“There is $50 trillion more in world debt today than there was in 2018.” And that will hurt equities. Larry McDonald
2021 global debt database shows largest one year debt surge post World War II to $226 trillion, i.e., 256% of global GDP in 2020. Government borrowing was half this increase; global public debt rose by 20% to an unprecedented level in over 50 years.
In a financial sense, the bond (or debt) market dwarfs the stock market. Although the rise in interest rates has been devastating for bond investors because of the inverse relationship between rates (yields) and bond prices. In actuality, both the debt and equity markets have fallen this year.
Yet, “The world is still in love with debt,” according to analysts at Bank of America Merrill Lynch. Debt vulnerabilities are rising, with potential costs and risks to debtors, creditors and, more broadly, global stability and prosperity. But, does it matter. After all, world governments owe the money to their own citizens. The rising total global debt is important for two reasons.
First, when debt rises faster than economic output (as it has been doing in recent years), higher government debt implies more state interference in the economy and higher taxes in the future.
Second, debt must be rolled over at regular intervals. This creates a recurring popularity test for individual governments’ sovereign bonds. Fail that test, as various euro-zone governments have done, and the country (and its neighbors) can be plunged into fiscal and economic crisis.
If the Federal Reserve raises the federal funds rate by another 100 basis points and continues its balance-sheet reductions at current levels, “they will crash the market,” states Larry McDonald, founder of The Bear Traps Report and author of “A Colossal Failure of Common Sense”.
A pivot may not prevent pain
McDonald expects the Federal Reserve to become concerned enough about the equity market’s reaction to its monetary tightening to “back away over the next three weeks,” announce a smaller federal funds rate increase of 0.50% in November “and then stop.”
U.S. inflation hits 8.2% in September — hotter than expected. Core CPI surges to 6.6%, the highest since 1982.
A key consumer inflation report, the Consumer Price Index (CPI), came in hotter than expected, signaling that the Federal Reserve will likely continue with aggressive interest rate hikes. Prices consumers pay for a wide variety of goods and services rose as inflation pressures continued to weigh on the U.S. economy.
The consumer price index for September increased 0.4% for the month, according to the Bureau of Labor Statistics. On a 12-month basis, so-called headline inflation was up 8.2%, off its peak around 9% in June but still hovering near the highest levels since the early 1980s. Core CPI, which strips out volatile food and energy prices, rose to 6.6% from 6.3%. Both numbers came in higher than economists polled by the Wall Street Journal had expected.
Source: Bloomberg
The report signals that inflation is a persistent problem even amid large interest rate hikes from the central bank. Going forward, the Fed will likely have to keep delivering increases and keep rates high until there are signs that inflation is cooling off.
Prioritizing climate change and green energy means that Democrats actually like high gas and fossil fuels prices. ~ American Enterprise Institute
The United States is sitting on 264 billion barrels of untapped oil — more than any other country on the planet, according to a new report from Rystad Energy. The vast quantity includes oil in existing fields, new projects, recent discoveries as well as projections in undiscovered fields.
More than half of America’s untapped oil is unconventional shale oil, according to Rystad. Thanks to fracking and the shale oil boom, the U.S. is sitting on more oil reserves than Russia.
Yet, the Biden Administration’s vow to make Saudi Arabia a pariah nation, to reduce the world’s dependence, and to curtail domestic fossil fuels production has made the United States more dependent on energy from foreign sources, writes Marc A. Thiessen, Senior Fellow, American Enterprise Institute. The hostility towards domestic hydrocarbons has also resulted in higher gasoline prices at the pump and in higher prices to generate electricity with natural gas.
Since taking office, the Biden Administration has leased fewer acres of federal land for oil and gas drilling, suspended all oil and gas leases in Alaska’s Arctic National Wildlife Refuge, and announced plans to block new offshore oil drilling in the Atlantic and Pacific oceans.
And the Biden Administration might be preparing to implement a ban on exports of gasoline, diesel and other refined petroleum products — a move that energy groups warn would backfire by reducing domestic refining capacity and further raising prices for U.S. consumers, explains Thiessen.
Prioritizing climate change and green energy means that Democrats may actually prefer high gas and fossil fuels prices. Higher gas and fossil fuels prices would encourage Americans to abandon fossil fuels. Rising gas and hydrocarbon prices would theoretically curb and ultimately end Americans use of fossil fuels.
When confidence is high, the ten-year treasury bond’s price drops and yields go higher because investors feel they can find higher returning investments and do not feel they need to play it safe.
The 10-year treasury bond is a debt instrument issued by the government of the United States. As its name implies, it matures in ten years. Over the course of that time, investors holding 10-year treasury notes, earn yields. The 10-year T-notes are issued at a face value of $1,000, and a coupon specifying a certain amount of interest to be paid every six months.
The importance of the ten-year treasury bond yield goes beyond just understanding the return on investment for the security. When confidence is high, the ten-year treasury bond’s price drops and yields go higher because investors feel they can find higher returning investments and do not feel they need to play it safe.
Like other types of investments, commercial property investors follow the,10-year treasury bond yield trends because it serves as a proxy indicator for things like mortgage rates. Put another way, as the 10-year treasury bond goes, so goes mortgage rates.
The 10-year treasury bond is important to commercial property investors because it acts as a strong indicator of how the macroeconomy will move in the short-term. The 10-year note price is determined by four factors: the face value, the dollar price, interest rate, and yield, writes Forbes.
Face value, also referred to as “par,” is the price the government agrees to pay out at maturity.
The dollar price is the amount paid for the bond, relative to its face value.
The interest rate is the amount of interest paid over the life of the note.
And, the yield, is a combination of the dollar price and the interest rate.
The 10-year treasury bond’s performance, as mentioned above, is a strong indicator of how the U.S. economy is currently performing and is forecast to perform in the future. Which means, since the 10-year note is a proxy for mortgage interest rates, that’s a very important metric to commercial property investors.
After all, if mortgage interests rates rise, the long-term cost of buying commercial property goes up. Meaning the ROI might shrink. However, if the forecast is for mortgage rates to fall, then commercial property investments become more lucrative over the long-term.
Changes in the 10-year Treasury yield tell us a great deal about the economic landscape and global market sentiment, professional investors analyze patterns in 10-year Treasury yields and make predictions about how yields will move over time. Declines in the 10-year Treasury yield generally indicate caution about global economic conditions while gains signal global economic confidence.
It’s the action in the secondary market that determines the yield. This is important to note because it’s this rate that people refer to when they’re talking about Treasuries. The coupon rate, while technically the interest rate you will receive in relation to the Treasury’s face value, will likely be different from the effective yield you end up getting. If you pay less than face value, your effective rate will be higher; more and it will be lower.
Prices (and therefore effective yields) change for bonds almost constantly. That’s because a bond’s price is inversely related to yield: When demand is high and Treasury prices rise, yields fall—conversely, when demand is low Treasury prices fall and yields rise. This ebb and flow ultimately creates the Treasury pricing market as people flock to (and then from) Treasuries based on the economic environment they find themselves in.
The 10-year Treasury yield serves as a vital economic benchmark, and it influences many other interest rates. When the 10-year yield goes up, so do mortgage rates and other borrowing rates. When the 10-year yield declines and mortgage rates fall, the housing market strengthens, which in turn has a positive impact on economic growth and the economy.
Bond market volatility is usually a sign of a weakening economy. The recent U.S. Treasury yield fluctuations have given market strategists reasons to be concerned about looming economic issues. Studies and empirical evidence show a volatile U.S. Treasury note market is not good for foreign countries holding U.S. T-notes and dealing with significant debt issues, writes Bitcoin.com. That’s because when U.S. T-notes are leveraged for restructuring purposes and a resolution tool, “sudden and sweeping daily swings” can punish countries trying to use these financial vehicles for debt restructuring.
Schwab Market Update: Stocks end higher after a choppy session as the markets await this week’s Fed monetary policy decision; the yield on the 10-year Treasury note hit 3.5% for the first time since 2011. Our latest Market Update: https://t.co/0dvcQ5REf2pic.twitter.com/Xdh0if9QLF
The 10-year Treasury yield also impacts the rate at which companies can borrow money. When the 10-year yield is high, companies will face more expensive borrowing costs that may reduce their ability to engage in the types of projects that lead to growth and innovation.
Higher 10-year Treasury yields should help cool down the economy and bring down decade high inflation in the long run.
The 10-year Treasury yield can also impact the stock market, with movements in yield creating volatility.
Rising yields may signal that investors are looking for higher return investments but could also spook investors who fear that the rising rates could draw capital away from the stock market. It can also means that borrowing is getting more expensive.
Falling yields suggest that corporate borrowing rates will also decline, making it easier for companies to borrow and expand, thus giving equities a boost.
All U.S. Treasury securities are regarded as relatively risk free—since they’re backed by the full faith and credit of the United States government, which has never defaulted on its debts. When investors get worried about the economy and market risk, they look for safe investments that preserve capital, and Treasuries are among the safest investments globally.
Interest rates don’t determine inflation; the amount of money circulating in the economy determines inflation. At this point, there are over $5 trillion in excess money in the system. Brian Wesbury
While inflation roars at its highest level in four decades, President Joe Biden tried to downplay skyrocketing inflation, insisting it was only up “just an inch” in the short term.
“Well, first of all, let’s put this in perspective. Inflation rate month to month was just– just an inch, hardly at all,” President Joe Biden on Sixty Minutes
Despite the fact that consumer prices rose in August by one-tenth of a percentage point to 8.3 percent, economists had expected inflation to go down. Additionally, median inflation hit the highest level ever recorded.
The median CPI, which excludes all the large changes in either direction and is better predicted by labor market slack, is extremely ugly at 9.2% annual rate in August, the single highest monthly print in their dataset which starts in 1983 (second highest was in June).
The Federal Reserve has been raising interest rates since March to slow the economy in a bid to tame America’s worst bout of inflation in four decades. However, the data suggested that their efforts have not yet had much of an effect.
The Federal Reserve raising interest rates may reduce economic growth, make capital more expensive and may throw the US economy into recession, however there is no guarantee that these actions will tame or fix inflation, opines Brian Wesbury, Chief Economist, First Trust Advisors L. P. Interest rates, supply disruptions or Russian’s war in Ukraine don’t determine inflation; the amount of money circulating in the economy determines inflation.
“Inflation is always and everywhere a monetary phenomenon.” ~ Milton Friedman
The Fed’s balance sheet held $850 billion in reserves at the end of 2007. Today, the balance sheet is close to $9 trillion. Most of these deposits at the Fed are bank reserves which the Fed created by buying Treasury bonds, much of which was money the Treasury itself handed out during the pandemic. At this point, there are over $5 trillion in excess money in the system.
Technically, banks can do whatever they want with these reserves as long as they meet the capital and liquidity ratio requirements set by regulators.
They can hold them at the Fed and get the interest rate the Fed sets, or
They can lend them out at current market interest rates.
In turn, the big question is whether the Fed can pay banks enough to stop them from lending in the private marketplace and multiplying the money supply.
The Fed has never tried to stop bank lending in an inflationary environment by just raising the interest rate on excess reserves (IOER). Moreover, the Fed is now losing money on much of its bond portfolio because it bought so many bonds at low interest rates. At some point the Fed will be paying out more in interest than it is earning on its securities.
Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today.
Inflation causes your money to be worth less over time. To hedge against inflation, you need to invest your money in assets.
Inflation in the U.S. is at the highest rate in four decades.
Inflation decreases the purchasing power of your dollars over time. Here are steps you can take to protect the purchasing power of your dollars, according to Forbes.
Trim your expenses. To minimize the impact of inflation, review your spending and identify areas to reduce or eliminate completely.
Wait to pay off low-interest debt. Paying off debt is usually good, but you may want to hold off on making extra payments if you have low-interest debt. Your debt becomes less expensive due to inflation. Use the money for other purposes—like paying off higher-interest loans.
Invest your money. Inflation causes your savings to be worth less over time. To hedge against inflation, you need to invest your money. If the prospect of investing is scary, consider a diversified portfolio of broad market index funds to lower your risk levels and costs.
Getting inflation under control
The Federal Reserve is tasked with keeping inflation at a healthy level by adjusting the nation’s money supply and interest rates.
When the economy is expanding too quickly and inflation rises, the Fed will typically raise interest rates or sell assets to reduce the amount of cash in circulation. These actions tend to reduce demand within the economy and can push the economy into recession.
The U.S. Federal Reserve’s balance sheet consists of the Fed’s portfolio of U.S. Treasury and government-guaranteed mortgage-backed securities (MBS).
The balance sheet is one of the Federal Reserve’s main instruments for conducting monetary policy and for fulfilling the Federal Reserve’s dual mandate that requires it to ensure both stable prices and maximum employment.
The traditional tool the Fed used to accomplish these goals was the adjustment of the federal funds rate, the short-term interest rate that determined how much it costs for banks to lend to each other overnight.
The 2007-2008 financial crisis, however, demonstrated that even lowering the interest rate to zero was considered insufficient to shore up economies in freefall, and the Fed turned to more unusual tactics.
One of these measures was what the Fed refers to as “large-scale asset purchases,” which is more commonly known as “quantitative easing.” Just as with any other firm, securities that the Fed purchases through quantitative easing are considered assets and therefore are represented on the Fed’s balance sheet.
The value of the balance sheet of the Federal Reserve increased overall since 2007, when it stood at roughly $0.9 trillion U.S. dollars.
As of September 6, 2022, the Federal Reserve had $8.82 trillion U.S. dollars of assets on its balance sheet.
This dramatic increase can be traced back to two black swan events that had a disastrous impact on the U.S. economy:
the 2008 financial crisis and
the COVID-19 pandemic,
Both events led to a negative annual growth of the real gross domestic product (GDP) of the United States, writes Thomas Wade is the Director of Financial Services Policy at the American Action Forum. Therefore, the Federal Reserve’s response to these crises was to adopt expansionary monetary policies to stimulate employment and economic growth.
Increasing the money supply — an expansionary monetary policies which intends to increase the amount of money circulating in the economy — tends to increase inflation, states Statista.com, which destabilizes the economy and erodes purchasing power. Currently, the inflation rate in the United States reached 8.5 percent in 2022, the largest value in four decades.
Bottomline is that by expanding its balance sheet—i.e., by buying government bonds and MBS—the Fed expands the nation’s money supply in the hope of lowering interest rates and stimulating the economy; contracting the balance sheet should have the opposite effect.
However, by expanding the money supply too much, the Fed ran the risk of igniting inflation [“Inflation is one form of taxation that can be imposed without legislation.” Milton Friedman], while overly contracting it may stifle economic activity, including increasing unemployment and triggering an economic recession.
Inflation’, quipped Milton Friedman, ‘is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.
Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today.
Inflation, which is a loss of purchasing power, is likely to stay elevated thanks to a variety of structural forces.
The Labor Department reported an 8.3% year-over-year increase in the total Consumer Price Index (CPI) for August. It was a bigger gain in inflation, which is a loss of purchasing power, than expected. Economists and financial strategists agreed that the latest data show inflation is sticky.
Sticky inflation is underlying inflation, or inflation in areas where prices tend to change relatively slowly. Additionally, inflation is structural, meaning the floor is higher than many might assume, and the potential implications go beyond recession.
Vincent Deluard, director of global macro strategy at StoneX Financial, says the current period of inflation is the result of three shortages: labor, energy, and trust.
Labor. The U.S. labor market is still about seven million workers short of pre-pandemic levels.
Energy. The transition to green energy requires moving down the energy-density ladder for the first time in history, meaning the green transition will consume more resources for similar output. And, when withdraws from the strategic petroleum reserve (SPR) stops, it will remove a downward force on oil prices.
Trust. Inflation is inversely proportional to the level of trust between a country’s citizens. “Inflation is a fever that tells you an economy has an underlying ailment of weakening trust, then the fever weakens the body, and it all worsens,” opined Deluard. Inflation is “always and everywhere a psychological phenomenon,” where the problem worsens the longer it persists, Deluard states, as he modifies Milton Friedman’s take on inflation.
Additionally, the August’s CPI report puts the “peak inflation” assumption into question and shows that the labor market and demand -– not supply — problems are driving price increases.
More volatile inflation in categories such as food and energy, which economists and policy makers back out of inflation readings to get to what they call core inflation.
The Fed’s attempt to front-load interest-rate increases is one attempt to regain public trust and restore price stability. The “transitory” inflation argument that has been retired in speeches but not in spirit.
Investors, and central bankers themselves, may therefore be underestimating what the Fed must do to curb inflation, while simultaneously underestimating the odds that inflation remains well above 2% for longer.
Inflation is the decline of purchasing power of a given currency over time and it is a result of central banks printing money (increasing the money supply M2).
In 2022, inflation surged during COVID in large part due to loose money policy by the Federal Reserve, writes Brian Wesbury, Chief Economist, First Trust Advisors. It is the increase in the money supply initiated by the Fed that’s responsible for inflation.
Inflation is based on decisions made by the Federal Reserve and other sovereign central banks. It doesn’t matter whether government spending or the budget deficit is high or low, whether the labor supply is growing or shrinking, whether free trade is waxing or waning.
If the money supply grows too fast, you get more inflation; if the money supply grows too slowly or shrinks, you get deflation. If the central bank does its job right, you get stable prices, opines Wesbury.
Photo by Pixabay on Pexels.com
The Federal Reserve kept short-term rates artificially low and the M2 measure of the money supply soared. Add supply chain bottlenecks and disruptions, U.S. consumers are experiencing near double digit inflation rates. inflation problem that existed before Putin ordered the invasion of Ukraine and, we think, will continue even if the invasion (hopefully) ends.
Inflation is measured by the Consumer Price Index and the Producer Price Index. And, all eyes will be focused on inflation data as CPI is expected to be released Tuesday and PPI expected on Wednesday.
According to Bloomberg’s economists’ survey, expectations are 8.0% year over year growth in CPI and 8.8% year over year growth in PPI, these are important data points for future Fed rate hikes and are likely going to move equity markets as a result.
The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.
Core CPI, which strips out the volatile food and energy components of the report and is closely tracked by the Federal Reserve
The Producer Price Index (PPI) is a group of indexes that calculates and represents the average movement in selling prices from domestic production over time. Producer Price Index represents a reading on inflation from the production side of the economy, measures the change in the prices paid to U.S. producers of goods and services,
Despite some signs inflation is abating, Federal Reserve officials have acknowledged continued tightening is likely needed to restore price stability to the central bank’s target rate.
In June 2022, the Federal Reserve (the “Fed”) raised the Fed Funds Target Rate by 75 basis point (“bps”), the largest increase since 1994. Along with a stunning large hike, there was a reiteration that reigning in of inflation was the top priority no matter the economic costs.
Central bankers, such as the Fed, have the mission and ability to adjust monetary policy so that higher inflation doesn’t result. It is ultimately the increase in the money supply that’s responsible for inflation.
Which is why inflation is going to keep exceeding the Federal Reserve’s supposed 2.0% long-term target for a long time to come until the money supply ceases growing rapidly and the Fed hikes the federal fund rates and tightens the money supply. Currently, the money supply is nowhere close to being tight and tight it will have to get in order to tame the inflation.
When GDP declines for multiple quarters in a row, it raises concerns over a possible recession.
An unofficial way to measure recessions is two consecutive quarters of negative real gross domestic product (GDP) growth. Real gross domestic product (GDP) is an official inflation-adjusted version of GDP calculated by the Bureau of Economic Analysis.
Annual percent change in real GDP shows how much higher or lower it is relative to the previous year. The higher that real GDP is, the larger absolute increase required to achieve a certain growth rate, and vice versa.
However, according to the Bureau of Economic Analysis (BEA), this is not an official designation of recession. But determining when the economy is in a recession is more complicated than looking at a single data set such as GDP.
Determining when the economy is in a recession is up to a committee of experts at the National Bureau of Economic Research (NBER). The committee officially designates recessions by monitoring a variety of economic indicators, including GDP. It also uses payroll employment, personal income, industrial production, and retail sales in the effort.
The NBER (National Bureau of Economic Research) defines recession:
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.
The official designation from NBER of when a recession starts or ends doesn’t happen until months after the recession is over. In other words, NBER looks backward, not at the present moment.
Two consecutive negative real GDP quarters is commonly believed to be the definition of a recession. This is a misperception.
Despite a negative U.S. GDP growth reading in Q1 and Q2 of calendar year 2022, many of the indicators the NBER monitors when evaluating the state of the economy remain healthy.
Coming into 2022, inflation was expected to moderate. Partially due to unforeseen events (including a war), inflation is likely to stick around longer.
The Fed has fully achieved the maximum employment half of its mandate, resulting in a sole focus on achieving price stability (cooling inflation).
Financial conditions have gone from record easy territory to nearly neutral in a matter of months.
Although conditions are not yet restrictive, the Federal Reserve’s dramatic move risks tipping the economy into a recession in the coming quarters.
Historically, there are 12 variables that have foreshadowed a looming recession. A few of those variables include retail sales, wage growth, commodities, ISM new orders, credit spreads and money supply.
During a recession, it’s essential for investors to continue to invest.
What recessions have looked like in the past
The US has gone through 34 recessions since 1857. Thirteen of those recessions occurred after World War II.
From 1857 to 2020, recessions lasted an average of 17 months. In the 20th and 21st centuries, the average length of a recession decreased to 14 months.
Source: Bureau of Economic Analysis (BEA)
The longest recession lasted 65 months, from October 1873 to March 1879. The shortest recession was the most recent, lasting two months from February 2020 to April 2020.
Investing during a recession
You, as an investor, should have an investing process and, and once decided, stick with it to improve your returns.
This dramatic increase can be traced back to two black swan events that had a disastrous impact on the U.S. economy:
