The mood among investors was upbeat following the long Memorial Day weekend. Refreshed and ready, they returned Tuesday, prompting a rally that saw the DOW rise by 125 points.
However, on Wednesday, concerns about an impending crisis looming in Europe shifted their sentiment. Instead of buying, they opted to sell, resulting in a 160-point drop in the DOW, erasing the previous day’s gains and then some. On Thursday, market confusion persisted; investors fluctuated between buying and selling, ultimately concluding with a modest loss of 26 points.
These days, the stock market often steals the spotlight, but intriguing developments are occurring in the more traditional bond market. On Thursday, for those who may have overlooked it, the yield on the 10-Year Treasury Note dipped to 1.53 percent, marking a historic low.
At the Economic Prism, we observed the impressive shift away from stocks in astonishment. It appeared that fear drove the masses from one perilous situation into a considerably graver one. In a paradoxical twist, playing it safe could inadvertently turn into a risky gamble with no potential upside.
Let’s delve deeper…
Rotten Tomatoes
Treasuries might currently serve as a reliable defensive investment. If the stock market continues its downward trajectory, preserving capital will matter far more than earning returns. In this context, Treasuries could be a prudent short-term choice.
Yet, after being perceived as the safest investment for over six decades, Treasuries may soon fail to guarantee capital preservation—unless one considers receiving outdated goods a fair trade. To illustrate, purchasing a 10-year Treasury today is akin to buying a fresh tomato: appetizing today, but likely to become spoiled and unpleasant tomorrow. A single bite could leave one feeling unwell.
Using the government’s questionable Consumer Price Index (CPI) data, current inflation rates hover at 2.3 percent. Thus, a 1.53 percent Treasury yield translates into an automatic loss. For the assurance of recovering your capital, you effectively incur a negative return on your investment, meaning you’ll receive less than you initially contributed.
Moreover, given the ongoing monetary easing and fiscal stimulus, it’s very plausible that inflation will climb over the next decade, exacerbating the situation. Imagine inflation climbing from 2.3 percent to 5 percent, or even 8 percent.
This scenario is not far-fetched. When it transpires, a 10-Year Treasury Note yielding 1.53 percent will quickly lose value. The repercussions will be devastating for those unfortunate enough to hold them.
There’s A Great Storm Coming
Eventually, should “official” inflation exceed 5 percent, the Federal Reserve will be compelled to relent on purchasing government debt. This will inevitably raise yields, increasing the costs the government faces in servicing its debt, thereby initiating a phase of enforced austerity—regardless of political or public sentiment.
In the interim, a wave of debt deflation could overwhelm both monetary and fiscal measures, forcing austerity measures upon the American populace through economic contraction, rising unemployment, and dwindling tax revenues. This scenario appears to be materializing.
Anecdotal evidence suggests that capable and experienced individuals are losing their jobs once again. This development is troubling, and we believe it correlates with the impending “fiscal cliff” that looms ahead. Businesses appear to be bracing for what lies ahead.
By the time you read this, the Labor Department’s unemployment report for May will have been published. Given the government’s tendency toward embellishment in presenting favorable figures, we wouldn’t be surprised if the headline reveals more than 150,000 newly created jobs. The unemployment rate may even experience a slight decline, primarily due to a shrinking labor force participation rate.
Nevertheless, the unemployment report may not reflect the true economic landscape. As a relevant indicator, it could obscure rather than clarify. To gauge what lies ahead, one might simply wet their finger and hold it to the wind, as this will reveal the approaching storm.
Prepare yourself; a significant storm is on the horizon.
Sincerely,
MN Gordon
for Economic Prism
