Last Week in Review: Congress Printing, Fed Exiting
Among the many stories happening this past week, the elephant in the room remains Afghanistan. There is so much uncertainty and it isn’t clear when, how and if it ends. In challenging times like these, bond prices and rates typically improve, but they didn’t. Rates crept higher week over week. Let’s break it all down and discuss what to look for next week.
Cranking up the Printing Press
Congress is preparing to vote on nearly $5T on spending next year. That is a serious amount of money, and it comes with a cost. First, the Treasury must sell bonds in weekly auctions in order to create the money to spend.
This means we need buyers, and a lot of them to purchase all this paper. These buyers must also be confident that the bonds don’t decline in value causing a capital loss sometime in the future.
What would cause bond prices to decline and rates to move higher? Here are a few things that could cause higher rates:
Persistently high inflation: At the moment, we are seeing very high year-over-year inflation, but the Fed says it will be mostly “transitory” or temporary in nature. If the Fed is incorrect and inflation remains persistently high, rates must creep higher. The Consumer Price Index, CPI, is currently 5.3% annually, more than three times higher than our 10-year yield, currently sitting at 1.35%. Inflation being higher than Treasury rates is an unsustainable trend but, there is a big reason why it exists today.
The Fed stops buying bonds: The Fed is currently purchasing at least $120B in Treasuries and Mortgage-backed securities every month. There are calls to taper and stop purchasing bonds. If and when the Fed exits, rates could move sharply higher, much like they did back in 2013 – hence the term “taper tantrum”.
U.S. Dollar decline: Should the enormous spending plan be passed; it could have a negative effect on the US Dollar. When the dollar declines, it makes US dollar denominated commodities like Oil more expensive, thereby lifting prices and causing inflation.
Bottom line: There is a lot of uncertainty in Afghanistan, Washington DC and the Fed. We don’t know if these spending bills will even pass or if conditions warrant the Fed to taper anytime soon. However, if and when the Fed signals they are exiting their bond buying program, rates are likely headed higher and possibly in a hurry.