Bond Market Rocks The Richter Scale

The global sovereign bond market is fracturing, and its ramifications for asset prices cannot be overstated. Borrowing costs around this debt-disabled world are now surging. The long-awaited reality check for those that believed they could borrow and print with impunity has arrived. From the U.S. to Europe and across Asia, February witnessed the biggest surge in borrowing costs in years.

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Thursday, February 25, 2021, was the worst 7-year Note Treasury auction in history. According to Reuters, the auction for $62 billion of 7-year notes by the U.S. Treasury witnessed demand that was the weakest ever, with a bid-to-cover ratio of 2.04, the lowest on record. Yields on the Benchmark Treasury yield surged by 26 bps at the high—to reach a year high of 1.61% intra-day--before settling at 1.53% at the close of trading.

What does the head of the Fed have to say about the move? Jerome Powell believes the volatility in bond yields is a healthy sign for the economy. Yet, out of the other side of his mouth is warning that nearly 30% of corporate bonds are now in “trouble.” The Federal Reserve and other bank regulators are warning that businesses impaired by Covid-19 are sitting on $1 trillion of debt and a high percentage of it is at risk of default—exactly 29.2% of lending was troubled in 2020, up from 13.5% in 2019, according to a report recently released by the Fed.

The average interest rate on U.S. Public Debt back in 2001 was 7%. Today, thanks to massive and unprecedented central bank intervention, it has plummeted to about 2%. Precisely because of the Fed’s manipulation of bond prices, the interest expense on that $27 trillion National debt was just $522 billion in 2020. If interest rates were to return to the normal level of 7%, the interest expense would soar to $1.9 trillion per year!

So, what pushed rates to record lows in the first place, and what conditions are necessary to keep them from surging much higher from here? There are three reasons for record-low bond yields. Number one: The Fed has been engaging in Q.E. at the record pace of $120 billion per month. It is in the process of purchasing $80 billion of Treasuries and $40 billion 0f M.B.S., which amounts to massive manipulation of bond prices. The second: The U.S. has experienced anemic G.D.P. growth. According to the B.E.A., real G.D.P. decreased 3.5 percent (from the 2019 annual level to the 2020 annual level), compared with an increase of 2.2 percent in 2019. Lower levels of growth push the flow of money towards fixed-income investments. And thirdly, inflation must be quiescent, for it is the bane of the bond market. The B.L.S. indicates that year-over-year C.P.I. increased by just 1.3% at the end of last year, which is well below where the Fed would like inflation to be. If either one of these conditions changes, rates will spike along with interest payments on the debt.

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Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called,  more

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