The Writing on the Wall

They say every prognosticator is eventually right, and I’m starting to feel like it might be my moment.  But it’s a moment I never wanted to come, and it does not feel good.

The bond market is finally opening its eyes to the handwriting on the wall. I’ve been saying interest rates are going to go up for so long I sound like a kook. When I’ve said those words, a few clients have replied “you’ve been saying that for years.” Because I have.

I’m not an economist. But you don’t have to be one to know central banks can only manipulate markets for so long before nature takes over, and the lid they’ve kept on rates wouldn’t last forever.

At the nadir of the last debt crisis in March 2009, The Federal Reserve handed US mega banks a mountain of tax payer cash, with no restrictions, and set them right back to doing the business that brought the crisis on in the first place. Yes, their intervention precluded a much deeper economic decline, which could easily have been a global depression. But they did practically nothing to address the structural problems that lead to the crisis. And neither did Congress. So the stage was set for the next crisis.

After they handed banks all that cash, they proceeded to create and spend four and a half trillion more dollars to buy Treasuries and mortgage backed securities (MBS), in an effort to further contain interest rates. The message they sent us was that this would encourage borrowing and spending, which will stimulate economic growth. And that was accurate. But the other motivation behind keeping a lid on rates has been to contain the cost of borrowing for the drunken sailors in Congress.

Actually, I take that back. Drunken sailors have nothing on Congress.

All that spending in the Treasury and MBS markets drove bond prices higher, and interest rates lower.  But every check they wrote had less and less impact on rate containment. So clearly they saw the hand writing on the wall well before bond investors, and announced they wanted to get out in front of inflation risk, stop all the bond buying, and begin raising rates. Slowly and incrementally.

That messaging has worked brilliantly. When I say rates are going to rise, people say to me, “But she says she’s only going to raise them slowly and a little at a time.” As if to suggest that Janet Yellen has had the interest rate markets on a string, and has complete control over everything.

To be clear, Janet Yellen is a very intelligent woman. Much smarter than me. But she and her successor Jerome Powell and her colleagues at the Federal Reserve Board do not have complete control over everything. In fact, they are in uncharted waters, and I suspect are feeling quite naked right about now.

As the Fed increases the amount of maturing debt proceeds they remove from the market, interest rates have nowhere to go but up. And the nine-year bull market in stocks, which was built on a foundation of more cheap, easy debt, will end by its removal.