The Big Bond Battle
David Haggith

Today’s top economic article is about the battle between stocks and bonds and even between US bonds and the global economy, which is all going to intensify this year. While I wrote extensively about that in this past weekend’s Deeper Dive, it’s helpful to see that Bloomberg is now saying the same thing with equal emphasis.

So, here are the highlights of a situation they are calling a “global bond tantrum,” which they claim is a “wrenching and worrisome” start to the New Year. If you read the full Deeper Dive, you know exactly where I think this is going to go … and why. And it’s here to stay for awhile:

For those unsettled by the relentless rise in government bond yields in the US and across much of the world lately, the message from markets is getting clearer by the day: Get used to it.

The world’s biggest bond market and global bellwether is leading a reset higher in borrowing costs, with the prospect of a prolonged period of elevated rates carrying consequences for economies and assets everywhere.

They state, as did I, that the Federal Reserve is now clearly recalibrating its rate-cutting plans. They put that more on the “strong economy” because of the latest jobs report. I don’t put much stock in that, but put it where the Fed put it … as being due to the return of rising inflation. That is what all the Fed chatter occurred around in the minutes—concern that they were starting to lose the battle against inflation.

The 10YR Treasury flashed a couple of times past 4.8% today, attempting to reach its way to 5. Other than a brief pass above that back in ’23 when the Fed was still trying to raise interest rates to kill the inflation it had fueled, the last time the 10YR hit today’s level was before the Great Recession, back about two decades ago when the economy was strong and the Fed was trying to throttle back the economy by raising rates. Now, the Fed is trying to back down on interest rates, but rates insist on rising against its will. As I laid out in that Deeper Dive, there is abundance of evidence that the bond vigilantes are back to ride herd on the Fed, and they are now a determined gang, not about to back off.

With oil prices absolutely screaming past $80 (Brent at $81) and oil pricing into everything else over time, the gusher-like pressure on inflation is only intensifying. It’s only taken a month to leap up $10/bbl.

I laid out another big new factor in that Deeper Dive that is going to increase pressure on inflation this year, and today we see a similar factor called out: Trump’s deportations, right as they might be for a number of reasons, will, regardless, increase operating costs in order to rapidly replace that cheap labor with more expensive labor and diminish the supply side of the economy as industry fails to make the full replacement so that production slows. That is good news in the long run for American workers that won’t have to compete against cheap outsourcing. (With immigrant labor, we insource the outsourcing by bringing the cheap labor here.) The effect on inflation will all depend, of course, on whether Trump follows through and how long it takes him.

I hadn’t considered deportations in my weekend explication, but they are a corollary to what we did talk about and are potentially equal in their ability to bring on the supply-line crisis that I included in the scenario I predict for 2025.

The U.S. saw inflation cool in 2024, but economists warn that President-elect Donald Trump’s plan for the mass deportation of undocumented immigrants could greatly affect prices.

“Certainly the economic impacts are going to be felt,” said David J. Bier, the director of immigration studies at the Cato Institute. “There’s going to be supply chain issues. There’s going to be increases in prices, decreases in services.”

Initially, however, it may also be hard on American workers as some businesses shut down lines or factories that they cannot staff adequately enough to keep running:

Experts are concerned that deporting such a large number of undocumented immigrants at once could leave a hole in the labor force. A 2023 study in the Journal of Labor Economics found that 44,000 U.S.-born workers could lose their jobs for every 500,000 immigrants removed from the labor force.

Once the dust finally settles, this will be good for American workers, but in the chaos of readjustment, it will likely be bad for everyone. With his threats to use the military to expedite the deportations, the rush will force adjustments faster than citizen laborers can be found.

All of this inflation we see rising now, along with the future forces that are likely to drive it up much more quickly, are causing what one chief investment officer in Bloomberg’s article calls “a tantrum-esque type of environment.”

Bonds sound the alarm

There is also economic warning to be had from the 10YR. It’s not just that it is rising in response to inflation (both current slowly growing inflation and future anticipated more rapid growth of inflation):

Historians point out that rising 10-year note yields have foreshadowed market and economic spasms such as the 2008 crisis as well as the previous decade’s bursting of the dot-com bubble.

You’ll hear some say it is not so much how high yields go as how quickly they rise, but really it is either one, and right now they’re doing both.

US yields are rising even after the Fed joined other major central banks in embarking on a course of rate cuts — a jarring disconnect that has few precedents in recent history.

They’ve risen quickly by bond standards. To give you an idea of the speed at which yields have been rising (keeping in mind that price/value does the opposite of yields) …

10-year Treasuries are suffering their second-worst [value] performance during 14 Fed easing cycles since 1966.

This has changed all expectations for Fed rate cuts:

Several Fed policymakers recently signaled they support keeping rates on hold for an extended period. In markets, swaps reflect a similar viewpoint, with the next quarter-point cut not fully priced in until the second half of the year.

A number of Wall Street banks on Friday trimmed their forecasts for 2025 cuts in the wake of strong jobs data. Bank of America Corp. and Deutsche Bank AG don’t see the Fed easing at all this year.

All totally contrary to what the Fed expected to see from its easing. So, really there is no reason for the Fed to even try to lower interest anymore because the bond vigilantes are driving it up, regardless, which only makes the Fed look impotent. That is, at least in part, because some of the angst that is causing Treasury buyers to demand higher interest is fear about the mushrooming federal debt that is becoming hard to manage. Apparently, they are not convinced Trump’s policies will help reduce the debt. (Neither am I based on past performance. Nor is Bill Bonner who writes a couple of good articles on that below, too. I’ll let him tell that part of the story.)

That can be seen in this dynamic:

Meanwhile, yields on longer-dated debt have climbed faster than those of their short-term counterparts, a sign of concern for the long-term outlook.

“Rising term premium to us indicates a growing concern around the US fiscal path,” said Zachary Griffiths, head of US investment grade and macro strategy at CreditSights. “The steepening of the curve is also more consistent with the historical relationship between large and rising deficits.”

And most financial writers now—a usually overoptimistic crowd in my opinion—don’t believe this situation is going to get better anytime soon.

PGIM Fixed Income’s Peters said he “wouldn’t be completely shocked at all” if 10-year yields rose beyond 5% in this environment, part of a growing camp who see yields resetting to a higher range.

Of course, if significant money starts pouring out of stocks, it is likely to flee to Treasuries and reduce yields again. So goes the stock-bond pump that I’ve mentioned in the past. I think, like Jim Bianco, we have entered a higher-rate environment for a long time to come:

The Covid shutdowns and the subsequent massive government stimulus reset the global economy and “changed things, frankly, for the rest of our life,” Bianco said. [So has all the government debt that created.] The consequence is persistently higher inflation, around 3%, and a 2% inflation-adjusted interest rates. Adding them together produces a 5% rate that Bianco says looks about right. He expects 10-year yields to move toward the 5% to 5.5% range.

Some note there are structural reasons behind the shift higher in yields that signal a paradigm shift as opposed to a return to normal….

For Bank of America, US Treasuries are already well into the latest “Great Bond Bear Market,” the third in 240 years after a decades-long bull run that ended in 2020

One thing is clear: The Fed has lost control of interest rates. Rising inflation is flying the plane, and runaway government debt is its co-pilot.

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