In the previous blog post, I suggested that if the FED was afraid of flat yield curves then they OUGHT to CUT overnight rates immediately by 50 basis points in an effort to steepen the curves to a more NORMAL slope. On Friday, in a nod to Notes From Underground, President Trump’s latest Fed nominee Steve Moore and White House advisor Larry Kudlow said that the central bank should slash interest rates by 50 basis points. Unlike my suggestion, the avid supply-siders offered no context for the rate cuts. There was no discussion of yield curves, dollar strength or the problems confronting global growth.
Even as the U.S. equity markets sustained its rally, emerging market currencies suffered a dreadful week as the Mexican peso, Brazilian real, Argentinian peso, South African rand and Russian rouble all suffered selloffs. Is the recent bout of dollar strength that’s setting the course for an ever greater global slowdown? The U.S. markets have applauded the recent dovish FED pivot but the emerging markets have not experienced a similar enthusiastic response: Yet another reason for the FOMC to be particularly vigilante about global headwinds.
But as far as Kudlow/Moore are concerned, let me suggest the following as for the most pressing reason for the administration’s urging for an immediate rate cut: The increasing deficit in the time of “robust” economic growth is going to become an election issue. Kudlow /Moore are both disciples of the Laffer curve and the concept of tax cuts generating enough growth to offset the immediate decline in government revenues. The problem for Kudlow is that the DEFICIT is increasing and with the recent interest rate increases by the FED the cost of financing the U.S. deficit is growing. This is a serious issue as growing interest costs will result in cutting discretionary programs to stem the increase in the deficit.
As of this year, the interest on the debt is roughly 8.7 percent of the budget and is projected to grow. (Please a take look at the table below, courtesy of the FY 2020 budget from the Office of Management and Budget.) The supply-side has to keep rates low in an effort to contain the explosion in the cost of maintaining the expanding deficit. This is not an effort to cast blame but merely the need to draw attention as to why investors have to BE INSANE to buy U.S. long duration sovereign bonds. If a recession comes soon the DEFICIT WILL INCREASE FASTER, calling more attention to the malfeasance plaguing the American political system.
| Fiscal Year | Interest
on Debt |
10-Year
Yield |
Total Debt | Percent
of Budget |
|---|---|---|---|---|
| 2008 | $253 | 3.7% | $5,803 | 8.5% |
| 2009 | $187 | 3.3% | $7,545 | 5.3% |
| 2010 | $196 | 3.2% | $9,019 | 5.7% |
| 2011 | $230 | 2.8% | $10,128 | 6.4% |
| 2012 | $220 | 1.8% | $11,281 | 6.2% |
| 2013 | $221 | 2.4% | $11,983 | 6.4% |
| 2014 | $229 | 2.5% | $12,780 | 6.5% |
| 2015 | $223 | 2.1% | $13,117 | 6.0% |
| 2016 | $240 | 1.8% | $14,168 | 6.2% |
| 2017 | $263 | 2.7% | $14,824 | 6.8% |
| 2018 | $325 | 2.9% | $15,750 | 7.9% |
| 2019 | $393 | 3.4% | $16,919 | 8.7% |
| 2020 | $479 | 3.6% | $18,087 | 10.1% |
| 2021 | $548 | 3.8% | $19,222 | 11.1% |
| 2022 | $610 | 3.8% | $20,334 | 11.8% |
| 2023 | $664 | 3.7% | $21,304 | 12.5% |
| 2024 | $702 | 3.7% | $22,064 | 12.9% |
| 2025 | $733 | 3.7% | $22,756 | 12.9% |
| 2026 | $762 | 3.7% | $23,390 | 12.9% |
The current period of low employment should result in the government experience BUDGET SURPLUSES, according to the work of Keynes. The Austrians will warn about the threat of the debt overhang to future growth. The MMTers and supply-siders will proclaim a printing press and/or debt doesn’t matter. However, I maintain that global finance is always about the debt load. Yes, the curves have flattened into quarter-end and maybe longer but I will not be trapped by the siren call of an extra 15 basis points for extended duration to placate the need for extra yield. Kudlow/Moore did not provide comfort to my portfolio as they need to paint a better budget picture as the next presidential election looms. This is not political but based on attention to the genuine narrative of flawed policies.
Fed Vice Chairman Richard Clarida delivered an important speech in Paris last week. In his remarks, titled “Global Shocks and the US Economy,” Clarida let the world know that the U.S. has the global financial system’s BACK. Clarida reiterated multiple times in the last three decades how the U.S. has come to the aid of the global financial system. He noted that Brexit, a slowdown in Asia, and, of course trade tensions pose real risks to the U.S., as well as the world. He said:
“Even though the Fed has been committed to a dual mandate to achieve maximum employment and price stability, in today’s world, U.S. policy makers can hardly ignore thee risks, and three of our most recent FOMC statements have highlighted concerns about global economic and financial developments.”
In discussions about the significance of the Clarida speech in an international forum, my old friend Kevin Mc Carthy noted this passage from Clarida: The FED Vice Chair noted that US global trade integration is only about 30% of GDP but US global financial exposure is 300% of GDP having grown from 25 percent in 1960. McCarthy wonders why Clarida failed to make relative international financial comparisons on the issue of financial exposure (external assets and liabilities) that the U.S. has encumbered. He said, “The obvious answer is that it would call to attention the imbalance of the U.S. economy, the extent of U.S. vulnerability to global financial instability, and therefore the FED‘s true “mandate” to service U.S. global financial interests at home and abroad.”
In June 2016, I asked then-Fed Governor Jerome Powell about what guarantees the balance sheet when it comes to the ECB. Powell said, “They have a printing press.” It is the printing press that provides the basis for my fear of U.S. debt and all that flows from there. I know what course others are taking but I will be avoiding long-term U.S. sovereign debt and the cost to me will remain slight. To KNOW balance sheet peace is to remain short duration as possible.
Tags: budget deficit, Fed, FOMC, Jerome Powell, Larry Kudlow, Richard Clarida, Steve Moore, yield curves
March 31, 2019 at 11:37 pm |
When I am structuring my portfolio and including Treasury paper, the decision I make is whether to take 3 or 6 month bills. A long term investor often misses the rewards of irrational exuberance (which presently has been quite long) but is consoled by being the tortoise and not the hare. Traders of course make other calculations.
When the printing press is the primary device left for the central banker to combat a sluggish or weak economy, than the associated fiat currency is not very long for existence. Endless debasing of a currency has historically never ended well going back to ancient times.
As has been pointed out recently on this blog, J M Keynes is almost always quoted in times of economic decline. But he also opined about reducing debt in times of plenty and robust employment. Spending in our national budget should have been cut at least five years ago with agencies eliminated and budget cuts almost across the board. There is much fat that has been accumulated and should have been excised to produce surpluses and debt reduced. A Faustian deal with the prodigal devil is what both the Ds and Rs can all agree upon. In the corporate world surpluses should have gone to reducing borrowings instead of stock buybacks that gladdened the heart of the hare.
Let’s start a new slogan.
LIPOSUCTION for the national budget!
Is it already too late? Maybe but let’s give it a try.
April 1, 2019 at 9:42 am |
Asherz—we of course are right in sync with this serious issue that all investors OUGHT to be concerned about–as Richard Papp notes ,there was an opportunity to buy the long end as a trade which I covered with Santelli as I saw the flattening of the yield curve coming–but now the valued has been squeezed out of the long end it is time to rebalance–the political battle will be fought over the budget and the cut in discretionary spending as the social safety net and the military are sacrosanct–unfortunately.Fiat money demands a responsible fiduciary
April 1, 2019 at 11:13 am |
Regarding the non-stop federal spending no matter which party is running Congress, I keep thinking that there’s a good reason for it.
Given the ever-larger influence of corporate financing of election campaigns (which are essential in modern politics), and their lobbyists’ heavy influence deep in the swamp, is it not feasible that the firms taking the other side of all the inefficient pork-barrel contracts make great profits from them, thus they have a vested interest making sure the gravy keeps poring in?
Or am I being too cynical?
April 1, 2019 at 11:38 am
Pgrommit–there is wisdom in thoughtful cynicism.All budget errors begin with defense–that was the real power of Bowles /Simpson as it sought to cut defense in an effort to get others to attack the sacred cows that are financed for the tit-for-tat of supporting the massive defense budget that is pork for so many congressional districts in America—-for as Phil Ochs sang many years ago —I am working in a defense plant in his famous –Draft Dodger Rag.No cynicism can be well founded and needed so love me love me love me —I am a liberal
April 1, 2019 at 4:46 am |
For those who were sharp enough in Oct, 2018 to catch the bottom in US Treasuries, big bucks were made on the long side. For example, the 2 1/4% UST Bond of 2046 bottomed at 78 1/2 and on Friday closed at 89 1/2. Ditto for TLT, CBOT near contract and all cash UST Bonds of 20 years or more. The 6 1/4% of 5/15/30 “only” gained 8 points.
As to what to do going forward……………………
April 1, 2019 at 5:35 am |
Richard FWIW my charts suggest more upside to come for TLT after a short term correction lower. Setting up a major swing high later. Likewise more correction for golds before resuming higher.
April 1, 2019 at 5:24 am |
Yra, I agree that those sovereign bonds are likely a terrible hold for the long run. As the long sovereigns might well lose value, but not necessarily because interest rates and/or debt service costs explode higher with higher gov’t debt levels. A similar fundamental argument was made ten years ago (and after) regarding the outlook for long rates, but that didn’t materialize beyond short-intermediate time horizons good for swing traders.
As you and asherz above remind us, there exists the factor of the printing press. Policymakers can and have used it to create a bond bid and/or cap interest rates including long rates through market intervention. They can use the printing press to help service the debt, or to avoid increasing the federal debt (MMT). They possibly have even more radical interventions they’re preparing to use.
So instead of the nominal value of bonds losing value, the release valve becomes the dollar. That is how long sovereign bonds can and have lost real value before at times. And this time, US policymakers are practically telling us they want a weaker dollar and historically low yields for longer. A weaker dollar, low rates and MMT are among the few things for which there seems to exist bipartisan support in the US. They seem to believe inflation is impossible regardless of what they do. But I say, we should fade that view and think like Gretzky: go where the puck is going, not where it has been. Slowing US growth, rising inflation.
(PS. How did Powell get away recently with citing oil as an example of falling inflation when in fact prices have been ripping for months and are no lower than a year ago?)
April 1, 2019 at 7:20 am |
Amazing how Kudlow (former “King Dollar” cheerleader a few short years ago) has “matured” now that he’s on the team!
April 1, 2019 at 7:21 am |
Yra,
based on your thinking, I bought the 4.75% Mexican 44s a couple of years ago. My timing was off a bit. But, I figured that interest rates will have to come down and stay down. And, that Mexico would not go out of business and continue to pay its US Dollar debts.
Lower wholesale interest rates may be good for the Government but not for regular people. If the Fed wanted to quickly stimulate the economy, it could put a ceiling on consumer interest rates. Say 500 BP over the Fed Funds rate. So, if a bank wanted to directly or indirectly borrow from the Fed, it could not charge more than the ceiling rate on consumer loans. Just consumer loans and not corporate loans.
That would destroy payday and other usurious loans. But those borrowers are not creditworthy anyway. The banks would not be hurt badly. They would collect less interest. And, the consumers would have more disposable income.
April 1, 2019 at 9:16 am |
Prepalaw –don’t forget the greatest payday loan place—H&R Block.But mandating such an outcome would spook the banking the industry as they write auto loans and installment debt through credit cards hoping that the consumers fall into arrears
April 1, 2019 at 9:49 am |
Prepalaw—also I admire your Mexico decision as with the right leadership Mexico can be the star of the emerging world markets.Corruption in Mexico is destructive of the entire economic edifice just like in Chicago.Crony capitalism is the breeding ground for wealth destruction and the erosion of investment that benefits the entire population.If Mexico under AMLO can revere the years of Salinas,Nieto,and Zedillo then things will really work to help develop a real Mexican middle class
April 1, 2019 at 9:16 pm |
“If the Fed wanted to quickly stimulate the economy”
Perhaps IOER dovetails with this subject.
April 2, 2019 at 4:37 pm
Chicken–without debt you are correct on the IOER –but if that cost becomes ever larger as rates were to rise or if the curve inverts then the person behind the curtain will be revealed to be a sham for the FED will have to bear a higher and higher cost to keep the reserves at the fed and from letting that money from leaking into the economy