.
Interest is going beyond what the Fed is doing due to the government’s choice to increase US government debt at the fastest rush we’ve ever seen and due to inflation starting to rise again, just when people thought it was going down for the count, making bonds that are highly impacted by inflation, edgy about pricing inflation in. The market is taking over.
The 10-year bond yield generally amounts to the average of short-term rates over the decade as well as the risk investors take by tying up their money for that long, which figures in the outlook for the economy and inflation.
The bond vigilantes are deciding that outlook is threatening, so they are demanding a lot of yield if they are going to hose up all that new government debt plus the old debt that the Fed is refusing to roll over under its quantitative tightening regime. (“Bond vigilantes” really just means market forces (bond investors) taking interest rates to the natural level that government deficit-spending, total debt and inflation merit. That, I’ve said, could only begin after the Fed got out of the bond pricing game and got busy rolling bonds off its balance sheet, rather than buying government debt.)
Fed independence imperiled
Another article today describes how the Fed loses its independent control of the dollar as it loses control of interest rates to these market vigilantes who insist on pricing bonds where government deficits and debt plus inflation say they should be:
US fiscal policy is increasingly infringing upon the Federal Reserve’s independence, heightening already elevated secular inflation risks and condemning the dollar to an even deeper debasement in its value.…
[Here the article is talking about the dollar’s purchasing power, not its value relative to other currencies in foreign exchange.]
Fiscal dominance occurs when the size of government debt and deficits “dominate” the central-bank’s goal of keeping inflation in check. Equivalently, it happens when the central-bank’s maneuverability is circumscribed by the size and structure of the sovereign’s debt and borrowing needs.
The US is already some of the way there. Recent Fed comments have highlighted that the term-premium driven rise in longer-term yields will reduce the need for further rate hikes. [I.e., the vigilantes are taking over.]
…None of this is much of an issue when the government is running fiscal deficits closer to their historical average. But the birth of the Treasury put has meant that what’s expected from governments, especially after the pandemic, has swollen greatly, and along with it sovereign spending and borrowing….
The fiscal deficit in the US recently hit its widest peacetime, ex-recession level at 8.3% of GDP, while the debt-to-GDP ratio has risen to 129%, from 107% in 2019. The Treasury put means that debt and deficits are likely to remain elevated for the foreseeable future.
With such large financing needs, central banks rigidly trying to enforce an arbitrary inflation target become a nuisance.
Needs must, and central banks - already experiencing a chipping away at their de facto independence - will see its further erosion and, possibly, its eradication eventually in all but name….
Central-bank independence stands little chance as governments borrow hand-over-fist to try to make up for expanding revenue shortfalls.
This is inflationary. As Charles Calomiris of Columbia Business School puts it: “Every major inflation in world history is a fiscal phenomenon before it is a monetary phenomenon.” When the public is no longer willing to fund the government (auction failure), governments move to fund their deficits with non-interest bearing debts, aka printing money.
This is the path to the Weimar Republic or to Zimbabwe dollars.
The tipping point
What we are starting to see is that long-feared moment where the burden of the federal debt starts tipping over to where the government cannot service its debt if the central bank fights inflation long enough and hard enough to get it down. Another good article in the headlines below explains why the inflation will reignite, which is also one of my own main themes.
In short, the Fed has the tools to push down the rise in interest being brought on now by the bond vigilantes. The tool is to go back to buying government bonds, thereby wresting control over bond pricing out of the hands of the market to the degree that it starts to dominate bond purchases.. However, the Fed cannot do that without the high risk of lighting inflation back on fire, which is going to make the Fed very reluctant, though the Fed ultimately must serve the government that grants it its charter to create money (hence loses its independence as the article above says).
(So we see former Fed Chair, Janet Yellen, below trying to walk a fine line — or just being plain dumb — praising the government she now directly works for, keeping the Fed off the radar, and explaining away the risk of the atomic bomb she is sitting on at the Treasury. Is she blithely unaware or walking the tight rope? Either way, it makes her sound like a fool)
Going back to the USA Today article that I started with,
If the economy weakens significantly, the Fed could cut rates sooner than expected, lowering 10-year yields and easing the financial strains.
It could … but only if it like searing inflation, which it doesn’t. This has been the stock market’s perpetual fantasy, which has been dead wrong throughout this battle, but market well-wishers keep coming back to it, no matter how wrong it is or how long it remains wrong.
High 10-year bond yields already have bumped 30-year mortgage rates to or near 8% for the first time since 2000, and additional rises could propel them further…. They’ve hurt existing home sales by discouraging homeowners from selling because they don’t want to be saddled with much higher payments when they buy another house…. Even higher mortgage rates would eventually dampen both new and existing home sales.
So far, existing home sales have been where the worst housing trouble is due to these rising bond yields. New home sales, on the other hand, have been pushed along by numerous deep contractor incentives for buyers and by the fact that there is no homeowner involved who is reluctant to sell their low-interest home and then get hit by high interest on the next home. (See: “The Deeper Dive: The US Housing Market Has Frozen Over.”)
Builders can build as many as they want to and can afford to. So, inventory in new homes is also better, keeping new homes peculiarly priced beneath older homes. But, at some point, the higher interest rates become damaging enough that home builders cannot afford the incentive programs that are now temporarily offsetting high interest rates. (Note that those incentive programs are all time bombs because the mortgage buydowns are short-term to get you in, but eventually, you’ll wind up, just like one does in an adjustable=-rate mortgage, paying higher market rates.)
Small businesses haven’t notably changed their capital spending plans, according to a September survey by the National Federation of Independent Business. But a growing share are saying their last loan was harder to obtain, more said financing was their top business problem and fewer say all their credit needs have been met, according to NFIB’s September survey.
Higher Treasury rates make it more attractive for U.S. and foreign investors to put their money in U.S. bonds, increasing the value of the dollar. That makes it more expensive for overseas companies to buy goods from American manufacturers, hurting U.S. exports and dinging economic growth….
A 5% Treasury yield should prompt many investors to shift their money from stocks to bonds, lowering equity prices. A down market makes consumers who invest in stocks or mutual funds feel less wealthy, hurting their spending.
That’s the dynamic I’ve been writing about.
So, that is the lite version of what the rise in bond rates will do. The heavy version looks at how those higher interest rates will force government back in line (hence, the term “bond vigilantes”) because government cannot afford to keep driving up its interest rates on all existing debt as it refinances while adding heaps of new debt at those higher rates. (The US just added $600 billion to its debt last month alone!) The only alternative is stripping the Fed of its independence.
The political war that will come out of that will result in paralyzed government and then big government cuts to try to maintain Fed independence, and that means more economic downturn as government projects dry up. While all of that NEEDS to happen if we are ever to get back to a real economy, it’s not likely to go down smoothly in an already deeply fractured economy that is utterly dependent on cheap interest, which is where the cracks matter … a lot.
The heavy version also realizes government will not easily step back in line, so yields will rise further still, even if the Fed sits tight, raising interest on absolutely everything else in the world, since the dollar is the global currency, and rising bond yields equal a stronger dollar, as noted above, raising the price of everything priced initially in dollars for everyone in the world. Let your imagination run, but I’m saying there is a long chain reaction throughout the world here as US bond interest reprices to real market rates.
Today we saw a small-scale test of what I’ve been writing about. With the US stock market diving hard today and bond yields falling back down because of that money that is running from stocks, it appears the stock-bond pump is functioning very well, meaning the rise back up to near the 5% line for the 10-YR became very attractive again in a matter of days and is now pumping money out of stocks so that bond yields settled back down again because stock money ran for a safe haven … again.
A strong GDP report didn’t stop it. Neither did stellar earnings reports from major corporate.
The strongest contrarian indicator of how bad the situation is, however came from Yammering’ Yellen who went on a Treasury face-saving, clean-up tour to attempt to claim,
Yield Surge Is Due to Strong Economy, Not Deficits.
She’s trying to repeat a claim she made a week or so ago to turn it into a fact by virtue of repetition. Of state propaganda there is no end. If you tapped Yellen on the head dust would puff out her ears.
Her mind-altering defense of that drivel was,
“I don’t think much of that [yield surge] is connected” to the US budget deficit, Yellen said at an event in Bloomberg’s Washington office Thursday. “We’re seeing yields go up in most advanced countries.”
That would be because many of those countries also went on debt binges, and their central banks are now rewinding their money printing just like the Fed. It would also be because their yields have to compete against the yields of the world’s ultimate safe haven — US Treasuries — or people will buy the rising dollar! She’s dim like that when it comes to market basics like competition — almost a black hole for light to enter and disappear forever.
You see, what she didn’t realize — like the village idiot — is that she almost spoke that kind of indavertant word of genius that comes out of the mouths of babes. She came that close to recognizing and stating publicly that the soaring yields on her own US Treasuries are assailing sovereign bond markets around the world. It’s an unintended (war?) on their currencies.
One more way US Treasury yield surges start a chain reaction throughout the entire world.
Who would take a European bond at 5% if they have an option available to them to get a US bond at 5%, which is priced in the global currency that many still yearn for? Yes, priced in dollars that are escalating in value against the currencies of European bonds during the time in which any European investor holds the bond. So, even without interest on the bond, they’d get a gain on their own money by storing it in the US bond for a couple of years and then selling it. So, you stack that on top of the interest on the US bond.
And then Yellen put the cherry on top by resorting to her favorite word in harmony with her president:
The global financial crisis — is instead “largely a reflection of the resilience people are seeing in the economy,” she said.
There it is. Beautiful. The perpetual talking point. That is why stocks went down on glowing earnings reports. It is all that resilience in the consumer and, therefore, the US economy that investors sensed up ahead.
To read the rest of this “Deeper Dive” and see the articles that the above quotes come from as well as many other good articles about oil inflation, the Israel-Hamas war, and especially today’s GDP report you need to be a paid subscriber. The remainder of the article digs deeper into today’s stunning GDP numbers and explains why the dazzling report created fear that caused investors to seek safe haven. It also shows how the US consumer is not nearly as “resilient” or “strong” as many economists, including our own National Treasure, Janet Yellen, keep saying. (Yes, believe it or not, she’s a bonafide economist.)