Japanification of the US Bond Market

The Fed has insisted that negative interest rates are not on the table.  Yet.  While I don't believe the Fed will go to negative interest rates until the market has a tantrum over it, the door is definitely open.  That's because the financial markets could demand negative interest rates if the bear market is deep and long enough, and stock and bond investors get desperate enough.

Which means there is a high probability of it happening.  Even if the banks don't want it, the pressure from the rest of the economy would be too great for the Fed to resist investor demand for even lower rates, even if they are negative.  I am sure the Fed would find more ways to subsidize the banks if the rates go negative to placate the banks under such a scenario.  Much like they have done with interest on excess reserves after ZIRP in 2008, which is a backdoor subsidy to the banks. 

The ECB didn't decide to go to negative interest rates to hurt the banks, or to provide interest relief for sovereigns, it was to drive the value of the euro lower and  to lower corporate and mortgage yields to stimulate their moribund economy.  And it didn't work.  Because the demand for credit is more inelastic to interest rates or even exchange rates than the central banks believe.  Not many corporations or individuals decide to suddenly borrow more money because the interest rate has dropped 0.5 or even 1%.

Even though it hasn't worked, the ECB still has maintained negative interest rates.  That's because once you lower interest rates to zero and beyond, the financial markets get used to it and price assets based off of that assumption.  And anytime you raise interest rates, it hurts financial assets.  And its pain that the central bank doesn't want to take or be blamed for.  So the easy way out is to just keep the same rates, or even lower them a bit more, even though the European banks are screaming not to.

The ZIRP and NIRP trap is almost inescapable.  The US was able to escape the ZIRP trap from 2017 to 2019, but that lasted 3 years, and now we're back at zero, and trapped much tighter to the zero bound than the last time.  There is a lot more debt, both public and private relative to GDP than 2008.  The US is now trapped to the zero bound as the easy money policies have encouraged an explosion of debt, which makes the economy vulnerable and weak when interest rates go higher,making it impossible to raise rates.

What about inflation, you say?  Lies, damn lies, and government statistics.  The CPI and PCE are fraudulent indicators of inflation.  They vastly underestimate price increases through hedonic pricing adjustments and substitution assumptions as well as technological "value" added.  A car that increases in price 10% with subjectively (the government decides) 10% better technology and features is considered a 0% increase in price, not 10%.

So the government will lie about inflation and if it gets high enough that the lie is obvious and investors revolt from buying US bonds, the Fed will just come in with a bigger QE, but more likely, tighten their yield curve control.  Yes, the final resort of central banks that have no natural organic demand for their bonds.  Manipulating the long end of the yield curve, just like they manipulate the short end.  Japan's yield curve control has kept the 10 year yield around zero.  And the volumes traded in the JGBs are tiny compared to when they were natural free flowing markets. That is a preview of things to come for the US Treasury market.

This comes back to what the implications are for the bond market.  It means that the whole yield curve will eventually be managed by yield curve control in the US, to suppress interest rates in longer maturities.  The volume of Treasuries being issued is enormous due to all the fiscal pork stimulus that's been passed.  The amount of QE that the Fed would have to do would make the balance sheet skyrocket beyond anything we've seen among the global central banks.  That would start to undermine the credibility of the US dollar as a reserve currency, so you can bet the Fed will try to find an easy way out of this mess by stating their willingness to buy unlimited Treasuries above a certain yield for each part of the curve, let's say 0.5% for 10 year notes, or 1% for 30 year bonds.  And those rates will be adjusted lower if the stock market goes down.

And remember, the BOJ is a trailblazer when it comes to experimental monetary policies.  They are still buying a ton of Japanese equity ETFs, and are the elephant in that market now.  The Fed will not go there until they get through doing more extensive buying of corporate bond ETFs, including junk, and then they'll move to yield curve control, and then finally the big bazooka, equity ETF purchases.

That would give enormous power not just to the Fed, but to those constructing the constituent companies in the ETFs that the Fed will buy.

The free market as we know it will be completely obliterated.  It doesn't make stocks a long term buy.  Not unless you hedge out the currency to gold or some other hard asset.  

Corporate socialism and cronyism are about to get upped several notches higher.  And there is no going back, unless you get a revolution.  And that's not happening when the masses are this dumb.  The lack of education among the masses in the US is the primary driver behind a continuation of these policies.  The only thing that will get through to the thick skulls of the masses is rampant inflation and a big drop in the standard of living, which probably will happen if globalization ends.

I am no fan of globalization, but it has kept inflation in a lot of manufactured goods relatively low for the past 20 years.  Whether you like China or not, they have been subsidizing US consumer spending for decades now by using their low cost labor force to pump out cheap goods everywhere.  The political pressure will now be to decrease trade reliance on China, and bring more manufacturing to the US. 

When globalization and free trade decreases, while fiscal deficits skyrocket and Fed money printing covers the deficits, inflation will increase, without a doubt.  Right now, probably for the next 12-18 months, inflation will be under control due to the huge economic hit from the coronavirus.  But unlike 2008, this crisis is leading to a gigantic explosion in the US budget deficit.  If you thought the 2008-2009 trillion dollar deficits were bad, the 5-10 trillion dollar deficits in the coming years will make it look like child's play.  When the dust settles and the crisis is over, you will be left with a mess of a financial situation: low rates, huge deficits, and high inflation. 

Once you get these huge budget deficits, much like zero interest rates, they remain sticky.  Its hard to cut government spending and raise taxes.  Especially when the Fed is willingly buying up all that newly issued debt and the dollar maintains its reserve currency status.  Until the rest of the world starts to rejects the US fiscal and monetary policy by moving to alternative currencies as a means of exchange for global trade, expect the pork to keep flowing and the Fed to keep buying.

MMT will be the beginning of the end for the US dollar as a reserve currency, and it is happening now.  With Trump's poor handling of the coronavirus and his weak poll numbers vs Biden, its likely that the Democrats will win the White House and probably both Houses of Congress.  That will be the open invitation for the US government to enact full blown MMT policies, massive government spending, minimal tax hikes to pay for it, and the subsequent Fed asset purchases to keep interest rates low and stock markets high.

Its coming, the US government will not let a crisis go to waste.  They are now hell bent on taking control of the US economy, soon to make China look like a complete free market system in comparison. 

We got a strong intraday bounce yesterday.  But is right back towards levels where I want to short, so I have entered a small short here in the premarket hours.  I will add more if we rally during regular market hours, with plans to cover below 2800.