In today’s chaotic landscape, it feels like there’s an endless array of shocking news stories that keep us on our toes. We browse through headlines in disbelief, much like our four-year-old son who was utterly mesmerized the first time he laid eyes on the oversized pigs at the LA County Fair.
Much like those colossal pigs, the headlines we encounter are both alarming and grotesque. Yet, we find it impossible to look away. We take a moment to reflect and connect the dots, all to bring clarity to you.
For example, this past Tuesday, the World Health Organization classified our cell phones as potential cancer-causing agents. Astonishingly, they placed cell phones in the same category as gasoline engine exhaust and coffee. How unbelievable!
We willingly indulge in coffee each morning, relishing its flavor and energizing effects. In contrast, we unknowingly inhale gasoline fumes daily during our rush hour commutes on the 405 freeway. The smell is unpleasant, and the effects are far from desirable. Yet, there are those who might appreciate it…
Last weekend, Sarah Palin addressed a group of motorcycle-riding veterans at the Memorial Day “Rolling Thunder” event on Washington’s National Mall, declaring, “I love the smell of the emissions.” Can you imagine it? A politician with such an odd affinity? It’s a tale that seems too bizarre to be true.
If you think a fondness for motorcycle emissions is peculiar, get ready for a look at the financial markets…things can get downright crazy.
Just What the Federal Reserve Needs
On Tuesday, the DOW surged by 126 points, only to plunge by 279 points the very next day—wiping out Tuesday’s gains. By the end of yesterday, market sentiment was in disarray, resulting in a 41-point loss for the DOW.
While stocks appear to be on an emotional rollercoaster, the real chaos is unfolding in the debt markets. On Wednesday, investors significantly increased demand for Treasuries, driving the yield on the 10-Year Note below 3 percent.
According to Reuters, “[Treasury] prices soared as data on private payrolls and manufacturing came in well below expectations.”
These disappointing payroll and manufacturing figures indicate a slowing economy. In a world with a stable money supply and a gentle central bank, Treasuries would be a wise investment. However, the prospect of a stock market crash makes Treasuries a safer place to safeguard your capital.
But we do not operate in such an economy. Instead, we are in an environment characterized by an expanding money supply and an aggressive central bank. A slowing economy coupled with escalating unemployment is exactly what the Federal Reserve needs to engage in questionable actions—like injecting more “funny money” into the market.
Moreover, the federal government is deeply buried in debt. If Congress fails to agree on raising the deficit ceiling by August 2, the U.S. risks defaulting on its obligations or repaying them with printed money. The consequences of this are unclear, but the inherent risks surely warrant more than a 3 percent yield.
Near the Boiling Point
Likely, Congress will reach a last-minute compromise. They will act as if they have tackled the debt issue with spending cuts, and life will proceed as usual. We remain confident that the Federal Reserve will eventually achieve its stated goal of inducing positive inflation.
In fact, we predict that within the next decade, inflation will surpass 3 percent, resulting in a negative real interest rate for today’s 10-Year Notes. When that occurs, those who purchased Treasuries recently will essentially be paying to lend their hard-earned money to the government.
To further illuminate the bond market’s intricacies, we turn to Bill Gross, known as the Bond King. He recently equated bond investors to a frog slowly being cooked in a pot of water:
“Much like gradually turning up the temperature on poor froggy’s kettle of water, monetary policy in developed countries has been lowering the temperature and absolute level of yields for the past two and a half years post Lehman Brothers. Teeter-totter yields down, teeter-totter prices up, and froggy’s total return euphoria at present seems to know no bounds. But once the potential for even lower interest rates is minimized, our future frog-legged entrée is left with a rather uncomfortable feeling…”
He continued, emphasizing the perilous state of bond prices as they near boiling point. As the Fed, Chinese investors, and banks continue to buy up available Treasury bonds, everything seems fine on the surface. However, those bond investors who possess a survival instinct should heed the warning of rising prices, which indicate diminishing yields.
In this climate, the risks involved signal a troubling outlook for bond investors, leaving them in a precariously vulnerable position. Ultimately, it appears that both prices and expected returns could lead one to feel quite “cooked.”
Best wishes,
MN Gordon
for Economic Prism