The bond market is increasing its strength

The bond market is increasing its strength

There is a stir in the bond market. The business world and the Federal Reserve have been forced to take notice. Politicians in Washington may soon need to do the same.

After years of low interest rates, yields are rising in the huge global bond market. Just last week, the yield on the 10-year Treasury note, the world’s most important fixed-income benchmark, briefly rose above 5 percent.

That apparent round number was a psychologically challenging boundary that had not been breached since July 2007The beginning of a major disaster.

This happened when the collapse of two Bear Stearns hedge funds triggered a chain of events that culminated in the worst global financial crisis since the 1930s. The world economy faltered. The Federal Reserve lowered the short-term interest rates under its control to near zero. And in the bond market, traders and central bankers pushed long-term yields below 1 percent. The yields on those depressed bond markets fluctuated but never recovered their previous heights. Interest rates were so low for so long that businesses and investors hardly had to think about them.

So far.

Of course, the bond market is back. Yields that were normal before the global financial crisis have suddenly returned to normal, with huge consequences. Losses are mounting for speculators who have wrongly bet that interest rate increases will slow down. But for working people who are saving for retirement, and for current retirees, better rates mean you can get far more income for your money than you have in years. In last week’s column, I discussed how risk-averse people can avoid risk and profit from high-yielding fixed income securities with relative safety.

The significance of the turmoil in the bond market is far-reaching. This goes far beyond individual investments, important though that may be.

For starters, almost everyone in the finance sector is watching bonds, and especially 10-year Treasuries, quite closely for clues about an abundance of significant issues.

Here are some things they’re thinking about:

  • Since bond rates set a range of consumer lending rates, how high will the burden of mortgage, car loan and credit card rates ultimately be?

  • How long can consumers and corporations withstand higher interest rates without making serious changes in their economic behavior?

  • Will higher rates soon cool the US economy’s surprisingly hot growth and end hyperinflation?

  • Will investors’ ability to earn secure returns of 5 percent or more per year deter them from buying stocks?

  • Will higher rates further weigh on an already strong dollar, altering trade flows and creating more distress in vulnerable regions around the world?

Prominent among those reading the tea leaves of the bond market are the policy makers of the Federal Reserve, who will meet next week. For now, higher bond yields are working for the Fed.

As Federal Reserve Chairman Jerome H. Powell said in a conversation Economic Club in New York, while the Fed sets short-term rates, the bond market sets a wide range of long-term rates, which has significantly tightened financial conditions in the United States. This should further the central Fed goal: reducing inflation.

Fed policymakers are widely expected to keep the benchmark short-term interest rate it controls — the federal funds rate — steady at a range of 5.25 to 5.5 percent at its next meeting on October 31 to November 1. futures prices show.

Higher long-term interest rates work in parallel to the Fed tightening short-term rates. All of these higher rates increase costs and limit business activity throughout the economy. Some estimates suggest bond market rates are rising counterpart An increase in the federal funds rate by half a percentage point (50 basis points in bond market jargon), and perhaps even more.

But whether the bond market itself will keep rates steady – or change them sharply in the coming weeks – is not yet known.

The bond market is not attractive. Bonds involve mathematics, arcane terminology and investment returns that are typically negligible compared to the returns available in the stock market.

But the bond market plays an extremely important role. Without it, governments cannot finance their debt.

Consider some statistics. world fixed income markets Its value is approximately $130 trillion, of which the United States accounts for 40 percent. And US Treasury securities make up about half of the US debt: $25 trillion In August, and counting.

That mountain of American government debt is growing rapidly. The US government deficit, $1.7 trillion, effectively doubled last year, requiring the Treasury to auction off unusually large amounts of securities. It should continue to do so in the near future.

At the same time, last year the Fed transferred From buying Treasuries to reducing the stock of US debt.

With the Fed gone from the market, bond investors are financing more Treasury debt than ever before, and they are collectively demanding higher interest rates to do so.

As economists say, the market is looking for a new equilibrium. To put it more bluntly, when Treasury yields rise as a result of a mismatch between supply and demand, politicians in Washington take notice. This happened in the 1990s.

The Clinton administration was forced to scale back some of its progressive ambitions and cut government spending as bond market rates were rising. Administration adopted fiscal austerity – President Clinton Complained Told his staff that they all became Eisenhower Republicans – and took the federal budget into surplus for several years.

James Carville, the political strategist who played a key role in getting Bill Clinton elected president, is known for the slogan, “It’s the economy, stupid.” Another statement of his, published in The Wall Street Journal in February 1993, is relevant here. He paid reluctant tribute to the bond market.

“I used to think that if there was reincarnation, I would want to come back as president or the Pope or a .400 baseball hitter,” Mr. Carville said. “But now I want to get back into the bond market. You can scare everyone.”

A decade ago, Ed Yardeni, now an independent economist on Long Island, coined the term “bond vigilance” when the bond market rebelled against the rising budget deficits brought about by the supply-side economics of the Reagan administration. “If fiscal and monetary officials will not regulate the economy, bond investors will,” Mr. Yardeni wrote in 1983.

So far this year, the US government has been unable to get its fiscal policy in order. The federal debt rating was downgraded, the government came close to hitting its debt limit and a government shutdown, and an actual shutdown could occur next month.

The bond market may not be scaring everyone yet, but it is becoming turbulent, and it is too powerful to be ignored for long.

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