Inflation-adjusted return of Treasuries fell to lowest since the 1980s. For bond investors, this is their version of Kevin’s Famous Chili from The Office! Or The Fed’s Famous Chili!
(Bloomberg) — Treasury investors are losing more money than they have in four decades, once inflation is taken into account. And if markets are right, they’re unlikely to come out ahead for years.
The federal government’s debt has already lost about 2% outright over the past year as the Federal Reserve started removing pandemic-era stimulus from the economy and inched closer toward raising interest rates. But on top of that, the consumer price index has surged 6.8%, putting investors even deeper in the hole.
Taken together, that’s resulting in the worst real returns — or those adjusted for inflation — since the early 1980s, when then Fed Chair Paul Volcker was in the midst of fighting a wage-price spiral. What’s more, the dynamic isn’t expected to change: The bond market is projecting that 10-year Treasury yields will hold below the inflation rate for the next decade, meaning any investment income will be more than wiped out by the rising cost of living.
If we look at the REAL 10-year Treasury yield and REAL Fed Funds Target Rate, they are both negative.
Let’s see if Powell spills his famous chili on Wednesday at 2:00PM EST. The Fed keeps saying they are serious about controlling inflation, just like Kevin Malone.
The U.S. went on a borrowing binge last year and the hangover could make it harder for the Federal Reserve to fight inflation without crashing the economy.
Corporate debt has surged $1.3 trillion since the start of 2020 as borrowers took advantage of emergency Fed action as the pandemic spread, slashing interest rates and backstopping financial markets to keep credit flowing. More debt held by more companies suggests potential risks as borrowing costs rise from currently low levels.
That could create financial stability concerns for Fed Chair Jerome Powell and his colleagues as they debate removing pandemic support in the face of what a report Friday showed were the hottest price rises in almost 40 years. And a tough task: Not since Alan Greenspan’s time has the U.S. central bank tried to navigate the economy back to price stability from too-high inflation.
Powell’s challenge is to try to curb price pressures without large costs to employment or growth, a move that would likely anger both political parties and blotch his record with the first Fed-assisted hard landing since the 1990-1991 downturn.”
The Fed’s Financial Stability Report on Nov. 2 noted that key measures of vulnerability from business debt, including leverage and interest cover ratios, were back at pre-pandemic levels.
To be sure, big firms that used the opportunity to issue longer-dated bonds at lower rates have strengthened their balance sheets.
Source: Moody’s Investors Service
The Federal Reserve is laying the groundwork for the start of a cycle of interest-rate hikes that the bond market warns might be unusually constrained in how far it can go, setting the two on a collision course where one will eventually have to give.
The Treasuries yield curve — or the spread between short-term and long-term interest rates — looks set to be the flattest at the beginning of a Fed tightening cycle in a generation if the central bank begins raising its benchmark overnight rate in mid-2022 as now forecast. The two-year, 10-year spread is about 83 basis points, with futures indicating 55 basis points in June.
The problem facing Powell and The Fed is that they are stuck in a trap. They can’t raise their target rate more than just a little (say 50 basis points) and shrinking their enormous balance sheet is really their only option. And that may fail if the 10 year Treasury yield starts to rise too rapidly or gets too high.
Here is one of the traps facing Powell and the Gang after their Covid printing splurge: dying M2 Money Velocity.
It will only get worse as Congress and the Biden Administration keep spending like drunken ORCs from Lord of the Rings. Particularly when the Penn-Wharton Budget Model finds that Build Back Better will reduce the long-term GDP by 2.8 percent, reduce wages by 1.5 percent, and reduce work hours by 1.3 percent. The only thing it will expand is government debt, by 25 percent.
The Washington DC spending Gollums need to control their urges.
“The Congressional Budget Office and the staff of the Joint Committee on Taxation project that a version of the bill modified as you have specified would increase the deficit by $3.0 trillion over the 2022–2031 period.”
The Penn-Wharton Budget Model estimates that — if Congress follows White House policy to make most provisions permanent — then Build Back Better will reduce the long-term GDP by 2.8 percent, reduce wages by 1.5 percent, and reduce work hours by 1.3 percent. The only thing it will expand is government debt, by 25 percent.
But that 6.9% YoY is very misleading because of the strange way the Bureau of Labor Statistics measures the largest asset in most households’ expenditures: housing.
The BLS measures inflation in housing using the Shelter measurement. Which was only 3.88% YoY. The problem is that the Case-Shiller National Home Price Index was 19.52% in its last reading. That is quite a discrepancy.
So, if we substitute the Case-Shiller National home price index for the CPI Shelter, we get an inflation rate of greater than 11%.
The U.S. is poised to enter Year Three of the pandemic with both a booming economy and a still-mutating virus. But for Washington and Wall Street, one Covid aftershock is starting to eclipse almost everything else.
Already-hot inflation is forecast to climb even further when November data comes out on Friday, to 6.8%. That would be the highest rate since Jimmy Carter was president in the early 1980s — and in the lifetimes of most Americans.
And the CPI change since last year, according to the Federal Reserve of St Louis FRED is a staggering 16.262%.
And with U.S. Jobless Claims plunge to 52-year low, its about time that The Fed begins removing the humongous monetary stimulus.
After all, largely thanks to Federal Reserve policies, we have seen the greatest wealth redistribution in US history … to the top 1%.
Just look at this chart of the University of Michigan Buying Conditions For Houses index. It was positive (meaning above 100) until shortly after COVID struck and The Federal Reserve rode to the rescue. National home price growth was already at 4.57% YoY in March 2020, then ballooned to 19.51% YoY at the last reading.
Here is the same chart with the broader M2 Money stock and The Fed’s Balance sheet. Same results, just not as dramatic as M1.
We will soon find out if The Federal Reserve will announce a rate hike or taper news. They are likely to confirm tapering, particularly if they believe that tapering won’t roil markets. After all, then Fed Chair Janet Yellen and the FOMC decided to let the Fed’s balance sheet taper (white line) while, at the same time, increasing the Fed’s target rate (yellow line). The S&P 500 index rose 9.5% over the taper/rate increase period of 12/29/2017 to 8/30/2019.
But since Stimulypto (2/28/2020 to 11/30/2021), the Fed’s balance sheet doubled+ from $4,158,637 to $8,681,771. And The Fed Funds Target Rate (UB) immediately fell from 1.75% in February 2020 to 0.25% in March 2020 … and has stayed there ever since. The S&P 500 index rose 54.6% over this Stimulypto period.
But The Fed’s upcoming decision on December 15, 2021 may be a Yellen-pivot (taper balance sheet, but raise The Fed Funds Target rate). But, then again, maybe not. The Fed is getting really bad about forward guidance and choose instead to surprise us. Hence, this is why an a-political rule is preferred (such as the Taylor Rule).
Unfortunately, the Taylor Rule infers a Fed Funds Target rate of 15.50% (using CPI YoY running at 6.20% YoY. If The Fed raises their target rate by 25-50 basis points at the December 15th meeting, color me surprised.
So, the Powell Pivot may just be the Yellen Pivot after all.
Despite the “Talk, Talk” from The Federal Reserve about balance sheet taper and rate “normalization,” we actually saw the 10-year Treasury yield fall from 1.6651% on 11/23/2021 to 1.343 on 12/3/2021. While the 30-year mortgage rate only fell from 3.31% to 3.3%, it is the SIGNAL that The Fed is sending that people should refinance their mortgages ASAP.
You can see the rise in mortgage refinancing applications of 56% week-over-week (WoW) (white line) with the drop in the 10-year Treasury yield (blue line) despite the relatively small drop in the Mortgage Bankers Association (MBA) tiny drop in their 30-year mortgage rate index.
Ditto for the MBA mortgage purchase application index. The drop in the US Treasury yield (blue line) resulted in a 28% WoW increase in mortgage purchase applications.
Here is the table of MBA data for the week of 12/03.
Please note that the 10-year Treasury yield have jumped since 12/03 indicating that mortgage application activity for the week of 12/10 will be lower.
Here is the MOVE bond volatility index and the US Treasury 10-yield chart. Can you spot the COVID outbreak??
If this what the Biden Administration had in mind? Soaring labor costs at the same time that labor productivity is falling to its lowest level since 1960?
Powell and the Gang’s monetary approach doesn’t seem to be working for the labor market …
Confounded Interest - Anthony B. Sanders 
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