This month marks the anniversary of the pandemic induced stock market crash, inducing government launched emergency credit facilities, aided by the Fed who announced it would purchase:
Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy...
A year later, the US Debt has surpassed $28 trillion. US 10-Year Treasuries topped 1.6%, mirroring pre-COVID levels. Regardless of how the pandemic is resolved, the Fed will always intervene in our lives. There will always be economic problems which need addressing. Regarding what’s needed to support “smooth market function,” the initial $700 billion of securities has tapered to $120 billion a month… for now.
This brings us to the latest problem: rising interest rates.
Despite a targeted Federal Funds Rate of 0 to 1/4 percent, yields, especially on long-dated bonds, can and do fluctuate. CNBC illustrates two commonly heard ideas:
Bond investors are getting worried about the potential for inflation.
Also:
This time the rise in yields is coming from economic growth, stimulus, and infrastructure. All of that is good for stocks.
Of course, the narrative is problematic. If yields rise due to price inflation, economic growth, and government stimulus (supposedly desirable), you’d think there shouldn’t be significant risk to the economy nor stock market when yields increase.
Luckily, the concern over rising rates can be explained: debt. Ironic, since we use a debt-based currency with the widespread belief spending leads to prosperity which government stimulates through borrowing. Somehow championed by those who claim debt doesn’t matter or deficits are a myth, we can’t deny this is where many of our problems stem.
When rates rise, interest costs increase. Imagine a world where the 10-year treasury is at, say, 4%. The interest expense on the $28 trillion would surpass $1 trillion a year. Mortgage rates would no longer be considered “cheap” and corporate bonds would be much higher. There are additional effects, such as making share buybacks not as attractive as they have been for over decade, but there are many areas of the economy that are affected.
If rising interest rates scare the market and the public now, what happens in the future when US Debt, household, and corporate debt are at greater highs and when asset valuations are even richer than today?
The US Debt will pass $30 trillion this year with no sign of slowing. The Fed would face difficulty if it wanted to raise rates then, or face backlash by not taking action when long dated bonds rise again.
Unfortunately, the Fed is stuck in limbo of sorts; letting rates rise would be economic destruction. But to keep rates low forever leads to a similar fate. The difference being, if rates are raised, the Fed will look like the villain. If they try to suppress rates and fail, they’ll be hailed as fallen heroes, whose earnest efforts to control the markets backfired due to uncontrollable forces, (e.g., blame capitalism).
Last March, Neel Kashkari, President of the Minneapolis Fed, gave a hint on 60 Minutes:
And there’s an infinite amount of cash at the Federal Reserve.
His quote was an answer to the question of whether or not our bank deposits are safe. Yet, he captures the ethos at the Fed. Whether they revisit ideas of yield curve control or use alternative approaches, the only way rates stay low for perpetuity is via perpetual money creation.
The Fed has long since committed to buying any bond necessary in times of crisis. But the crisis will never end. Society’s debt level will never shrink and its growth will accelerate year after year. The only way to ensure rates don’t stay too high for too long is to utilize its infinite cash position, seeking to solve the problem with the same method used to create it in the first place.
