The tried-and-true Wall Street maxim of he or she is “talking their book” couldn’t be more accurate or timely to describe what is being spewed from Treasury Secretary Janet Yellen. She is, apparently, in full denial of the stress being placed on the bond market due to escalating debt issuance and elevating yields from lack of demand for U.S. debt by all classes of buyers.
In her words, Yellen suggests the rise in yields — which has resulted in benchmark Treasury rates reaching their highest level since the global financial crisis — essentially points to the strength of the economy, according to Bloomberg. Last Thursday, she dismissed the notion that the surge is a consequence of the United States budget deficit.
I guess she missed the news flash that the five-year note auction drew a high yield of 4.23% and a bid-to-cover ratio of 2.27, below the norm of 2.42. And at the most recent 30-year Treasury auction, bidders showed their lowest interest in the long bond since 2021, evidenced by primary dealers having to buy nearly 18.2% of the debt. The yield jumped to 4.86% before the flight-to-safety trade took hold Friday. As a rule, primary dealers are required to take the debt not purchased by other bidders.
There was better sponsorship in the seven-year auction last Thursday, implying that might be the sweet spot for the institutional appetite as to length of maturities. When foreign central banks, sovereign country funds, pensions and endowments don’t line up to soak up large-scale bond auctions, it is then left to mutual funds, hedge funds, smaller pension funds and retail investors to soak up the excess. China has also been a net seller of Treasuries that have to be absorbed as well, adding further pressure.
Even Fed Reserve Chairman Powell is chiming in lately about the role of escalating bond yields and the potential to rapidly tighten financial conditions. Such a public view from the Fed could imply some influence on monetary policy going forward. Powell noted the resilience of the economy possibly contributing to the role in rising yields, which is what Yellen is touting as the boogie man for plunging bond prices.
This week, investors will be riveted on two non-earnings-related events, the Federal Open Market Committee (FOMC) meeting on Wednesday, Nov. 1 and the announcement of the Treasury Department’s new borrowing plan that will be announced just prior to the Fed’s release of their policy statement. Early insight into the plan shows an emphasis on increasing sales of long-dated debt to fund a growing budget deficit. Bond dealers are forecasting a refunding size of around $115 billion, which would be consistent with increases in previous funding. The Treasury may opt for shorter-term maturities given the spike in long-term yields and the recent lower level of demand for long-term maturities.
Yellen continues to defend her position that the surging Federal debt burden remains under control. “The statistic I look at most often to judge our fiscal course is net interest as a share of GDP,” she noted in a CNBC interview, referring to the net payments the federal government makes on its debt relative to U.S. gross domestic product. “And even with the rise we have seen in interest rates, that remains at a reasonable level.”
Yellen points to federal interest payments of 1.86% of GDP for 2022, according to data from the Federal Reserve. That is in line with the historical average going back to 1960 of just under 2%. What fails to be mentioned is that the 1.86% represents a carrying cost of tens of trillions in debt with fixed rates of less than 2% issued from 2008 through 2021. That 2% also reflects extremely low budget deficits relative to today’s ballooning debt. When factoring in the surge in rates over the past year on $33.5 trillion of outstanding debt, the going-forward net payments on debt relative to GDP will likely gap way higher when the Fed reports the 2023 data.
Critics of Yellen assail her policy stance as that of having a zero-interest rate introductory offer for a credit card followed by multiple approvals for new spending limits, where higher interest rates kick in along the way and create monthly payments that can’t be sustained because they eventually become the largest line item within the federal budget.
Mark Spitznagel, founder of the hedge fund Universa Investments, told Fortune magazine in August that we’re living through the “greatest credit bubble in human history.” We’ve never seen anything like this level of total debt and leverage in the system. “It’s an experiment” he said. “But we know that credit bubbles have to pop. We don’t know when, but we know they have to.”
Spitznagel pointed out that total public household debt hit a record $17 trillion in the second quarter, with non-housing debt hitting an all-time high of $4.7 trillion and the U.S. debt to GDP ratio at 120%, according to the Federal Reserve. While Yellen admits that, moving forward, the government will need to “make sure” to keep deficits under control or the national debt could become an issue, it seems she is blind to the fact that the problem is here and now. America needs a new Treasury secretary that has the mind of a responsible banker and doesn’t think like a credit card company.
