Debt, bonds and gold: Has the Federal Reserve overdone it?By Mike Maharrey Over the last four months, the Federal Reserve has cut interest rates by a full percentage point. It started with a supersize 50 basis point cut in September, followed by quarter-point cuts in November and December. But despite slashing rates, Treasury bond yields have risen sharply. What's going on in the bond market? Why are we seeing this disconnect between monetary policy and the long end of the yield curve? Financial analyst and bond guru Jim Grant talked about this incongruous trend on CNBC. He said he thinks decades of monetary malfeasance coupled with out-of-control government borrowing and spending have finally caught up with us.
What does Grant mean by "overdone it?" He's referring to the aggressive rate cuts despite sticky price inflation created by decades of easy money. Grant thinks at some level, the markets understand the inflation dragon isn't dead and investors are demanding a higher rate of return to cover that potential inflation risk. And on the fiscal side of the coin, the world is growing increasingly concerned about the debt situation in the U.S. Despite a ballooning national debt eclipsing $36 trillion, the federal government continues to spend excessively more than it takes in, running massive deficits month after month. Gold Newsletter editor Brien Lundin told MarketWatch that dollar strength, rising Treasury yields, and the surging price of gold are all evidence of this global concern about the U.S. fiscal situation.
Grant emphasized that these two factors are weighing on the bond market and causing yields to rise.
Lundin made a similar observation.
Grant said this problem has been in the making for decades. Artificially suppressed interest rates allowed everybody to sweep the government spending and debt problems under the rug.
Grant pointed out that under Reagan, interest rates were sawed in half as the debt nearly doubled. This kicked off a bull market in bonds, with yields falling for 40 years between 1991 and 2021. That had consequences.
Grant has observed that bull and bear cycles in the bond market tend to be generational. He pointed out that the bear market in bonds preceding the most recent 40-year bull market lasted for 35 years.
And the downward spiral in bonds could be significant, meaning a substantial rise in bond yields. "Common sense would tend to support this proposition that great excesses characterize great bull market tops and great bear market bottoms," Grant said. This is bad news for a government that depends on low borrowing costs to sustain its borrow-and-spend habits, and it spotlights the Catch-22 facing the Federal Reserve. It needs to keep driving rates down due to the massive level of debt (And it's not just government debt. Corporations and consumers are levered to the hilt as well.), but it also needs to keep rates higher to keep inflation at bay. It can't do both. Grant cautioned that his projection of a generational bear market in bonds is "conjecture based upon historical observation" and that things don't have to play out that way. But...
Some people claim that we don't need to worry about borrowing and money printing because the U.S. issues the reserve currency. In essence, it's like a credit card with no limit. But Grant cautions that the benefits of reserve currency privilege have their limits.
As far as inflation, Grant doesn't think it's dead and buried. In fact, he expects more rounds of price inflation.
One might expect rising yields to create headwinds for gold, but so far, that hasn't been the case. Gold has been surprisingly resilient despite the surging dollar and bond yields. The ongoing inflation problem and the elevated levels of risk due to the federal government's fiscal irresponsibility are bullish for gold. The yellow metal will also likely benefit from the ongoing global diversification away from the dollar. We saw this play out last year as central bank gold buying supported the market even with interest rates at relatively high levels. Mike Maharrey is a journalist and market analyst for MoneyMetals.com with over a decade of experience in precious metals. He holds a BS in accounting from the University of Kentucky and a BA in journalism from the University of South Florida.
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