Thoughts on the bond market

Thoughts on the bond market

October 11, 2023

As the 10-Year US Treasury yield closes in on 5% for the first time since 2007, people are beginning to ask if rates will continue to rise.  Yes, the last time we saw long term yields this high, it was 2007 and Prince played Purple Rain at the Super Bowl (in the rain) while the iPhone had its debut.  Then, less than 18 months later, during the financial crisis, the 10-year fell to 2%.  Now, I understand that these were extreme circumstances.  At the time, most market watchers could hardly imagine rates going so low.  Little did we know that the Covid Pandemic would we see rates fall even further to .50% in the U.S. and go negative in most developed countries around the world.

When it comes to the current and future state of U.S. rates, there is a lot to unpack now – suitcases! I have read or am aware of most of theories, both logical and conspiratorial.  However, I think that the interest rate conundrum that we see can be best looked upon through a lens of facts, that may instruct the future.

First, our national debt is at record levels. At last glance we stand at around $33 Trillion. By comparison, in 2007 our national debt was around $9 Trillion.  Our national debt has an average maturity of around 3.8 years**, with over $7 Trillion coming due in the next year**. Therefore, it is incredibly burdensome to add additional debt service to an already bloated budget and federal deficit which now tracks at over 8%.

Secondly, inflation seems to have been tamed on a pretty substantial level. A website called Truflation.com attempts to track inflation in real time through proprietary metrics and AI. At last glance, the website estimates current inflation at 2.47% while the US government’s measure hovers around 3.7%.  A quick look at commodity prices the last 12 months demonstrates that prices have been declining as of late, reference; wheat, soybeans, corn, lumber, coffee, milk, and natural gas. Oil is basically flat.

Although the direction of interest rates in the short run is uncertain, I would submit to you that higher rates for longer is unsustainable in a debtor country likes the United States.  Consumers, politicians, and the corporations who “buy” our politicians on both sides of the isle don’t want higher rates either. My guess is that they’ll get their wish eventually.

If I am right, the bond market might be a great value at current levels. And, when the recession comes, (and it will at some point), we are likely to see Powell cut rates by 3,4, or even 5%, depending on its severity. 

In summary, I think there is a ceiling on where rates can go given our national debt. Moreover, if the inflation dragon has been slain (or at least tamed), there is little reason for Powell to keep hiking. His next move may not be from a position of “choice” but necessity – cutting. If so, we may look back at current rates as an opportunity.

As always, if you have any questions on this topic or anything else, please don’t hesitate to contact me.




**https://fiscaldata.treasury.gov/datasets/schedules-federal-debt/schedules-of-federal-debt-by-month

 

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