The Fed Wrecked the World’s Most Important Market
Do you wish to know where the economy is heading? The bond market holds the answer, say the veterans.
The birds of the moment, the flighty birds, flock to the stock market. But the owls nest in the bond market.
The owls are the wiseacres.
The Federal Reserve’s hocus-pocus fails to trick them. They know the card is up the sleeve. And they enjoy exposing the fraud.
New York Times economics reporter Neil Irwin:
Savvy economic analysts have always known the bond market is the place to look for a real sense of where the economy is going, or at least where the smart money thinks it is going.
For example: Is inflation ahead? The bond market will tell you — Treasury bonds in particular.
Bonds and Inflation
Longer-dated Treasury notes will telegraph the signal. If they wire an inflationary message, their prices will fall. And their yields will rise.
(Bonds operate as seesaws operate. When prices go up, yields go down. When yields go up, prices go down).
Yields would rise because inflation would eat into the bond’s value… as the termite eats into wood. Under inflation a bond is a sawdust asset.
Bond purchasers would demand a higher yield to compensate them for inflation’s ravages.
That is, they would demand insurance against the termite’s evils.
The Message of the Bond Market
Does today’s bond market indicate inflation is ahead?
It does not. 10-year Treasury notes presently yield under 1% — 0.923%.
These are historic lows. 10-year yields average 4.40% across time.
In brief… the bond market indicates no inflationary menace. Inflation is as tame as a tabby.
But is today’s bond market the reliable inflation detector it once was? Alas, it is not.
That is because the Federal Reserve has distorted, garbled, jammed and censored its messages.
The bond market is transmitting static.
Investors who depend upon its clear telegraphing fumble about, lost.
The owls are down from their perches.
The Fed’s Buying Spree
And so we ask:
Do 10-year yields hover at historic lows because inflation expectations hover at historic lows?
Or do 10-year yields hover at historic lows because Federal Reserve Treasury purchases hover at record highs — which pummels down yields?
The Federal Reserve has purchased a walloping $2.4 trillion of Treasuries this past year…doubling its Treasury holdings.
It now owns 16.5% of United States government debt — a record amount. It owned 9.3% before the pandemic… in contrast.
Macroeconomic analyst Peter Schiff:
The bond market is not working the way it has in the past because the Fed is artificially manipulating interest rates. The biggest buyer (of Treasuries) is the Federal Reserve…
The Fed is… trying to influence the economy, stimulate the economy, prop up the stock market. That is the purpose of the Fed buying Treasury bonds… And so when you have the Fed in the market, the whole thing is distorted… The bond market is broken. You can’t look at the bond market.
It would appear not. But the wildly distorted bond market holds aloft the wildly distorted stock market.
1,124 Times Earnings???
The Federal Reserve’s gargantuan bond purchases are the energy behind quantitative easing. Schiff:
The Fed is trying to maintain these excess stock market valuations… the key to the overvalued stock market is the overvalued bond market.
We must agree — the stock market is overvalued. The S&P’s price-to-earnings ratio presently reads 37.21. Its historic average is 16.
Individual stocks are preposterously, deliriously overvalued. Netflix boasts a P/E ratio of 84. Amazon, 92.
And Tesla? An impossible 1,124 — if you can believe it. The stock trades at 1,124 times company earnings.
That is, at current earnings a fellow purchasing the stock would require 1,124 years of accumulated earnings to justify the purchase!
But let us recover our wits… and refocus our attention on the question of inflation…
Food: An Omen of Inflation
Bonds report little inflation ahead. Yet we have documented how the Federal Reserve has overpowered bonds’ signals with its own.
Is inflation closer than bonds indicate? Let us seek our answer in the supermarket…
Food prices have jumped 3.9% these past 12 months — most of all consumer items. It is the greatest increase in 11.5 years.
The Federal Reserve’s Personal Consumption Expenditures (PCE) is an atrocious bellwether of inflation. Its crystal-gazing is hopelessly botched.
Yet the Federal Reserve itself admits that food prices give a far truer inflation reading:
We see that past inflation in food prices has been a better forecaster of future inflation than has the popular core measure… we find that the food component still ranks the best among them all…
We doff our cap to Phoenix Capital Research for supplying the quote.
The 10-year bear market in food prices is ending, concludes Phoenix:
“Higher inflation is coming. And coming soon.”
Clues From the Stock Market
Is the stock market — ironically — the market presently telegraphing inflation? Consider commodities…
The S&P Metals & Mining ETF has jumped nearly 130% since March. The S&P Oil & Gas Exploration & Production ETF is 94% higher.
In all, inflation-sensitive assets have outraced the broader market since March. The “contrarian” KCI Research:
Inflationary equities are appreciating at their most rapid clip since the recovery out of their late 2015 and early 2016 lows… Commodity prices are signaling that we are on the cusp of higher than expected future inflationary pressures.
Yet, the bond market argues the signals are false. Deflation — disinflation, at least — is its message.
Which is correct? Time will tell us.
Toying With Fire
But to toy with inflation is to toy with fire. Strike a match, and you risk an inferno. Explains Jim Rickards:
Once inflation expectations develop, they can take on lives of their own. Once they take root, inflation will likely strike with a vengeance. Double-digit inflation could quickly follow.
Double-digit inflation is a non-linear development. What I mean by that is, inflation doesn’t go simply from two percent, three percent, four, five, six.
What happens is it’s really hard to get it from two to three, which is ultimately what the Fed wants. But it can jump rapidly from there.
We could see a struggle to get from two to three percent, but then a quick bounce to six, and then a jump to nine or ten percent.
The bottom line is, inflation can spin out of control very quickly.
Is inflation on the way?
We suspect it is on the way, and for the reasons listed. Yet like a dreaded mother-in-law, we do not know when it will turn up.
Nor do we know if it spins beyond control once it does.
The gods have denied us the gift of foresight… and the wisdom that attends it.
Like most, our answer will likely arrive after the fatal hour.
Minerva’s owl — Minerva’s Owl of Wisdom — flies only at dusk…
Managing Editor, The Daily Reckoning