The US federal government is the brokest entity the dark side of humankind could have ever conceived. And while that’s certainly the case, it is simultaneously true that our out-of-control politicians have no trouble whatsoever selling this deepening debt to a deflationary marketplace only too willing to snap up whatever is offered as if it was somehow scarce. Count me among the vigilantes, recognizing and pointing out these facts does not make me a cheerleader for the recklessness.

The fools in Congress (power of the purse, supposedly) have been able to take advantage of a situation that because of its specific properties has removed any kind of constraint on their foolishness. This is one prominent outcome of underlying, baseline deflation. Get rid of that, then watch what happens.

Bye bye deflation, hello vigilantism.

Such a categorical change has been professed numerous times over the past dozen years since the depth of the Great “Recession” shocked the official sector into action; breaking with all prior sense of proportions, first the ARRA (in the US) and then continuing, excruciatingly ineffective high deficits year after year. Eventually, everyone knows the piper must be paid.

Piper payday is always said to be right around the corner but has yet to visit the present tense. Because of this situation, and its rather unique characteristics, many have stated that the bond market itself therefore cannot and will not be the predictive engine for forecasting judgement day. Or even just the transitionary phase out from the deflationary grip.

Thus, currently low yields in 2021 are trivial, according to many. We shouldn’t care that yields remain incredibly low, factor just the selloff and the extrapolated continued direction (interest rates have nowhere to go but up).

The questions, therefore, is there predictive value in the yield curve?

Some influential researchers have said, no, if inflation is about to show up and batter the unwise then the bond market is the last place you’d see it coming (these same Economists at least admit bonds are consistent with, if not the best indicator of, concurrent inflationary circumstances).

One problem we have in assessing this view’s validity is that, obviously, there hasn’t been any inflation. After realizing how the underlying fundamental situation has absolutely changed since, oh, August 9, 2007, and that inflation has persistently, defyingly undershot ever since, academic studiers can only look at past cases and in different places to make some statistical comparisons.

They are free to do so, of course, but while they do we can compare yield behavior and curve dynamics to short- and intermediate-term disinflationary conditions as they have happened (as with the very much related QEnundrum, what follows is not intended to be a scientific study of the relationship, merely a general outline of these factors and their arrangement in time).

Reflation cycles (or, more appropriately, the dollar shortage cycles that reflation temporarily fits in between).

Maybe bond yields won’t tell us what inflation might be lying in wait over the horizon, though to this point they’ve done an excellent job of predicting – well in advance – the specific periods when inflation will undershoot the most (what we call Euro$ #n’s). Even more astounding (if you’re a follower of the mainstream view), the trends in curves/rates in the bond market are actually a good predictor of the Federal Reserve’s own modeled projections.

See for yourself:

The eurodollar futures curve (not pictured) was first to hint at trouble in September 2013, followed shortly by the yield curve and dollar’s rising exchange value against the Chinese yuan. From the first day of trading in 2014, all these things began to slide back into the deflationary trends which had only been broken by those few months of Reflation #3 (wrongly cited as the “taper tantrum”).

Throughout 2014, as Economists and even policymakers grew more confident in the recovery/inflation/overheating case, the market was instead forecasting a radically increased likelihood of its opposite. Renewed dollar shortage eventually squeezing financial markets before economic growth itself (especially around the world outside the US).

By 2015, that economic bearishness being priced for a year and more in the bond market (the whole thing, not just US Treasuries or the UST yield curve) wound up being quite accurate indeed. Confused, central bank math was forced to succumb to its view rather than the other way around.

Hardly the first time, this was merely the third instance in a row dating back to late 2006 when the eurodollar futures curve had first inverted forecasting the developing deflation of the first Global Financial Crisis “no one saw coming” (except everyone in the bond market). In the years since, temporary ups and more downs along the way, the mainstream, the Fed, and the narrative have all been trying to catch up to falling yields, not the other way around.

The problem is unearned disbelief caused by ideology (central banks are central).

This was again the case for the fourth bite at the inflation-is-coming-despite-low-rates apple: 2017’s globally synchronized growth. Then, as now, inflation was forecast by models but not by bonds. The latter were said to be “wrong” in all the media stories written favorably instead about the surefire chances of long-awaited liftoff.

True to form, first the flattening curve and then another outright drop in nominal rates while further flattening (all pre-COVID) again led rather than followed. And in this instance, it wasn’t just, like before, Fed models and the narrative which would end up compelled to reset in the direction this same market had previously set forward.

Jay Powell himself was obliged to turn his own monetary policy around 180 degrees to eventually align with what the bond market had predicted long before.

In short, maybe the bond market won’t be able to see inflation coming; we simply don’t know whether that’s the case because – so far – there hasn’t been any inflation coming despite all the very same promises and descriptions. What we do know, and what has been thoroughly established through repeated action, is that the bond market does predict very well the same ongoing downside case, otherwise known as renewed disinflation or deflation.

Incorporated within that is, at the very least, some minimized chances for an upside breakout. In other words, low, flat curves like there are today are suggesting the same disinflationary mess (if not worse, remember the current curves come after a “historic” upswing in January and February) they’ve been very good at identifying ahead of time for a prolonged, highly significant period.

Along those lines, the US Treasury Department had no issue today with its 7-year note auction – bid-to-cover and the underlying metrics all demonstrating again that it had been only the one auction gone astray. And why it had gone wrong, Fedwire, a reminder for how and why bonds have expressed only inflation and upside skepticism going back such a long time.

The Fed’s models like mainstream commentary can ignore real monetary issues that the real economy and the bond market simply cannot. You’d think that, over time, models and commentary would have to adjust to what bonds are indicating, but, again, ideology not science.

No one has wanted to believe it, protestations as regular and dependable as collapsing curves, yet here we are. The government gets broker by the minute, by the second, and the bond market cares nothing about it stepping up for every last penny on auction. Deflation comes first because deflation remains the likely case (over the intermediate- and long-term).

Put very simply, bonds don’t see that anything of substance has changed; in every meaningful way, there’s nothing truly different. Thirteen-digit government “rescues” aren’t actually different. You don’t have to take my word for it. The fact that the market keeps literally buying is, as it has been, more than a dependable forecast signal.