The bond market is flashing a warning, energy geopolitics expert warns
With no end in sight to the war in Iran and oil prices stuck above $100 a barrel, bond traders worried about inflation have sold off long-term government debt in the U.S. and developed economies in recent days. That has the effect of raising bond yields, including on the benchmark 10-year Treasury note , which rose nearly 24 basis points in the past week to end Friday near 4.6%.
The 10-year Treasury yield influences the cost of mortgages, auto loans, credit card rates and other consumer debt. When it goes up, consumers feel the pinch. Its rate is set by the market, not the Federal Reserve.
If we’re going to live in a world in which fiscal deficits continue to increase indefinitely, there’s really not any political will to do something about that, and you have, at least in the U.S., a central bank that’s, let’s just say, uniquely hesitant to hike, then it just stands to reason that the yield curve is going to steepen. Long-term yields will continue to increase, because buyers need more compensation against the fiscal risk and the inflation risk that they’re absorbing now.
Savvy investors will understand this is a multi-stage process, and the U.S. government will also get to decide how to react to a sharp and sustained spike in long-end yields.
If this continues, and let’s say Treasury yields [on the 10-year note] march to 5% or above, it won’t be long before the Treasury secretary says, “Listen, I have a toolkit as well, and I’m not afraid to use it.” The Treasury secretary can shorten the weighted average maturity of our debt issuance, make more aggressive use of the buyback tool, and potentially jawbone the market with the Fed and say we may have to engage in purchases of long-end bonds to align them with long-term fundamentals.
In other words, that is financial repression [when the government artificially holds interest rates down, making debt more manageable at the cost of harming savers, among other risks].
I think that’s the end game for the bond market, because 5%-plus bond yields are not sustainable for a variety of reasons.