The year is 1983. The sharp “double-dip” recession of the early ’80s has ended, and bond yields–which had finally been “broken” by Paul Volcker’s massive rate hikes–are showing signs of breaking out again. The 10-year Treasury jumps from roughly 10% to nearly 12% that summer.
In his weekly client note that June, Ed Yardeni issues his famous warning: “Bond Investors are the Economy’s Bond Vigilantes,” warning that “if the fiscal and monetary authorities won’t regulate the economy, the bond investors will.” Yields continued to rise to a high of nearly 14% the following year.
Exactly forty years later, we are back in that same position today. The 10-year Treasury was around 3.8% in January; it is now about to pierce 5% as the upward surge in long-term bond yields shows no sign of slowing down yet. As of yesterday, that has officially put mortgage rates at 8%.
“The bond market has stepped into the driver’s seat now,” warns former Dallas Fed President Robert Kaplan, who will join us at 1 p.m. today. ″[Fed Chair] Powell is not in charge anymore.” Powell actually happens to be giving a speech at noon today, which takes on added urgency as yields continue to soar. “Will Powell try to slow it down?” asked Natalliance strategist Andrew Brenner in a note last night. The real question now is, can he?
The Fed’s plans for further rate hikes are in some ways the sideshow here. The only way they can bring the Treasury market back into control is to announce they’ll start massively buying government debt again. But if they do that, restart “quantitative easing,” that will stimulate the economy and cause inflation to pick up again. The Fed is stuck.
So if Powell can’t fix it, then who can? Here’s the problem: it’s the government. Yes, it’s up to Washington now. They have to close the much-worse-than-expected deficit quickly, to stem the flow of Treasuries coming into a market that has little appetite for them. Over the past 15 years of ultra-low rates, followed by Covid’s massive spending, we now have a Treasury market that’s $25 trillion in size, compared with just $5 trillion pre-2008. And the biggest buyers of government debt during that period–central banks–are no longer buying.
Washington, however, does not even have a Speaker of the House at present. There is zero sign of any meaningful change to the $1.7 trillion budget deficit in the near term. Less than a third of our more than $6 trillion in spending this year is even changeable without touching entitlement programs. Tax hikes to close the deficit would have to take revenues to a level we’ve never been able to achieve before, and at a time when consumers already feel maxed out.
Even a recession–likely the only “cure” for high bond yields–would further exacerbate the fiscal problems. Government revenues plunge during recessions, resulting in bigger deficits that add to the debt. The subsequent recovery and rise in yields would once again cause interest payments to doubly grow the deficit, increase the debt pile, and keep us trapped in the so-called “fiscal doom loop.”
No, the only real “way out” here is…Ross Perot. Yes, the Texas entrepreneur who ended up winning 19% of the popular vote for President in his shocking success as an outside candidate running a campaign focused on tackling federal deficits and debt. His ideas wound up serving as the bedrock for much of the “Contract With America” that Republicans then used to push for changes that later helped result in the first balanced budget in three decades.
But here’s the rub: the year of Clinton’s balanced budget announcement…was 1998. Six years after Perot’s campaign, which itself was nine years after Ed Yardeni’s column that first coined the term “bond vigilantes.” Fifteen years from start to finish, and we’re only in the “1983” moment right now.
So even as I listened to Chris Christie make a strong case on CNBC yesterday for why his balanced-budget success in New Jersey (with a legislature from the opposite party, no less) should make him a front-runner in next year’s election, I couldn’t help but think: it’s too soon. Things haven’t gotten bad enough yet. But if we could just somehow tackle these fiscal problems now, maybe they wouldn’t have to.