Of all the financial markets, the bond market is, to me, the most exquisite. Its precision is second to none. And here I'm talking about the US Treasuries, bonds, notes, and agencies. Which make up one of the largest collections of securities in the world.
The bond market is important, the chief means by which the US Government finances its operations. But it's also a major place for those of us who are investors to place our funds. Considered one of the safest investments in the world, it can also provide a consistent secure return for the shrewd and knowledgeable.
Properly treated, the bond market can serve both borrowers, the US Government, and Lender, those of us who invest in the bonds, well. Indeed, we've had optimal conditions in the bond market for a very long time.
In fact, many analysts consider the bond market to be the most favorable market over the past generation or more. With many calculating the bond market to have a 30-year bull phase. 30 years of progressively lower interest rates, and thereby higher principal.
All this did not come entirely by accident. Generally, the political class in America has operated with some restraint over the past 30 years.
Well, there was that matter of the Obama Administration's spending so much, that they caused our bond market to lose its Triple “A” Rating, for the first time in our history.
But ignoring that for the moment. Essentially, the bond market has been able to finance the steadily growing debt of the country, while maintaining its low-interest rate.
Unfortunately the policies and initiatives of the current US President, Joe Biden threaten that equilibrium, of low-interest rates, and high bond issuance.
The first way that the Biden Administration threatens the bond market, is by the sheer volume of bonds that will need to be issued to support current spending. Like his former boss, President Obama,
President Biden is taking spending to a new level. Order's of magnitude above what we've seen before. Inevitably this new supply will likely mean higher rates.
Ironically, it may be the action of Joe Manchin, Senator from West Virginia, who has announced that he will vote against the enhanced spending of the White House, that will give a needed reprieve to the bond market. A reprieve from this mounting bond issuance, which is sorely needed.
But excessive supply is only one of the issues which are currently troubling the bond market.
So the first area that Biden is creating trouble for the bond market is just the amount of spending he proposes. Leading to a tremendous amount of bonds that will need to be issued to support that spending.
But there is another way, more subtle, and perhaps more sinister that Biden is threatening bonds. It's through inflation: the overall price level in the economy. I refer you to an excellent article over the weekend by Professor Peter Navarro on just how the Biden policies have produced this current wave of inflation.
Suffice it to say, that inflation is here, and in a very big way.
Let me take you through the impact of inflation on the bond market.
We're going to take the really big picture look at where the bond market is currently, and where it may be headed. I'm using the US Debt Clock dot org, for my reference.
Currently, the US Pays $420 billion dollars per year in interest on its debt.
In the bond market that $420 billion translates into a bond yield somewhere less than 3%. But let's just round things off, and say that the bond market on average currently is yielding 3%.
Now, it's a generally accepted benchmark that bond investors are looking for a 3% yield AFTER inflation. That is a real return of 3%.
With zero inflation, that's what brought us to today's 3% yield on bonds. But under President Biden inflation is no longer at zero. By the recent measures, it's 6%. So the bond market will adjust to that inflation number, giving investors a yield of the rate of inflation plus 3%. In other words look for bonds to start yielding closer to 9%, than today's level.
This would triple our nation's current interest expense. Going from $420 billion to triple that, roughly 1.2 trillion dollars. And presto, interest suddenly becomes the largest line item in the federal budget. Larger than defense, larger than social security, larger than medicare. Number one becomes "interest," which, as we've seen with Evergrande, has to be paid.
SO there are two basic ways in which the Biden Administration threatens bonds. First by dramatically increasing the number of bonds needed to support this burgeoning budget. And second by the general increase in the economy's price level. In other words: by Inflation.
Unless some policy changes are made by the President, I'm afraid that we're going to see a dramatic reaction from those staid old securities, the US Treasury Bonds and Notes.