Raise interest rates or we’ll do it for you


Jerome Powell has played with fire, and the US economy is about to catch fire. The bond market will be the incinerator.

The bond market is not getting the attention it deserves. People are focused on the Dow Jones, the S&P, the Nasdaq because average investors don’t stick to bonds like they do stocks.

But bond markets are strange when it comes to predicting future economic problems. The Biden administration may have touted “transitional” inflation, but bonds sniffed the BS early on.

Now, bonds are smelling more BS in the Fed’s policy of gradual interest rate hikes in an effort to stifle rising inflation. Bonds say it’s not enough; we will need much higher rates and possibly a recession if we are to bring inflation down to a more manageable level.

How did we get to a place where we needed a recession? In recent years, bonds have offered very little in return, as the Federal Reserve has continued to buy them to stimulate the economy despite financial meltdowns, economic downturns and the pandemic.

This action, known as quantitative easing, infused the economy and markets with liquidity (a euphemism for “printing money”). This drove up stock prices and lowered interest rates significantly, which initially made bonds unattractive due to lower yields or yields.

Federal Reserve Chairman Jerome Powell announced that the Federal Reserve is raising interest rates by half a percentage point to combat record inflation.
Win McNamee/Getty Images

For a while, the bond market was okay with that as long as inflation remained contained. But the economy and the markets have soared too much. Borrowing became almost free with low interest rates and people used it to buy houses, stocks and everything else. New asset classes like crypto have created money out of thin air.

All was well until inflation set in – as it always does when government policy overreacts. The economy has overheated to the point that inflation has eaten up most of your paycheck. The official figure announced last week is 8.6%, but the real figure which is not massaged by the government is probably in the double digits.

Now, no matter how much you may have earned in crypto or your home’s value, you struggle to buy food for your family or fill your car. Inflation is a tax on everyone, but hits the working class hardest because they are stuck in a miserable cycle of making ends meet.

The policy tools to end inflation are limited. Literally the only thing the central bank – aka the Fed – can do is create an economic slowdown by raising interest rates. And that’s why the markets are collapsing.

But the Fed is not the only one controlling interest rates. Bond traders do the same, trading so-called fixed-income investments that are highly inflation-sensitive.

When inflation soars, bonds and the interest payments they provide, as well as the principal they repay at a later date, are worth less.

So their prices fall and their yields soar – investors demand more for their risk as inflation eats away at yields. It drives up interest rates on everything. The US economy is shrinking as consumers stop spending on homes (we are already seeing rising mortgage rates) and other things; businesses borrow less to grow because it’s more expensive. Unemployment rises and you get a pretty deep recession.

You would rather the Fed control interest rates than the bond market. The government may try to take it easy, while the bond market is indifferent to the suffering of the American people. But by buying so many bonds to keep the economy flooded just in case, Jerome Powell lost a lot of weight to stage what is called a “soft landing”.

Powell is set to raise short-term interest rates this week, but the bond market is showing warning signs – saying it’s not enough.

They also say that if Powell doesn’t fix the problem, the bond market will fix it for him. And the pain of the American people will only get worse.


About Author

Comments are closed.