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Category: Soap Box

Soapbox: What are US bonds telling us?

The consensus about the US (and the global) economic recovery is that it will be strong, fuelled by a successful and widespread vaccination programme...

25 March 2021

Gary Mead

The consensus about the US (and the global) economic recovery is that it will be strong, fuelled by a successful and widespread vaccination programme which is likely to ensure herd immunity in the UK and US – perhaps Europe won’t be able to join the party – by the early summer.

In the US, the personal saving rate – personal saving as a percentage of disposable personal income, which may “generally be viewed as the portion of personal income that is used either to provide funds to capital markets or to invest in real assets such as residences” has reached a record high. All that lovely money waiting to escape!

The US Federal Reserve expects growth to be 6.5% this year, unemployment to be 4.5% by the end of the year and “core personal consumption expenditure inflation”, the Fed’s preferred inflation measure, is expected to rise to 2.2%, above its 2% target. The Fed is taking a relaxed view about inflation; Robert Kaplan, president and CEO of the US Federal Reserve, says that he expects the Fed to “start raising rates in 2022”. In March 2020, the Fed said it was expanding its quantitative easing (QE) to unlimited amounts. The Fed will continue to buy US Treasury bonds at the rate of $120 billion a month until “substantial further progress” is made towards its goals – which are, we remind you, two-fold – “stable prices and maximum sustainable employment”. It deliberately avoids defining what “maximum stable employment” might mean. About 41% of Americans who are out of work have been without a job since last August and are classified as ‘long-term unemployed’; in the Great Recession of 2007-09 it took almost two years for the long-term unemployment rate to reach that level.

In February, Janet Yellen, the US Treasury Secretary said although the official unemployment rate was 6.3%, the effective rate was close to 10%; pre-pandemic it was 3.5%. Getting to 4.5% unemployment by the end of this year is a very tall order. Yellen is super-relaxed; she also said that interest payments on the US federal debt were no higher than in 2007 and stood at about 2% of GDP – i.e. about $429 billion. Others have calculated that the US must pay its creditors $1 million (£725,000) every 1.4 seconds.

The Fed used to hike interest rates in anticipation of higher inflation. Now it’s waiting to see how high inflation goes before any rate rises.

All this sounds like mom-and-apple pie. What could upset the apple cart?

The Biden-Yellen gamble


What happens in bond markets gives a more objective view of the future than given by any central banker, all of whom have a vested interest in taking a rose-tinted view of likely outcomes.

In this respect, it’s worth noting that the yield on the US 10-year Treasury bond, one of the world’s most closely watched interest rates, rose above 1.7% last Friday, up from 0.92% at the beginning of the year, as investors sold the debt. The yield on the 30-year Treasury bond moved above 2.5%.

This run-up in bond interest rates at the long end of the curve reflects expectations of a higher inflation rate – which is precisely what the Fed wants to see happen. Treasury yields are often seen as a barometer of inflation expectations; when investors expect higher inflation, bonds become less attractive and are sold, while yields, which have an inverse relationship with bond prices, increase.

The question is – who to believe? US bond yields are telling us that inflation is coming back, possibly quite strongly. Yellen and the US Federal Reserve Governor, Jerome Powell, are telling us to stay calm, relax, nothing to see here, move along. What President Joe Biden, architect of a gargantuan $1.9 trillion ‘stimulus’ package, thinks, is anyone’s guess. On top of that $1.9 trillion, Biden is now contemplating an additional $3 trillion splurge on infrastructure, clean energy and education.

The temptation for Yellen and Powell will be to ignore the inflation-is-back market signals until the very last minute; if they pushed up interest rates too soon that would choke off Biden’s stimulus efforts. Rudiger Dornbusch, the late German-born economist who worked at MIT for 27 years, once said that none of the US expansion efforts in the second half of the 20th century died in bed of old age: they were all “murdered by the Federal Reserve”.

The latest expansion effort is so closely aligned with Biden’s electoral success and the Democrat Party’s principle mission – “a better, fairer, and brighter future for every American” – that it is unlikely to be murdered by the Fed moving on interest rates.

But leave it too late and inflation might get a grip and move beyond control. In 1965, the US inflation rate was just 1%; 15 years later it hit 14%. Biden’s $1.9 trillion could turn out to be no more than a sugar rush; where will all this free money go? It’s already had a notable impact on the inflows into equity funds – almost $170 billion have gone into stocks and shares in the past month. US money supply has been growing at an annual rate of 30% and in January this year reached its highest level in history.



The free money idea is starting to take hold in the US. The Universal Basic Income (UBI) notion is getting wider attention and grassroots’ support, following a two-year experiment conducted in Stockton, California, which gave all its inhabitants $500 a month, no strings attached. Dozens of town mayors have now joined the Mayors for Guaranteed Income organisation. The Stockton mayor said there was a remarkable increase in reported wellbeing among his citizens as a result of the $500 per month. Who doesn’t like free money?

There are two essential forms of inflation – demand-pull and cost-push. In my view –the Fed and the Biden administration are taking “steps into the unknown” in the words of Larry Summers, President Obama’s former top economic adviser. Pumping money into an economy will increase demand for goods and services, businesses will struggle to increase production; supply could remain constant and hey presto! we have demand-pull inflation.

In any case however, more extreme currency movements are likely, bonds will continue to give us inflationary signals, and – despite some short-term volatility, resulting in a 20% or so decline since gold’s peak last August – using gold as money via a Glint account may help you to withstand a weakening fiat currency; and could help offset the likely continued decline this year in the US dollar’s purchasing power.

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