Tag Archives: interest rates

Bond Market Smells Inflation, Begins to React, by Wolf Richter

The bond market probably topped out in July 2016. Interest rates are starting to move up again. From Wolf Richter at wolfstreet.com:

Inflation expectations now exceed the Fed’s target.

The 10-year US Treasury yield breached 2.5% on January 9 and hasn’t looked back since, closing on Friday at 2.55%. The three year yield closed at 2.12%, the highest since October 2008. The two year yield, after breaching 2% on Friday intraday, closed at 1.99%, the highest since September 2008.

Bond prices fall when yields rise. And the selloff in three-year maturities and below shows that the short end of the bond market is reacting to the Fed’s rate-hike environment.

The moves in the 10-year yield, however, defied the Fed in much of 2017, with the yield actually dropping. With long-term yields falling and short-term yields rising, the yield curve “flattened,” and there were fears that the yield curve would “invert,” with 10-year yields dropping below two-year yields – a scenario that has proven dreadful in the past, including just before the Financial Crisis. But recently, the 10-year yield too has begun to respond.

Though the “new Fed” in 2018 hasn’t fully taken shape yet, with several key vacancies still to be filled, there is already tough talk even among the “doves.” And that’s where tough talk matters.

On Thursday it was New York Fed President William Dudley who outlined the “two macroeconomic concerns” he is “worried about”: “The risk of economic overheating,” and that the markets are blowing off the Fed. In the end, the Fed “may have to press harder on the brakes,” he said.

On Friday, it was Boston Fed President Eric Rosengren who told the Wall Street Journal that he expected “more than three” rate hikes this year to get this under control before it’s too late. “I don’t want to get to a situation where we have to tighten more quickly,” he said, citing specifically the “fairly ebullient financial markets,” and the risks of waiting too long.

These “doves” are worried that the Fed will have to speed up its rate hikes to get a grip on asset price inflation, wage inflation, and consumer price inflation before they become difficult to control.

To continue reading: Bond Market Smells Inflation, Begins to React, by Wolf Richter

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Fed Tightens, “and so far, Nothing Has Blown Up”, by Wolf Richter

The end of the world will come on its own timetable, not the Fed’s. From Wolf Richter at wolfstreet.com:

Gundlach frets about bonds during QE unwind, rate hikes, tax cuts, and rising deficits.

“A tax cut will reduce revenue and it will grow the deficit and therefore, it will probably grow bond supply, and perhaps boost economic growth,” DoubleLine Capital CEO Jeffrey Gundlach said on an investor webcast on Tuesday. And if it does, “it is going to be bond unfriendly.”

And possibly in a big way.

It’s a “strange environment” for cutting corporate taxes as the economy is already in its eighth year of expansion, he said, according to Reuters, which reported the webcast. He reiterated his prediction that the 10-year Treasury yield could reach 6% over the next “four years or so.”

Let that sink in for a moment. The last time the 10-year Treasury yield was at 6% (on the way down) was in August 2000! Four years from now, 6% would be a two-decade high-water mark.

“I don’t think it is at all strange to think we can tack on something like 75 basis points, on average, with volatility of course, per year for the next four years or so,” he said.

The 10-year yield is currently 2.36%, and sliding, as opposed to the shorter maturities whose yields have surged: the three-month yield reached 1.30% today and the two-year yield jumped to 1.83%, the highest since September 2008.

When bond yields rise, bond prices fall by definition. The 10-year yield is still very low. But if it rises from this level to 6% over the next few years, there will be a lot of wailing and gnashing of teeth along the way by bond investors, and it’s not going to be a fun time for a bond-fund manager to navigate this environment.

To continue reading: Fed Tightens, “and so far, Nothing Has Blown Up

Pension Storm Warning, by John Mauldin

Governments have made promises of pension benefits that they will never be able to keep. From John Mauldin at maudlineconomics.com:

This time is different are the four most dangerous words any economist or money manager can utter. We learn new things and invent new technologies. Players come and go. But in the big picture, this time is usually not fundamentally different, because fallible humans are still in charge. (Ken Rogoff and Carmen Reinhart wrote an important book called This Time Is Different on the 260-odd times that governments have defaulted on their debts; and on each occasion, up until the moment of collapse, investors kept telling themselves “This time is different.” It never was.)

Nevertheless, I uttered those four words in last week’s letter. I stand by them, too. In the next 20 years, we’re going to see changes that humanity has never seen before, and in some cases never even imagined, and we’re going to have to change. I truly believe this. We have unleashed economic and technological forces we can observe but not entirely control.

I will defend this bold claim at greater length in my forthcoming book, The Age of Transformation.

Today we will zero in on one of those forces, which last week I called “the bubble in government promises,” which I think is arguably the biggest bubble in human history. Elected officials at all levels have promised workers they will receive pension benefits without taking the hard steps necessary to deliver on those promises. This situation will end badly and hurt many people. Unfortunately, massive snafus like this rarely hurt the politicians who made those overly optimistic promises, often years ago.

Earlier this year I called the pension mess “The Crisis We Can’t Muddle Through.” Reflecting since then, I think I was too optimistic. Simply waiting for the floodwaters to drop down to muddle-through depth won’t be enough. We face an entire new ocean, deeper and wider than we can ever cross unaided.

To continue reading: Pension Storm Warning

No Fooling, by Robert Gore

DOUBLING TIME = 72/rate of interest

Math can be a real bitch.

The numbers behind this story come from the Wall Street Journal, “National Debt Is Projected To Nearly Double in 30 Years,” (paywall) 3/30/17. For a Zero Hedge summary, see “CBO Warns Of Fiscal Catastrophe As A Result Of Exponential Debt Growth In The U.S.

The Congressional Budget Office (CBO) released figures this week on the government’s deficits and the national debt that are downright scary. Unfortunately, they’re not nearly scary enough. The assumptions the CBO incorporates are optimistic and will almost certainly be undercut by reality.

The headline projection was the national debt will almost double in 30 years. Using the rule of 72, T=72/r, where T is the time in years required for principle to double and r is the annual interest rate compounded, a 30-year doubling time implies the debt is growing at 2.4 percent annually (30=72/2.4). However, the national debt almost doubled during George W. Bush’s two terms, and almost doubled again during Barack Obama’s two terms. That implies a T of a little more than 8 years. To be conservative (because debt almost doubled but not quite), round the T up to 9 years. Plug that into the rule of 72, and you have the debt growing at 8 percent per year (9=72/8), or over 3.3 times the rate the CBO is assuming. Scary as that 30-year doubling sounds, simply extrapolating the reality of the last 16 years projects another doubling in not 30, but 9 years, or a year longer than Donald Trump’s potential two terms.

But wait, there’s more. The CBO assumes the 10-year Treasury rate will be 1.5 percent after inflation over the long term, but last year that rate was 1.9 percent and the year before, 2.2 percent. Ask yourself, with exploding debt and an increasing supply of Treasury bills, notes and bonds, are real rates (the interest rate after inflation) likely to go higher or lower? The CBO says lower; SLL says higher. The CBO also assumes that potential GDP will grow at 1.9 percent per year over the long term, although it grew an estimated 1.6 percent last year. Ask yourself, with debt service consuming an ever larger share of the GDP (see next paragraph), will that help or hamper economic growth? The CBO says it will help; SLL says it will hamper. Finally, the CBO assumes that net interest costs will average 2.1 percent of the GDP over the next decade, although last year they were 2.5 percent. Again, ask yourself, will a rising national debt lead to more or less debt service cost relative to the GDP? The CBO says less; SLL says more.

Even the too rosy CBO numbers paint a grim picture. It projects that debt service’s share of total federal spending will triple, from the present 7 percent to 21 percent, over the next 30 years. In the same time frame, the national debt as a percent of the GDP will increase from 77 to 150 percent.

President Trump wants to spend “yugely” on infrastructure, increase the military’s budget, cut taxes, and not touch entitlement spending. This is all pure fantasy; it’s simply not going to happen. Something’s got to give, and it will probably start in the bond market. Indeed, it probably already has; the 10-year Treasury rate reached generational lows last July  and interest rates have been in an irregular uptrend since. So if you read the Zero Hedge CBO post and are feeling glum, cheer down; you’re not feeling glum enough. Unfortunately, this is not an April Fools gag.

NO FOOLING, GREAT NOVELS!

AMAZON

KINDLE

AMAZON

KINDLE

CBO Warns Of Fiscal Catastrophe As A Result Of Exponential Debt Growth In The U.S., by Tyler Durden

The CBO’s numbers are grim, but as SLL argues in the next post, “No Fooling,” they’re not grim enough. From Tyler Durden at zerohedge.com:

In a just released report from the CBO looking at the long-term US budget outlook, the budget office forecasts that both government debt and deficits are expected to soar in the coming 30 years, with debt/GDP expected to hit 150% by 2047 if the current government spending picture remains unchanged.

The CBO’s revision from the last, 2016 projection, shows a marked deterioration in both total debt and budget deficits, with the former increasing by 5% to 146%, while the latter rising by almost 1% from 8.8% of GDP to 9.6% by 2017.

In addition to the booming debts, the office expects the deficit to more than triple from the projected 2.9% of GDP in 2017 to 9.8% in 2047. The deficit at the end of fiscal year 2016 stood at $587 billion.

A comaprison of government spending and revenues in 2017 vs 2047 shows the following picture:

The CBO also mentions rising rates as another key reason for the increasing debt burden. The Federal Reserve has kept rates low since the financial crisis but is on track to gradually hike rates in the coming year.

On the growth side, the CBO expects 2% or less GDP growth over the next three decades, far below the number proposed by the Trump administration.

The budget office breaks down the primary causes of projected growth in US spending as follows: not surprisingly, it is all about unsustainable social security and health care program outlays.

The CBO’s troubling conclusion:

Greater Chance of a Fiscal Crisis. A large and continuously growing federal debt would increase the chance of a fiscal crisis in the United States. Specifically, investors might become less willing to finance federal borrowing unless they were compensated with high returns. If so, interest rates on federal debt would rise abruptly, dramatically increasing the cost of government borrowing. That increase would reduce the market value of outstanding government securities, and investors could lose money. The resulting losses for mutual funds, pension funds, insurance companies, banks, and other holders of government debt might be large enough to cause some financial institutions to fail, creating a fiscal crisis. An additional result would be a higher cost for private-sector borrowing because uncertainty about the government’s responses could reduce confidence in the viability of private-sector enterprises.

It is impossible for anyone to accurately predict whether or when such a fiscal crisis might occur in the United States. In particular, the debt-to-GDP ratio has no identifiable tipping point to indicate that a crisis is likely or imminent. All else being equal, however, the larger a government’s debt, the greater the risk of a fiscal crisis.

The likelihood of such a crisis also depends on conditions in the economy. If investors expect continued growth, they are generally less concerned about the government’s debt burden. Conversely, substantial debt can reinforce more generalized concern about an economy. Thus, fiscal crises around the world often have begun during recessions and, in turn, have exacerbated them.

If a fiscal crisis occurred in the United States, policymakers would have only limited—and unattractive—options for responding. The government would need to undertake some combination of three approaches: restructure the debt (that is, seek to modify the contractual terms of existing obligations), use monetary policy to raise inflation above expectations, or adopt large and abrupt spending cuts or tax increases.

Then again, as the past 8 years have shown, only debt cures more debt, so expect nothing to change.

Also, we find it just a little confusing why the CBO never warned of an imminent “fiscal crisis” over the past 8 years when total US debt doubled, increasing by $10 trillion under the previous administration.

http://www.zerohedge.com/news/2017-03-30/cbo-warns-coming-fiscal-crisis-result-exponential-us-debt-growth

Bond “Carnage” hits Mortgage Rates, Aims at Housing Bubble 2, by Wolf Richter

The relationship between the housing market and higher interest rates isn’t as straightforward as many people think. Sometimes rates rise and the housing market does well for the same reason: the economy is strong. Interest rates probably hit bottom in July, 2016, and have embarked on a long-term rising trend. It remains to be seen how that will affect the housing market. From Wolf Richter at wolfstreet.com:

“Many fear the Fed is behind the curve. The market is even further behind: This is clearly a dangerous situation.”

US government debt took another beating today. As prices fell, yields rose to new multi-year highs. The 10-year Treasury yield rose 5 points to 2.625%, the highest since September 2014, when it just briefly kissed that level. At this pace, the yield will soon double from the record low of 1.36% in July last year.

This chart shows the progression of the 10-year Treasury yield since late August (chart via StockCharts.com):

When yields were surging maniacally in November and December – broadly called the “bond massacre” or the “bond meltdown” or similar – I pontificated that eventually yields would fall back some, “on the theory that nothing goes to heck in a straight line.” And they did start falling back in mid-December. But that three-month breather has now been totally undone.

Two-year Treasuries took it on the chin too today, and the yield jumped to 1.40%, the highest since June 2009.

To continue reading: Bond “Carnage” hits Mortgage Rates, Aims at Housing Bubble 2

The Lowest Common Denominator, by Michael Lebowitz

Probably because most people don’t like to think or write about it, debt is one of SLL’s favorite subjects. Michael Lebowitz analyzes bond math and what it means for the debt-saturated US and global economies. From Lebowitz at 720global.com:

At a recent investment conference, hedge fund billionaire Stanley Druckenmiller predicted that interest rates would continue rising. Specifically, he suggested that, consistent with the prospects for economic growth, the 10-year U.S. Treasury yield could reach 6.00% over the next couple of years. Druckenmiller’s track record lends credence to his economic perspectives. While we would very much like to share his optimism, we find it difficult given the record levels of public and private debt.

Druckenmiller’s comments appear to be based largely on enthusiasm for the new administration’s proposals for increased infrastructure and military spending along with tax cuts and deregulation. This is consistent with the outlook of most investors today. Although proposals of this nature have stimulated economic growth in the past, today’s economic environment is dramatically different from prior periods. Investors and the market as a whole are failing to consider the importance of the confluence of the highest debt levels (outright and as a % of GDP) and the lowest interest rates (real and nominal) in the nation’s history. Because of the magnitude and extreme nature of these two factors, the economic sensitivity to interest rates is greater and more asymmetric now than it has ever been. Additionally, due the manner in which debt and interest rates have evolved over time, the amount of interest rate risk held by fixed income and equity investors poses unparalleled risks and remains, for the moment, grossly under-appreciated.

Proper assessment of future investment and economic conditions must carefully consider changes in the debt load and the interest rates at which new and existing debt will be serviced.

To continue reading: The Lowest Common Denominator