Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
How to Play Interest Rates in US Real Estate - 20th Aug 19
Stocks Likely to Breakout Instead of Gold - 20th Aug 19
Top 6 Tips to Attract Followers On SoundCloud - 20th Aug 19
Holiday Nightmares - Your Caravan is Missing! - 20th Aug 19
UK House Building and House Prices Trend Forecast - 20th Aug 19
The Next Stock Market Breakdown And The Setup - 20th Aug 19
5 Ways to Save by Using a Mortgage Broker - 20th Aug 19
Is This Time Different? Predictive Power of the Yield Curve and Gold - 19th Aug 19
New Dawn for the iGaming Industry in the United States - 19th Aug 19
Gold Set to Correct but Internals Remain Bullish - 19th Aug 19
Stock Market Correction Continues - 19th Aug 19
The Number One Gold Stock Of 2019 - 19th Aug 19
The State of the Financial Union - 18th Aug 19
The Nuts and Bolts: Yield Inversion Says Recession is Coming But it May take 24 months - 18th Aug 19
Markets August 19 Turn Date is Tomorrow – Are You Ready? - 18th Aug 19
JOHNSON AND JOHNSON - JNJ for Life Extension Pharma Stocks Investing - 17th Aug 19
Negative Bond Market Yields Tell A Story Of Shifting Economic Stock Market Leadership - 17th Aug 19
Is Stock Market About to Crash? Three Charts That Suggest It’s Possible - 17th Aug 19
It’s Time For Colombia To Dump The Peso - 17th Aug 19
Gold & Silver Stand Strong amid Stock Volatility & Falling Rates - 16th Aug 19
Gold Mining Stocks Q2’19 Fundamentals - 16th Aug 19
Silver, Transports, and Dow Jones Index At Targets – What Direct Next? - 16th Aug 19
When the US Bond Market Bubble Blows Up! - 16th Aug 19
Dark days are closing in on Apple - 16th Aug 19
Precious Metals Gone Wild! Reaching Initial Targets – Now What’s Next - 16th Aug 19
US Government Is Beholden To The Fed; And Vice-Versa - 15th Aug 19
GBP vs USD Forex Pair Swings Into Focus Amid Brexit Chaos - 15th Aug 19
US Negative Interest Rates Go Mainstream - With Some Glaring Omissions - 15th Aug 19
US Stock Market Could Fall 12% to 25% - 15th Aug 19
A Level Exam Results School Live Reaction Shock 2019! - 15th Aug 19
It's Time to Get Serious about Silver - 15th Aug 19
The EagleFX Beginners Guide – Financial Markets - 15th Aug 19
Central Banks Move To Keep The Global Markets Party Rolling – Part III - 14th Aug 19
You Have to Buy Bonds Even When Interest Rates Are Low - 14th Aug 19
Gold Near Term Risk is Increasing - 14th Aug 19
Installment Loans vs Personal Bank Loans - 14th Aug 19
ROCHE - RHHBY Life Extension Pharma Stocks Investing - 14th Aug 19
Gold Bulls Must Love the Hong Kong Protests - 14th Aug 19
Gold, Markets and Invasive Species - 14th Aug 19
Cannabis Stocks With Millennial Appeal - 14th Aug 19
August 19 (Crazy Ivan) Stock Market Event Only A Few Days Away - 13th Aug 19
This is the real move in gold and silver… it’s going to be multiyear - 13th Aug 19
Global Central Banks Kick Can Down The Road Again - 13th Aug 19
US Dollar Finally the Achillles Heel - 13th Aug 19
Financial Success Formula Failure - 13th Aug 19
How to Test Your Car Alternator with a Multimeter - 13th Aug 19
London Under Attack! Victoria Embankment Gardens Statues and Monuments - 13th Aug 19
More Stock Market Weakness Ahead - 12th Aug 19
Global Central Banks Move To Keep The Party Rolling Onward - 12th Aug 19
All Eyes On Copper - 12th Aug 19
History of Yield Curve Inversions and Gold - 12th Aug 19
Precious Metals Soar on Falling Yields, Currency Turmoil - 12th Aug 19
Why GraphQL? The Benefits Explained - 12th Aug 19

Market Oracle FREE Newsletter

The No 1 Gold Stock for 2019

Will Interest Rates Sky Rocket as Inflationary Pressures Build?

Interest-Rates / US Interest Rates May 07, 2009 - 06:28 AM GMT

By: Money_Morning


Best Financial Markets Analysis ArticleMartin Hutchinson writes: U.S. Treasury bond yields are going higher - much higher. And that’s even before we factor in the likely effects of rising inflation, which we haven’t seen yet, but can certainly anticipate.

Throughout the news media, commentators are noticing new “green shoots” - early signs of a recovery in the U.S. economy, or at least preliminary evidence that this nasty recession may be bottoming out. This is probably still a little premature, although the evidence that the recession’s downward slope has eased is overwhelming enough to have fueled a two-month rally in stock prices.

That stock-market rally is probably premature, too; in the near term, at the very least, stock prices have clearly outpaced economic reality. Indeed, investors should bear in mind one very important caveat: This time around, the recession’s bottoming out will likely lead to much higher long-term interest rates. And those higher rates will manifest themselves in the form of higher U.S. Treasury bond yields.

Let’s take a closer look to see why this is so.

An Overview of a Rebound

Normally, at the nadir of a deep recession, interest rates do not move much. Funding needs for capital investment are low, housing finance is in the doldrums, inventory-finance needs are low and consumer savings rates are relatively high. As long as the government deficit is under control, there’s no need for rates to move up until consumer and business loan demand starts to grow robustly.

Moreover, any tendency for rates to move up is self-correcting, since it produces a moderation of loan growth. Indeed, if the government-financing deficit is kept under control, there is a tendency for long-term interest rates to move down, accelerating the recovery.

Naturally, inflationary expectations can distort this picture. If, as in 1974, inflation isn’t a problem, you can get the extraordinary effect of the U.S. federal government switching from handing out “Whip Inflation Now” buttons to frantic fiscal stimulus within the space of six weeks. On the other hand, if inflationary expectations are very high, as they were back in 1982, real interest rates may reach extraordinarily high levels - even while the economy is in recession.

The Catalysts for Higher Yields

This time around, however, we are not in a normal recession.

Monetary policy has been extremely stimulative for the last six months, with broad money growth running at more than 15%, and real interest rates substantially negative. The justification for this - that the United States was in danger of substantial deflation - was proved to be erroneous by last week’s report on first-quarter gross domestic product (GDP). In that report, the deflator - the rate at which domestically produced goods increase in price - was a surprisingly high 2.9%, indicating that inflation has by no means gone away.

In addition, the U.S. Federal Reserve is buying securities in the markets and financing others to do the same; its purchases of U.S. Treasury bonds, in particular, are nothing more than a pure monetization of the U.S. federal deficit, which can only lead directly to higher inflation.

The German Weimar Republic, during the years leading the 1 trillion percent inflation in 1923, monetized 50% of government expenditure. The Fed, through its program of buying $300 billion of T-bonds in six months, is currently monetizing about 15% of federal expenditures, not as high as Weimar, but enough to nonetheless bring about a severe danger of inflation.

On the fiscal side, the federal government is going to borrow about $2.5 trillion this year - money that will enable it to finance its $1.8 trillion budget deficit, while also fueling investments in banking, housing finance, automobile production, etc. (which don’t count toward the deficit because there’s some chance that taxpayers will get some of their money back).

Overall, we’re talking about aggregate borrowing that equates to about 20% of GDP, a record-breaking number that can be expected to put a huge strain on the world bond markets.

With inventories collapsing (they were down by $103 trillion in the first quarter), and releasing cash to businesses, some of the strain of this financing has so far been hidden.  In addition, April is the U.S. Treasury’s best cash flow month, usually showing a substantial surplus, as businesses and individuals make their final 2008 tax payments.

However, we are now in May. And as the economy begins to bottom out, the inventory decline of the first quarter is showing signs of halting, or even reversing. That’s why people are so optimistic about “green shoots” of recovery.

Hence, the Fed’s borrowing numbers over the next few months are going to be well in excess of previous records (other than at the height of World War II).

That is bound to put upward pressure on medium- and long-term Treasury bond rates, as well as on inflation. Already, the People’s Bank of China - Mainland China’s central bank and one of the world’s major buyers of T-bonds and federal agency bonds over the last few years - has expressed deep unease at the trends in the dollar and in federal financing.

You can already see the results of the pressure on Treasury financing. The 10-year Treasury bond yield, which bottomed out at 2.07% in December, last week broke decisively above 3% for the first times since the financial crisis started last September, and is currently trading at around 3.17%.

The fact that the market isn’t yet worried about this is evidenced by the continued strength in stocks. For market bulls, the growing signs in the last two months that we are close to the bottom of the recession must truly mean that “Happy Days are Here Again.”

But with the U.S. Treasury singing “Brother, Can You Spare a Dime” - or rather $2.5 trillion - Treasury bond yields are going much, much higher. And that’s without even considering the likely effects of rising inflation.

How much higher will Treasury bond yields move? In the 1990s, for example, 10-year Treasury bond yields averaged 6.67%. That’s a period when inflation averaged 2.9% - ironically, the same as the deflator in the first quarter GDP announced last week - and the federal budget deficit averaged a mere 2.3% of GDP.

So it seems reasonable to me that 10-year Treasury bond yields could easily rise to that level again. And if my prediction proves correct, we’ll see that there’s going to have to be one hell of an adjustment by the U.S. housing market, the stock market and the U.S. economy in general.

Money Morning/The Money Map Report

©2009 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email:

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Jon Nap
07 May 09, 16:13

Well written. I agree on all points. As an investor, it is time to be an observer and keep your powder dry. Some politicians have been quick to critisize China and their monetary policy. Wait until China decides NOT to buy our treasuries unless/until the price/yield is acceptable to them. That's when many in the bond market will run for the exit; all at the same time aka "bond bubble" bursting.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules