10 Year Treasury Yield Hints at Two Routes to the Same Destination
I’m long past athletic peak, but the playoff atmosphere, in which decisions and execution become palpably more consequential, still excites a resilient competitive ambition. I wonder if Jerome Powell, recently exposed to “World Series pressure” by the 40 year high inflation he personally created, feels confident or afraid right now. What is the financial backdrop, what are Powell’s policy options, and how will ‘the Fed’s’ decisions affect your investments?
The 10 Year Treasury yield, the most accurate economic forecaster in the world today and the most influential financial component, has recently sounded the alarm on both escalating inflation and coming economic contraction. Ordinarily, in this phase of the economic cycle, the Fed would raise interest rates until the economy ‘breaks’, and then quickly revert to lowering rates and printing money to restart the cycle. I’m not saying this is what ‘the Fed’ should do; I’m saying this is their program. Facing the two unique dynamics in this particular cycle of 1) 40 year high inflation, and 2) the greatest debt any government has ever amassed, what are Powell’s options, and what are the implications?
Scenario 1: The 10 Year yield, now bumping up against a 30+ year downtrend line, rolls over and begins to decline with the economy and inflation rate. The yield curve inverts further, and ‘the Fed’ raises rates into recession and then reverses course. The stock market enters a bear market, bottoms, and then begins to climb the “wall of worry”, eventually beginning a new bull market. ‘The Fed’ and its Reserve Note live to inflate another financial bubble.
Scenario 2: The 10 Year yield rises through the downtrend line due to high inflation and a lack of demand for U.S. government debt. The Fed aggressively raises rates to fight inflation, causing a deep economic contraction. Higher interest expense on outstanding debt, coupled with lower tax receipts from recession, mean the government will then have to a) stop paying interest on Treasury bonds, b) slash entitlement spending, or c) borrow the difference.¹ ‘The Fed’ comes to the rescue with additional quantitative easing to purchase the government debt no one else wants. America has a perpetual inflation problem and the demise of ‘the Fed’ and its Reserve Note hastens.
Our central bank’s highest priority is to monetize the U.S. government’s debt; if we can remember this, the financial world will make far more sense to us. It’s no coincidence both scenarios result in additional money printing, it’s just a matter of how fast we get there, and how much pain American workers and investors must endure in the process. Keep in mind the 10 year Treasury yield calls the shots, not the Fed; ultimately, it will declare the “Federal Reserve Note” the failed currency that it is. This means we generally need to be investing for inflation, yet always protected from the occasional deflationary collapse.
Think about it, Shaun.
“He who earns wages does so to put them into a bag with holes. “Thus says the Lord of hosts: Consider your ways.” ~Haggai 1:6-7
1 Inside Tradesmith, by Justin Brill, “What the Fed and Inflation Could Mean for Your Investments, April 5, 2022
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial. The economic forecasts set forth in this commentary may not develop as predicted.
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