"The Next Surprise"
And the big question that keeps us up late at night...
by Bill Bonner
Paris, France - "Where will the next surprise come from? What will cause the next Big Loss? Here’s the latest, from MarketsInsider: "Wall Street thought 2023 would be "the year of the bond" – and while that's yet to come about, the past few weeks have finally brought some good news for fixed income after a nightmarish run since the start of the pandemic. US Treasury prices have staged a mini-comeback, and benchmark 10-year yields have started to cool off after spiking to a 16-year high of 5% in mid-October."
Everyone knows the Fed has finished its rate tightening. Everyone knows it will lower rates in the spring. Everyone knows you ‘can’t fight the Fed.’ And everyone knows that lower rates will bring higher bond prices. So…everyone knows bonds are safe again. And higher yields make them attractive.
Here’s more from Bloomberg: "Junk Bonds Yielding Over 10% Hit $325 Billion, Tempting Investors. Bonds yielding at least 10% grew by about $45 billion to $325 billion, or about 30% of the speculative-grade index, according to Bloomberg Intelligence analyst Mike Holland. Almost $139 billion of that lot come from the communications sector, which includes the likes of Altice USA Inc. and Dish Network Corp. As the highest-yielding junk sector, it trades at a yield [over 12%]." Just last week, a private borrower offered us a 10% yield on a short-term loan. We took the money.
A $10 Trillion Loss: But does this mean that the Primary Trend has turned? Is it an opportunity…or a trap? “Yep,” says Dan out in Laramie, “that’s the question that keeps us up at night.” It keeps us up because US bonds are where the big money is. There’s $33 trillion outstanding in US government bonds alone. If the next three years were like the last three, it would mean another 17% loss on the bonds themselves…along with an inflationary loss of 16% loss on the money they’re calibrated in (dollars). That would be a total loss of 33% – or more than $10 trillion. That’s a Big Loss.
These are not NFTs we’re talking about. Or cryptos. Or even ‘junk’ bonds. These are the safest credits in the world…the building blocks of the whole financial capital structure. They undergird values in insurance plans…pension programs…bank reserves and corporate treasuries. Even the Fed counts its assets in US bonds.
And maybe everyone is right: bonds are safe from here on out. But what a surprise it would be if they weren’t! As we discussed yesterday, there’s a time to be a lender and a time to be a borrower. There is also a time to neither borrower nor lender be; this might be one of those times. After such an impressive sell-off, it is probably a good bet that interest rates will dip and bond prices will rise. Inflation readings are generally going down. The Fed is ‘pausing.’ Everybody knows the tightening cycle is over. But there’s gotta be a big surprise coming from somewhere. What a pity if it came – again – to the US bond market. Is that possible? Maybe…
A Temporary Truce: First, inflation is not finished. It was never ‘transitory.’ And it was not just the result of the Fed’s 2020-21 printing spree. Prices are determined by balancing output against the quantity of money ready and willing to purchase it. While not predictable with any precision, it is still a good bet that when output goes down and spending goes up, prices will rise.
US trade policies, sanctions, work rules…regulations, taxes and intercessions – and the dead weight of debt itself – all restrict output. Real output – measured by the number of hours people actually work – is rising at less than half the rate of the 20th century. And though the feds may have declared a temporary truce on their monetary inflation, they’ve increased inflation pressures on the fiscal front. So while the quantity of lendable money is restrained, the world’s biggest borrower – the US government – spends more money than ever.
The latest jackassery from the Biden Team is that sending weapons to the Ukraine and Israel is ‘good for the economy.’ But unless you are in the market for a Lockheed Martin F-35 fighter jet, the extra money to the firepower industry just reduces investment and output in the consumer economy. Prices go up, in other words.
And so do interest rates. Money wasted on bombs is not available to buy Treasury debt. In addition to the new, two-trillion-dollar deficits that must be financed out of savings, there is also the old debt that must be refinanced. There is $7.6 trillion in Treasury debt that will mature in the next 12 months. That will bring the total funding requirement to nearly $10 trillion. Whatever else might happen as a result, interest rates will probably go up. If that is so…could lenders be in for another Big Loss on their bonds? Maybe. Our advice, keep the loans short term."
Note from the Research Desk: The United States has a sovereign debt-to-GDP ratio of 123.3%. In the developed world, only Italy at 143.3% and Japan at 255.2% have more debt relative to GDP. Sudan has a ratio of 256%. In the last 120 years, research shows that countries with debt-to-GDP ratios of over 130% default on their debt 98% of the time.
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