Higher Rates “Maybe Forever”

Reads a Wall Street Journal headline:

“Higher Interest Rates Not Just for Longer, but Maybe Forever.”

Beneath this headline we are informed that:

In their projections and commentary, some [Federal Reserve] officials hint that rates might be higher not just for longer, but forever…

This matters to any investor, business or household whose plans depend on interest rates over a decade or longer. It could explain why long-term Treasury yields have risen sharply in the past few months, and why stocks are struggling.

Just so. Yet why “forever”?

The Journal cites differing reasons.

These include demographics. Global capital demand. Astronomic government debt… and investor inflation expectations.

No Going Back to Zero

Continues the Journal:

Federal debt held by the public now stands at 95% of gross domestic product, up from 80% at the start of 2020, and federal deficits are now 6% of GDP and projected to keep rising, from under 5% before the pandemic.

To get investors to hold so much more debt probably requires paying them more. The Fed bought bonds after the financial crisis and again during the pandemic to push down long-term interest rates. It is now shedding those bondholdings.

More:

Before the pandemic the Fed’s principal concern was that inflation would persist below 2%, a situation that makes it difficult to stimulate spending and can lead to deflation, and that is why it kept rates near zero from 2008–2015. In the future it will worry more that inflation persists above 2%, and err on the side of higher rates with little appetite for returning to zero.

Thus, “forever.”

If not forever… certainly for the moment…

An “Earthquake in Bond Land”

Ten-year Treasury yields are on the jump.

At 3.28% in early April, 10-year Treasury yields presently vault to 4.47%.

A 1.19 percentage point leap may not alert or alarm you.

Yet the 10-year Treasury note generally advances or retreats not in miles, yards, feet or inches.

It is an instrument that generally advances or retreats in centimeters and millimeters.

A glacier is an airplane next to it. Yet here it is.

Jim Rickards labels such a happening “an earthquake in bond land.”

Recall, bond prices and bond yields exist in a state of antagonistic polarity.

If prices increase yields decrease. If prices decrease yields increase.

Imagine a seesaw in operation. Imagine its polar ends swinging in perfect antagonism.

Now you have the picture of it.

Thus today’s upswinging yields equal downswinging bond values.

In the case before us, downswinging 10-year Treasury values.

From Oaks to Sawdust

You recall this spring’s run of bank deaths.

These portfolios were loaded through with long-term Treasury bonds.

The banks had purchased these “safe” bonds in a period of severely depressed interest rates.

In such a period bonds maintain an elevated value. They are lovely portfolio jewels.

These banks expected this period of severely depressed interest rates to run and run.

Yet this period of severely depressed interest rates did not run and run.

The bond seesaw experienced a directional swing last March.

That is when the Federal Reserve  commenced the most frenzied and dizzied campaign of interest rate increases ever hazarded.

The banks’ long-dated bonds that had been oaken assets?

They transitioned rapidly to sawdust assets in the period of rapidly elevating interest rates.

Thus the bank portfolios that stabled them endured a mighty chainsawing.

And the banks themselves began going over… felled trees in a banking forest.

Explains the abovesaid Jim Rickards:

Those bonds were way underwater. They were worth 80 cents on the dollar. People did the math and said if your bond portfolio is down 20% and we subtract that from your capital, you’re broke, you’re insolvent, you have no capital on a market-to market basis. So I’m getting my money out. And that triggered the run on the bank.

Timber!

Forest management within the regulatory agencies sprung to action… and proceeded to brace vulnerable trees confronting similar collapse.

These trees remain upright — for now. Yet Jim hears strange creaks and groans issuing from the forest.

He fears the temporary braces are giving way. He fears a second string of bank topplings — perhaps even within weeks.

Yet let us extend our vision beyond the banking forest. Let us consider the larger economic forest we inhabit.

Much of the prior decade’s “growth” sprung from the Federal Reserve’s zero interest rate acorns.

These were genetically engineered, Frankenstein, alien things.

They yielded sickly saplings with weak wood… shallow roots… and restricted growth.

A moderate wind can knock them down.

How can they withstand the savage gales of — as the Wall Street Journal styles it — “higher interest rates not just for longer, but maybe forever”?

Rabobank’s Michael Every is far from convinced that they can:

Put simply, if rates fall in 2024, we are still very unlikely to be going back to the post-2008 ‘New Normal’…

While rates will fall in 2024, they are not going to fall fast or far. Indeed, on the Fed… the floor may well be as high as 3.5%. Yes, that’s lower than 5.5%… However, it’s far too high for a swathe of the market and economy predicated on zero or negative rates.

This fellow’s concern is our concern.

Conceived in Debt

The United States’ debt-to-GDP ratio rises presently to 124%. That is, the United States heaves up more debt than economic output.

Evidence indicates — evidence we deem credible — that any figure exceeding 90% represents a menace.

It indicates an economy overburdened with debt. This overburdened economy can merely gutter along.

Or to revisit our arboreal analogy, this economic tree cannot much grow.

Its defective genetics condemn it to a stunted and frustrated existence.

It was conceived in debt.

Reckless Forest Management

Debt is not what an academic man might term a malum in se. That is, debt is not necessarily an evil in itself.

That is because debt can be shoveled into productive pursuits.

The proceeds from these productive pursuits can repay the loan by many multiples.

Yet has our forest management an eye for the morrow?

Has it borrowed to ensure a future for forestry — for a productive American future? No it has not.

It has razed the forest largely to satisfy the consumptive needs of the moment.

That is, we have a very poor forest manager on our hands — in fact, a reckless forest manager.

He has transformed a once-dense forest into a barren and treeless waste.

And any future growth?

It must rise against “forever” high interest rates…