The Once-Dismissed Possibility Of Rising Rates Is Now A Reality

A weekend topic starting with the Boston Globe in Massachusetts. “Steve McKenna, a real estate broker at Gibson Sotheby’s, said he is dealing with an elderly couple contemplating whether to sell their $1.1 million home in Arlington and whether they can live off the proceeds. They bought their home in the early 1970s for $80,000, but refinanced a few times to put their three children through college and pay for health care expenses. The couple still owes $410,000 on the mortgage. ‘People selling their houses for a million dollars, they’re not rich,’ said McKenna.”

The Washington Post. “The U.S. government spent $659 billion this year paying off the interest on its debt, according to a Treasury report released Friday, as the nation’s widening fiscal imbalance and the Federal Reserve’s rate hikes dramatically raised the federal cost of borrowing. Because the federal government spends more than it collects in tax revenue, the Treasury Department issues new debt to cover the rest of its payment obligations. That debt must be repaid with interest — costs that grow as the debt grows. The United States spent more on interest than on all federal programs for children, including child care, education and tax credits for families, according to the Committee for a Responsible Federal Budget, which advocates for a lower deficit.”

“This year’s sum was almost twice as much as two years ago. The government spent $476 billion paying off the interest on its debt last year and $352 billion doing so in 2021. ‘The federal government is sitting on a ticking time bomb. Payments on the debt already doubled over the last two years, and are expected to double again over the next decade,’ said Brian Riedl, senior fellow at the Manhattan Institute, a conservative-leaning think tank. ‘Congress remains completely asleep at the wheel, and unwilling to make even minor gestures toward reining in the toxic combination of rising debt and higher interest rates.'”

From Bloomberg . “The Federal Reserve faces potential policy pitfalls ahead as it wrestles with how to respond to investor angst about the US government’s $33.5 trillion mountain of debt. Concerns about America’s fiscal future have already contributed to a run-up in US bond yields that has surprised policymakers and prompted them to consider postponing for now plans for another interest-rate increase. Worries on Wall Street about the US budgetary morass pose risks to both sides of the central bank’s dual mandate.”

“The disquiet over deficits and debt puts upward pressure on long-term interest rates, threatening to slow growth and push up unemployment. At the same time, it can also act as kindling for higher inflation, especially if the Fed is perceived as downplaying its goal of price stability in order to limit the federal government’s borrowing costs. ‘We are witnessing the beginning of a regime change in how investors perceive America’s fiscal sustainability,’ said former Fed Governor Kevin Warsh, who was an adviser to President George W. Bush from 2002 to 2006.”

“In August, Fitch Ratings Inc. stripped the US of its top-tier AAA credit rating while the Treasury announced a bigger-than-expected quarterly borrowing requirement. An estimate last week from the Congressional Budget Office that the deficit jumped by more than 20% in the just-ended fiscal year, to $1.7 trillion, added to the unease. ‘It’s just hard to believe that this is a sustainable policy going forward,’ Fed Governor Christopher Waller said on Oct. 11 at the E2 Summit in Park City, Utah.”

“The rise in yields is threatening to make the untenable fiscal outlook even worse, said former CBO Director Douglas Holtz-Eakin, who advised George W. Bush while he was in office. ‘We have a super-interest-sensitive budget,’ said Holtz-Eakin, president of the American Action Forum. ‘If the bond market is starting to decipher more accurately the effective fiscal position of the US, then we’re in trouble.’ Warsh agreed. ‘It’s exceedingly difficult to have sound monetary policy without sound fiscal policy,’ the Hoover Institution visiting fellow said. ‘And US fiscal policy is decidedly unsound.'”

From Reuters . “Buying into one of the biggest bubble bursts in history is brave and maybe even smart – but, like all market shocks, fraught in timing the turn. Three years of plunging global bond prices and the resulting spike in yields shows few signs of abating – and it’s all happening in some of the ‘safest’ sovereign debt on the planet. The reasons are all well documented – high inflation, tight labor markets, rising policy interest rates, unwinding central bank bond stashes and historically high and rising government deficits and debts. The 40-year bond bull market – a slow-inflating bubble like any other to some people – has crashed.”

“The scale of the drop in many long-term U.S. Treasury bond funds over the past three years is eye-watering – a price loss of more than 50% and counting from pandemic peaks of 2020. That’s now on par with the gigantic S&P500 equity drawdowns of the bust and banking crash 15 years ago. Benchmark U.S. Treasury yields across the maturity spectrum are climbing to 5% and beyond for the first time in more than 16 years and show few signs of cresting so far.”

“It’s worth bearing in mind that global funds reported being net underweight bonds for more than 10 years prior to last December. Perhaps significantly, the last time funds held such an overweight position on bonds for so long was during the banking crash and recession of 2008-2009 – when yields were near current levels and the Federal Reserve kicked off a quantitative easing policy that stacked its balance sheet full with Treasuries.”

“And even if you get the maths of all that right, there now enters the relative unknown of what happens with unprecedented sovereign debt piles, new bond supply and likely tortuous attempts to rein in bloated post-pandemic government deficits. That’s why so much attention has lately fallen back on the nebulous ‘term premium’ – a re-emerging risk premium demanded by investors to hold long-term bonds to maturity as opposed to rolling short-dated debt over the same time horizon.”

“While experts differ on both the measurement and direct causes of the term premium, the New York Fed’s favoured model puts it back positive again to the tune of about 30 bps having spent most of the past eight years in negative territory. Others estimate it’s far higher. Olivier Davanne at Paris-based advisory Risk Premium Invest says his model of this ‘buy and hold risk premium’ suggests some 90bps of the 106bp rise in 10-year Treasury yields since midyear was down to this factor – with only 16 bps related to more aggressive pricing of long-term policy rates.”

“By his calculation this premium in 10-year bonds is higher than at any time since the 1990s at more than 100 bps – due variously to unpredictable debt supply dynamics, geopolitics, uncertainty on where inflation will be allowed to settle and a residual fear of many years of equity and bond correlation. ‘As such, funds may simply be seeing a natural top – the final deflation of a 15-year bubble and the prospect that swinging central bank tightening will eventually see economic slowdown, if not recession, as corporate and household debt stress surely follows the credit squeeze. ‘In the ‘higher for longer’ context, it is therefore difficult to have a firm view on the behavior of this key market in the months to come,’ Davanne said, adding he ‘certainly cannot rule out a further significant rise in long-term rates.'”

From . “Money supply growth fell again in August, remaining deep in negative territory after turning negative in November 2022 for the first time in twenty-eight years. August’s drop continues a steep downward trend from the unprecedented highs experienced during much of the past two years. Since April 2021, money supply growth has slowed quickly, and since November, we’ve been seeing the money supply repeatedly contract year over year. The last time the year-over-year (YOY) change in the money supply slipped into negative territory was in November 1994. At that time, negative growth continued for fifteen months, finally turning positive again in January 1996.”

“Money-supply growth has now been negative for ten months in a row. During August 2023, the downturn continued as YOY growth in the money supply was at –10.8 percent. That’s unchanged from July’s rate of –10.8 percent, and was far below August 2022’s rate of 4.4 percent. With negative growth now falling near or below –10 percent for the sixth month in a row, money-supply contraction is the largest we’ve seen since the Great Depression. Prior to this year, at no other point for at least sixty years has the money supply fallen by more than 6 percent (YoY) in any month.”

“The money supply metric used here—the ‘true,’ or Rothbard-Salerno, money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. The Mises Institute now offers regular updates on this metric and its growth. This measure of the money supply differs from M2 in that it includes Treasury deposits at the Fed (and excludes short-time deposits and retail money funds).”

“The fact that the money supply is shrinking at all is remarkable because the money supply in modern times almost never gets smaller. The money supply has now fallen by $2.9 trillion (or 13.4 percent) since the peak in April 2022. Proportionally, the drop in money supply since 2022 is the largest fall we’ve seen since the Depression. (Rothbard estimates that in the lead-up to the Great Depression, the money supply fell by 12 percent from its peak of $73 billion in mid-1929 to $64 billion at the end of 1932.)”

“In spite of this recent drop in total money supply, the trend in money-supply remains well above what existed during the twenty-year period from 1989 to 2009. To return to this trend, the money supply would have to drop at least another $3 trillion or so—or 15 percent—down to a total below $15 trillion. Since 2009, the TMS money supply is now up by nearly 185 percent. (M2 has grown by 142 percent in that period.) Out of the current money supply of $18.8 trillion, $4.6 trillion—or 24 percent—of that has been created since January 2020. Since 2009, $12.2 trillion of the current money supply has been created. In other words, nearly two-thirds of the total existing money supply have been created just in the past thirteen years.”

“With these kinds of totals, a ten-percent drop only puts a small dent in the huge edifice of newly created money. The US economy still faces a very large monetary overhang from the past several years, and this is partly why after eighteen months of slowing money-supply growth, we are not yet seeing a sizable slowdown in the labor market. The inflationary boom has not yet ended.”

“An inflationary boom begins to turn to bust once new injections of money subside, and we are seeing this now. Not surprisingly, the current signs of malaise come after the Federal Reserve finally pulled its foot slightly off the money-creation accelerator after more than a decade of quantitative easing, financial repression, and a general devotion to easy money. As of September, the Fed has allowed the federal funds rate to rise to 5.50 percent, the highest since 2001. This has meant short-term interest rates overall have risen as well. In September, for example, the yield on 3-month Treasurys reached the highest level measured in more than 20 years.”

“Without ongoing access to easy money at near-zero rates, however, banks are less enthusiastic about making loans, and many marginal companies will no longer be able to stave off financial trouble by refinancing or taking out new loans. The banking sector itself has warned investors to prepare for new rounds of layoffs. Meanwhile, large corporate bankruptcy filings surged in the first half of the year. Lending for private consumption is getting more expensive also. This week, the average 30-year mortgage rate rose to the highest point reached since the year 2000.”

“These factors all point toward a bubble that is in the process of popping. The situation is unsustainable, yet the Fed cannot change course without reigniting a new surge in price inflation. Although some professional economists insist that price inflation has all but disappeared, the sentiment on the ground is clearly one in which most workers believe their wages are not keeping up with rising prices. Any surge in prices would be especially problematic given the rising cost of living. Ordinary Americans face a similar problem with home prices. According to the Atlanta Fed, the housing affordability index is now the worst it’s been since 2006, in the midst of the Housing Bubble.”

“If the Fed reverses course now, and embraces a new flood of new money, prices will only spiral upward. It didn’t have to be this way, but ordinary people are now paying the price for a decade of easy money cheered by Wall Street and the profligates in Washington. The only way to put the economy on a more stable long-term path is for the Fed to stop pumping new money into the economy. That means a falling money supply and popping economic bubbles. But it also lays the groundwork for a real economy—i.e., an economy not built on endless bubbles—built by saving and investment rather than spending made possible by artificially low interest rates and easy money.”

From Reason . “Countless financial soothsayers and Wall Street wizards were once members of a curious cult. Their doctrine? The unshakable belief that interest rates had managed to find something resembling the fabled Fountain of Youth, leaving their numbers eternally low and never rising. The ‘Forever Low’ brigade dismissed those of us who argued that high government debt was unsustainable and, partly because low repayment rates would not last forever, we should control spending.”

“Now, let’s be clear. Predicting the economic future isn’t like reading the morning weather forecast. Nevertheless, the certainty of the Forever Low cult felt a bit like confidently asserting that winter would never come to Alaska because June was particularly warm. Interest rates have historically fluctuated due to various economic factors. Somehow, many believed that the unprecedented period of declining and low rates over the past few decades had become the new normal, never to change much.”

“In a way, the curious cult’s certainty was impressive. It’s not every day we witness such unwavering confidence in the face of rising red ink. It was even more stunning during the pandemic, when we saw the national debt rise by $5 trillion over a mere two years. That included $2 trillion in March 2021 with no call for future austerity, a time when the economy was already recovering and inflation was thus significant.”

“When inflation warnings became hard to ignore, the Forever Low gang retorted that it was silly to worry because, in the worst-case scenario, ‘the Fed has the tool to bring inflation down.’ That tool amounts to hiking interest rates to slow down the economy—which seems in direct contradiction to the belief that debt accumulation was OK because, you know, interest rates would remain forever low.”

“But then, as fate (and economics) arranged matters, the winds shifted. Whispers started circulating about tangible changes on the horizon. The first signs were subtle, but soon the murmurs became louder. The once-dismissed possibility of rising rates is now a reality. With the yield on a 10-year Treasury yield above 4.5 percent, the new refrain is that we could ignore deficits in the past, but we can’t anymore. Of course, this too is wrong. We should have never ignored deficits, which, along with spending and debt projections, were on an uphill trajectory that made us susceptible to a crisis if interest rates rose suddenly—especially since half of our debt has a maturing time of three years or less.”

“In the end, the Forever Low believers were correct in their own transitory way. After all, interest rates did remain low for an extended period, catching many by surprise. Their main mistake, though, was tragic: concluding that there was no cost to trillions of dollars in additional debt.”

State House News Service. “Massachusetts continued to record more births than deaths from July 2021 to July 2022 even though the state’s total population shrunk in that span, suggesting that residents decamping to other locales is the primary driver of a trend that has steadily ramped up pressure on policymakers, analysts said Wednesday. Luc Schuster, the executive director of the Boston Indicators research center, said the data ‘just jumps off the page how much housing has to be a central driver of the domestic outmigration we’re seeing.'”

“‘It’s a weird dynamic because we’re starting to see an acceleration of people moving out of Greater Boston, so in a sense, that’s demand going down, but it’s as housing costs continue to rise dramatically,’ he said. ‘To me, there’s just a lot going on here, but I can’t help but think about how much more prosperous we could be if we fixed our housing problem.'”

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