The Bond Market Is Calling The Fed’s Bluff – Things Aren’t Looking Good

What this means is that banks and hedge funds borrow short term debt and invest the funds in the long term high-yielding market.

For instance, a local bank will borrow from the Fed at 1.75% then turn around and lend it out to a mortgage customer at a fixed rate of 4.5%. Their ‘nominal’ profit (before subtracting inflation costs) being the difference – which is 2.75%.

Many economic crises have happened because of short term rates shooting higher then long-term ones. It creates illiquidity problems. And many bank runs have started from this. So now that we know the Fed will put up with much higher inflation than their ‘2%’ target rate – like we expected – but how much higher is yet to be seen.

Second Revelation

If the Fed is hiking rates, unwinding their balance sheet through Quantitative Tightening – selling their bonds – and with inflation already at 2.5% and rising, why are investors buying 10-year bonds only yielding 2.99%?

Inflation alone is killing the ‘real’ gains – for instance, a 2.99% yield minus 2.5% inflation equals only 0.49% ‘real’ profit.

That’s more than an 85% ‘real’ loss. 

And since the Fed said they’re okay with even higher inflation – that means the 10-year bonds bought today are facing serious ‘real’ losses. So, the real question is – why are investors today buying long dated bonds when the Fed is hiking rates, running Q.T., and inflation is rising?

Shouldn’t investors be selling their bonds and asking for higher yields to protect themselves from the coming inflation and rate hikes?

The only answer I can think of is that the bond market is calling the Fed’s ‘economic growth’ bluff. They understand that the U.S. economy is fragile. And that the chance of deflation and recession is very likely within the next few years.

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The piece is from my original write-up at Palisade-Research.com - All ideas expressed and charts are my own.

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Gary Anderson 1 year ago Contributor's comment

Long bonds are pricing in financial trouble. If inflation does not help workers and lack of inflation does not help them, helicopter money is the only answer.