Federal Reserve

It’s Only “Academic”…

By David Stockman  |  October 22, 2018

Bubblevision is thick with heads talking about how rising interest rates are actually “good.”

It’s a sign the U.S. economy is stronger than an ox, these financiers/strategists/spokesmodels say. Fade bonds and fixed-income funds, but back up the truck for equities and maybe some sector ETFs, too.

“Buy the dip!”

“Buy the rip!!”

Don’t sweat the “small stuff”…

Now more than ever, Wall Street’s job is to spin the economic weather – rain or shine, sleet or snow – into something “just right” for the stock market of the moment.

Folks, this is “ritual incantation.” The salience of the strategy is a function of repetition. It has nothing to do with observed reality.

Here’s the thing: Even the most hardcore bull-slingers are beginning to talk about these “red” days – and the Dow Jones Industrial Average is off another 135 points at midday – in terms of “trends” rather than “tests.”

Here’s why equity indexes are in the red:

That’s the recent history of the yield on the 10-year U.S. Treasury note, the global benchmark for “risk-free rate of return.” It’s the basis for pricing just about every financial asset.

Wall Street has been suckled for so long by monetary central planning it actually believes in a free lunch.

Here’s Paul Donovan, the chief economist for UBS Group, in an email to clients in early October: “The media attention on this bond yield move is out of all proportion to the economic and financial implications of the bond yield move of course. This is hardly 1994.”

He added some color for MarketWatch, explaining that this move is “too small to have any meaningful economic impact. Indeed, the real yield this year (deflating by CPI) has barely moved at all – a 20bp increase in real yields (approx.) is hardly cause for panic.”

Indeed, “The Fed debate has resolved into the rather academic argument about the position of the neutral interest rate, not about the pace of tightening accelerating or decelerating.”

Donovan is saying that sharply rising bond yields are no sweat whatsoever because inflation is rising even more rapidly. He’s saying there’s nothing to see here, that it’s just some Keynesian debate about “neutral” rate of interest.

Neither the Federal Reserve’s unprecedented “quantitative tightening” nor the U.S. government’s insatiable appetite for debt and deficits matters a wit.

It all comes out in the inflationary wash; the more inflation, the better!

You can’t make this stuff up.

The household sector currently carries $15.4 trillion of debt, nonfinancial businesses have $14.8 trillion, and the public sector is hobbled with nearly $20.5 trillion.

But never mind about nominal interest rates on that $50.7 trillion.

Forget the fact that debt service will rise by a staggering $500 billion per year for every 100 basis points of higher yield.

And forget that there’s nothing “strong” about the U.S. economy right now. Here are some pictures; it’s weak, tired, beaten down, and exhausted…

“Real personal consumption expenditures” are slowing – and the U.S. economy is all about consumer spending.

But the personal savings rate is not accelerating.

The same is true of new single-family housing starts. They’re still 40% below the pre-crisis peak, and there’s zero sign of acceleration since November 2016.

The annualized start-rate was 873,000 in October 2016. It posted at 871,000 units for September 2018. That’s about as close to unchanged as it comes.

And, despite a historically massive draw on Uncle Sam’s credit card, capital expenditures haven’t accelerated, either.

Net private business CAPEX was an annualized $590 billion – virtually identical to the $585 billion rate posted during the second quarter of 2014.

And these are nominal dollars. So, in real terms, net business investment is actually down.

None of this indicates any kind of “booming” – or even “strong” – economy.

Indeed, interest rates are soaring because Imperial Washington has “engineered” the Mother of All Yield Shocks.

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR