Secular Low in Long-Term Bond Yields Coming Up
Hoisington’s bond managers, Lacy Hunt and Van Hoisington, doubt the global economy will rebound soon thanks to low industrial output, heavy debt, and the commodities collapse. No Inflation In Sight, Say Two Bond Masters.
Since the 2008-09 Great Recession, it has been an article of faith in many circles that the loose monetary policy of zero-bound short-term interest rates and successive rounds of quantitative easing would lead ineluctably to a ruinous surge in inflation and interest rates. Yet just the opposite has occurred.
Much of their continuing dour outlook on U.S. and global growth revolves around the explosion of combined private and public debt as a percentage of economic output. According to Hoisington, in the U.S., that has jumped from 200% in 1987 to about 370%. In the euro zone, it has gone from about 300% of GDP in 1999 to more than 460%. Japan’s debt stands at a monstrous 650% of GDP, while China’s total debt has quadrupled since 2008, to 300% of GDP. And that’s probably a conservative measure, considering that China consistently juices its GDP growth numbers.
According to Hunt, the growing debt load, especially in the past decade, acts as a blanket of snow and ice, freezing growth. Money is wasted by financing temporary boosts in consumption, rather than being used for sensible capital spending and infrastructure projects that would yield much future growth. As China has shown, capital investment is unproductive if it just builds highways to nowhere, redundant industrial capacity, and empty housing complexes.
Debt growth is sustainable only if the projects it underwrites produce a stream of income sufficient to repay the interest and principal.
According to Hunt, overindebted economies have certain telltale characteristics. Jumps in economic growth, inflation, and high-grade bond yields prove short-lived because debt constrains economic activity. Difficulties in making debt payments, in turn, push economies into frequent downturns and hurt productivity. Monetary policy loses effectiveness as the debt overhang stunts expansion of the money supply, slows monetary velocity, and quenches the animal spirits of producers and confidence of consumers.
Hunt sees just such trends at work in the U.S., where industrial production dropped 1.8% in December from the year-earlier level, despite a red-hot automotive sector. One can argue that manufacturing employment accounts for under 10% of total U.S. jobs. But, as Hunt points out, the U.S. industrial sector, according to Fed estimates, delivers about a quarter of GDP on a value-added basis. Likewise, industrial activities generate more than 65% of the earnings of S&P 500 stocks, he adds.
Finally, Hunt contends, much of the disappointing U.S. output growth during the current economic recovery can be laid at the feet of the Federal Reserve and unintended negative side effects of its loose money policy.
Citing research by Nobel laureate economist Michael Spense and former Fed governor Kevin Warsh, Hunt claims that the U.S. central bank’s successive waves of quantitative easing diverted funds from productive uses in the real economy and into financial assets, sending the latter’s prices higher.
Hunt realizes that the decades-long slide in U.S. government bond rates can’t go on forever. He and Hoisington, as confirmed monetarists, are watching closely for any significant pickup in monetary growth and velocity that would indicate a possible surge in inflation. But as long as tepid industrial-output gains and disinflation obtain in the U.S., the Hoisington funds will continue to ride the long end of the bond curve.
Or, as Hunt and Hoisington put it in their January client letter: “In short, we believe that the long-awaited secular low in long-term Treasury bond yields remains ahead.”
This Storm Will Pass
Compare Hunt’s position with that of Barron’s current cover story by Gene Epstein: “This Storm Will Pass“. Epstein says the U.S. economy will avoid a recession and grow at a 3% pace this year.
I side with Hunt, mentioning Epstein in my February 22 post Real Time Tax Data Consistent With Recession.
No Inflation in Sight
I have had the same views as Hunt for quite some time. When others predicted hyperinflation, I called for record low yields in treasuries.
That said, there’s plenty of inflation, depending on how you define the word. As a result of perpetually loose monetary policies, the Fed has blown asset bubble after asset bubble. Those bubbles and the corresponding huge expansion of credit along with it, constitute inflation in my book.
Asset Bubble Deflation
The problem for central banks is bubbles burst by definition. And when bubbles burst, the corresponding asset deflation makes it impossible for all the debt that has been issued to be paid back.
As long as credit on the balance sheets of banks is not in question, everything seems OK. The moment the market doubts that credit can be paid back, huge troubles begin.
We are at that point now, globally. European bank shares have been hammered.
- Europe’s Largest Bank, HSBC, Posts Surprise $858 Million Loss: Analysts Expected Profit of $1.95 Billion.
- Eurozone Recovery is Over: Deflationary Pressures Intensify as Growth Slows
- ECB Admits 5 Banks Don’t Meet Capital Requirements; Cockroach Theory Does Not Stop at Five
In Japan, Safes Sold Out: Customers Hoard Cash in Response to Negative Rates.
It’s asset deflation not CPI deflation that central banks ought to fear. Even the BIS agrees with that statement. For discussion please see Historical Perspective on CPI Deflations: How Damaging are They?
Myopic central banks and their foolish attempts to halt benign consumer price deflation have once again brought about very destructive asset deflation that they should have been worried about.
Nonetheless, Central bankers never learn. Damn the Side Effects, More Stimulus Coming.
Mike “Mish” Shedlock
Great article, and looking forward to my final refi.
My only quibble is I see inflation as more than credit levels but a velocity kicker is required, and so we keep it all in financial assets until we achieve some.
Thanks, long time follower.
Lacy Hunt Rocks
When he speaks … I listen.
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Banks are poor investors in wealth producing endeavor so long as banks are allowed to gamble deposits and free central bank loans on stocks, bonds, commodity markets, and derivatives. Moreover the banks can manipulate markets with high frequency computer trading schemes. Investment in productive enterprise is unattractive to banks. Little or no Federal Reserve stimulus finds its way to main street, manufacturing, and jobs.
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Interest rates are decoupled from risk. Federal Reserve loans are free. When banks control and manipulate market prices there is no risk other than catastrophic risk. Presumably and by precedent the Federal Reserve eliminates catastrophic risk as well. The only risky activity in contemporary banking is lending to small business, entrepreneurs, job creators, capital projects, and business expansion.
While stimulus are coming, their effectiveness seems to be dropping by the day. At this rate, it is by no means going to be easy for the CBs to stimulate… Bullard talk does not seem to get the same bang for the buck like it did in Oct 2014.
Basically a double whammy, you have to do more for less or same effect and your ability to do more diminishes each time implying the fuse is lit on the CBs actions and countdown has begun.
This is going to be a beauty WHEN it bursts. Probably in another 50-100 years you will get another idiot like Bernanke who will study this depression and come up with some inane theories and call himself an expert and bring an end to the financial system. Hopefully people will hang those Central Bankers then at least, since we have not done so.
People are as smart as they need to be. They are as stupid as they can get away with. It’s easy to be stupid when you are using other people’s money. It’s easy to be stupid when you get positive reinforcement from those who benefit from the stupidity they encourage you to perform. It’s easy to be stupid when it pays so well to look stupid.
Central bankers do stupid things with printed money because there is no personal cost to them for doing it. Economists proffer idiotic theories because those theories put food on their table and they cost them nothing. The ECB is going nuts with debt subsidization because it’s a last stand to keep the European Project alive a little longer, plus much of its money printing is essentially collateralized by deposits in European banks (stupid Europeans). Nobody truly understands Japan. China’s situation is what happens when you give the uneducated masses a printing press and tell them it’s all ok if the government does it.
Stupidity is subordinate to denial. Only an aggressive moron or a liar couldn’t recognize the asset inflation that resulted from Fed QE exercises. I’m still undecided as to which applies there.
It appears stupid if you can’t see the bigger picture.
Those who run the Central Banks are not stupid. They are the mot intelligent people in the world.
We, the stupid, assume this is about jobs, prices, the people, etc. No, it isn’t
No. You give them too much credit. They are clueless.
From the get go I knew their policies would end with a deflationary bust. And no way no how do the banks (the Federal Reserve’s masters) want that…. flat(ter) yield curve and depreciating collateral.
The dopes kept doubling down on failed policies.
While stimulus are coming, the effectiveness seems to be dropping… I agree. http://www.howtogetrichandwealthy.com/
Honest question: Equities are toxic, the bond market is a ticking time-bomb, real estate remains in a bubble. Other than hoarding cash & buying gold, in what vehicle should we protect our assets?
You
Good question. All I know is that buy and hold days over.
I listen to the No Agenda Show podcast. The hosts, Adam Curry and John Dvorak have a theory that the reason this election (and the last 2, for that matter) has such lack-luster candidates is because everyone knows what’s happening (or not happening) with the economy and no one of any substance wants to get caught on the wrong end of history. After all, they’ve tried everything in the book and it isn’t working.
The crackpot theory is that the political insiders are more than happy to let some “outsider” candidate get the nomination so that in 4 years they can come back and “See, we told you so! Let politics to the professionals.”
That theory implies a level of competency & coherence on the part of our masters that I find extremely difficult to believe.
It is more profound than that.
Read a poem by Rudyard Kipling called: “The Awakened Saxon” (something like that).
What is happening is “natural”, instinctive and fascinating. AND, it can not be reversed.
The more the Left protects Hilary, the more she will be hated
The more “they” attack Trump, the more he will be loved.
Corrupt judges and corrupt leaders are are a sign of God’s wrath on a nation.
Woe to the U.S.A.
“…there is no authority except that which God has established. The authorities that exist have been established by God.” Romans 13:1
I second SD3’s question…
I just filled up my 25 GALLON Chevy Avalanche “tank” this morning. Price $1.53 per gal.
Bring on “Deflation”. I love it.
Isn’t the point of industrialization, efficiency, invention, etc to LOWER PRICES?
While I don’t disagree, the ‘cure’ for deflation is what I’m preparing for.
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Both Lacy Hunt and Gary Shilling where out making the rounds of media recently — wonder if they are talking their book up as a way to exit. Bit of pain today on the long bond…
Lacy is a firm believer in what he says. I know him fairly well and consider him a friend. We have spoken at conferences together, and we are on the same side of most issues. Lacy is a person of high integrity. I have no connection with Shilling but I believe he does not play games either.