Between September 1981 and July 2020, the bond market experienced an extraordinary bull run, during which the yield on the 10-Year Treasury note plummeted from 15.32 percent to 0.62 percent. In recent times, however, this yield has surged to approximately 4.66 percent.
The swift fluctuations in interest rates have been challenging for banks, borrowers, and businesses alike. Our belief is that this discomfort is just the beginning.
After nearly four decades of lenient credit markets, where debts could be refinanced at increasingly lower rates, a significant cleansing of the financial system is necessary. We anticipate a substantial liquidation of asset prices, provided central planners do not intervene.
But what if the worst is already behind us?
Could it be that one of the most significant bear markets in bonds over the past 247 years is nearing its conclusion? Is this an opportune moment for stock market investors to consider acquiring shares in their preferred companies?
Jeremy Siegel, a professor at Wharton, recently shared his insights on these matters. According to Siegel:
“I actually think growth is going to be better next year, and I think that the higher real interests that we’ve seen are reflective of optimism regarding growth in 2024. This is likely to put pressure on the stock market as it has to adjust to the prospect of higher earnings, but I believe those increased earnings will indeed materialize.”
Siegel is also of the opinion that Treasury yields are approaching their peak: “I think we’re pretty near the top of the 10-year, maybe five and a quarter.”
The “five and a quarter” refers to his expected peak yield of 5.25 percent on the 10-Year Treasury note.
What Could Go Wrong?
No doubt, Siegel is incredibly knowledgeable. As a Finance Professor at the Wharton School of the University of Pennsylvania, he frequently shares his expertise on CNN, CNBC, and NPR. He also writes for Kiplinger’s Personal Finance and Yahoo! Finance.
Nearly 30 years ago, Siegel published his celebrated book, “Stocks for the Long Run.” It has been lauded by many and continues to be seen as the definitive guide for buy-and-hold investing.
Siegel has revised and released updated editions of his book multiple times, including a recent sixth edition that covers ESG (Environmental/Social/Governance) investing. His extensive body of work underscores his expertise.
However, here at Economic Prism, we find it hard to accept assertions that don’t align with our reasoning. Regarding the claim that Treasury yields are near their peak, we have inquiries that are as substantial as Siegel’s intellect.
Firstly: What could go awry?
Are these rising real interest rates a genuine sign of optimism about 2024’s growth? Or do they instead indicate concerns about the staggering $1.59 trillion that the Treasury plans to borrow within the next six months?
With such a vast quantity of Treasury bonds hitting the market, is their quality called into question? Who will be willing to purchase this influx of Treasuries, and at what pricing?
In this regard, we believe Treasury investors will require higher yields to offset the associated risks. The potential risks are numerous and severe.
Lender of Last Resort
For instance, the emergence of a new Israeli-Hamas conflict, coupled with the ongoing Russo-Ukrainian War, could be financially burdensome. Moreover, both conflicts carry the risk of escalating into a larger global conflict.
If that occurs, $1.59 trillion will hardly suffice; instead, we may see the need for tens of trillions more in the short term. This will exacerbate deficits, elevate debt levels, and push interest rates higher.
The trifecta of increased deficits, mounting debt, and rising interest rates is conspiring to drive the federal government’s net interest on its debt towards $1 trillion annually. The outcome? A vicious cycle of greater deficits, escalating debt, and climbing interest rates.
You don’t need to be a financial expert to recognize the disarray in government finances. More crucially, how high will interest rates need to rise before the Federal Reserve feels compelled to act as the lender of last resort?
With the U.S. government holding $33.5 trillion in debt, it cannot sustain interest rates at current levels. As debt is refinanced at significantly higher rates than two years ago, the financial pressure intensifies.
Considering the associated risks and the likely reluctance of buyers, interest rates could potentially double once more. Naturally, the Fed will intervene before an outright default occurs, likely returning to its bond-buying practices.
With the impending issuance of debt, the Fed’s balance sheet could rapidly expand from $7.9 trillion to $16 trillion and possibly exceed $20 trillion.
Once Upon a Time in Flagstaff
These purchases of Treasuries by the Fed will indeed help to lower interest rates. However, it’s crucial to note that the Fed will be financing this massive quantity of Treasuries using credit generated from thin air through ledger entries.
While the monetary authorities may successfully reduce interest rates, they will simultaneously ignite rampant consumer price inflation, ultimately leading to a crisis with the dollar.
As this unfolds, all kinds of unexpected and chaotic scenarios may arise. What will the economy look like when the Fed’s balance sheet exceeds $20 trillion? How many zeros will be added to today’s prices when the national debt surpasses $50 trillion?
What types of schemes and frauds will flourish when a simple cup of coffee costs fifty dollars?
An increasing number of individuals are recognizing the ominous trends ahead. This week, for instance, a cashier at O’Reilly Auto Parts in Flagstaff, Arizona, remarked, “Those who cannot remember the past are condemned to repeat it.”
Whether he’s familiar with George Santayana is uncertain, but his comment wasn’t prompted by anything we said.
The inspiration for his insight? A can of fix-a-flat that rung up over $16. In his eyes, this pricing reflects the excessive absurdity permeating today’s economy.
From our perspective, we’ll appreciate a $16 can of fix-a-flat while it lasts. In the coming years, the price could easily soar to $160. This isn’t a joke.
There’s a cabal of financial operatives at the Fed and Treasury working hard to increase pricing across the board. Their aim seems to be transforming dollars into currencies akin to pesos.
But what do we truly know?
Perhaps Siegel is correct. Perhaps interest rates are nearing their peak, and favorable conditions for investors are on the horizon for 2024.
Nonetheless, following thorough contemplation, we remain skeptical.
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Sincerely,
MN Gordon
for Economic Prism
