James Carville, political consultant to the Clinton campaign in 1992’s victory, is a walking sound-byte machine. One of his most famous: “It’s the economy, stupid.” Here’s another one:
If there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.
Keep that in mind if you read former Federal Reserve Governor Kevin Warsh’s op-ed in the Wall Street Journal about what the bond market is telling us. Here’s a snippet from his opening:
Hold short-term interest rates at current levels, and threaten to raise them if inflation morale doesn’t improve. That’s current Federal Reserve policy. The trouble is that the central bank doesn’t set interest rates anymore. The bond market does.
and here’s its kernel:
The coming supply of Treasury securities required to fund U.S. government deficits will likely be substantially larger than official estimates. And purchasers of Treasury debt will demand higher yields, at least until something breaks in the economy.
First, on the supply side. The government currently funds $33 trillion of outstanding debt at an average interest rate of about 2.9%. Funding costs on the growing debt burden are forecast to average only a fraction of a percentage point higher over the next 10 years, according to the Congressional Budget Office. I’ll take the over.
The bond market is signaling heightened uncertainty about the range of possible outcomes. If the Fed’s recent rosy economic forecasts for growth and inflation are wrong and a recession ensues, there will be a gusher of new debt. Every additional 1-point increase in interest rates will add more than $2.5 trillion of expense in the next decade.
Next, on the demand side. After the global financial crisis, four of the largest purchasers of Treasury debt were price-insensitive. That is, they were buying Treasury debt for policy reasons—economic, geopolitical or regulatory. Price didn’t matter. How fortunate. These buyers, however, have largely exited the market. The Fed bought about a quarter of all Treasury debt in the past decade but warns that its Treasury holdings will shrink for at least another year.
China, another massive buyer in recent years, is unlikely to sell its existing holdings at a loss. But don’t expect Chinese leadership to do the U.S. any favors by showing up in size at the next Treasury auction. Japan’s domestic growth profile is the most robust in decades. The lion’s share of its excess savings will stay closer to home. And after the banking debacle in March catalyzed by Silicon Valley Bank, the largest banks—firmly overseen by their regulators—are no longer keen to load up on “risk-free†long-dated Treasury bonds.
He says pay more attention to the bond market than to what the Fed is doing.
I think that China’s “massive buying in recent years” depends on what you mean by recent and what you mean by massive:
and here’s Japan’s:
Were those adjusted to constant dollars they would look even worse.
Will much higher yields, as the bond market seems to be telling us, lead to the Chinese and Japanese resuming their purchases of U. S. Treasuries? Frankly, I doubt it.
The chickens are coming home to roost.
By the way, my understanding is the two charts of Chinese and Japanese holdings are deceptive.
The Chinese and Japanese aren’t selling or even letting their treasures holdings run off. The decline in value is simply because treasury yield have increased from 1% to 5%, and bond math dictates that as yields go up, the value of bond assets decreases.
The charts are implying the Chinese and Japanese are each sitting on $200 billion in losses in their holding of US treasures.
Which in turn suggests to me that they are unlikely either to sell off or buy more.