Why Aren't Yields Going Higher?

The 10 year yield started the year at what now seems like an absurdly low 0.91%.  The 10 year yield is now at 1.50%.  

Depending on your time frame, you get different perspectives.  If you aren't focused on the day to day movements, but are looking at moves over several months, the yields have gone up a lot and even seem a little bit HIGH.  If you are looking at just the past 2 months, when the yields have mostly been between a super tight 1.55%-1.63% range, with fleeting moves towards 1.46% and 1.70%, 1.50% seems LOW.  

Based on how most investors feel, which is that yields are still low, you can guess what time frame most of them operate on.  Almost all of the fixed income "experts" are calling for 2.00% 10 yr yields by the end of the year, yet the yields are going lower, towards the bottom of the recent range.  Those experts are almost always calling for higher yields, like a broken record. 

 

So why aren't yields going higher, with all this fiscal stimulus, with the jumbo sized Treasury coupon auctions, and with all of this inflation?  The Fed buying $120B a month has a large part to do with it.  But another part of it is the sheer amount of liquidity in the system.  A lot of the Covid fiscal stimulus was just a money spew that had no real purpose.  The government panicked and picked some huge number to pump out and had the Fed monetize almost all of it.  Most of that money has not been spent on real goods.  A lot of that money is being pumped into stocks, bonds, and real estate.  

I would guess that a vast majority of that fiscal stimulus has gone into:  1. cash deposits at banks 2. stocks 3. bonds, or 4. real estate.   

So even if just a minor portion of that fiscal stimulus money is going into the bond market, it is enough to offset the large Treasury issuance and keep yields steady at these levels.  An aging population still want safe assets, despite the long equity bull market.  And Powell seems determined to stay with his dovish approach and delay tightening as long as possible, or until he gets reappointed. 

The fiscal stimulus was overkill.  It was a giant helicopter drop of money that ended up helping asset markets more than the real economy.  I know everyone says the real economy is doing great, the reopening hype, the hottest economy ever, etc.  But if you are going to compare any economy to one that was halfway shutdown in 2020, it would look great.  In reality, you are just going to eventually end up going back to trend level economic growth, even with all of the fiscal stimulus.  Real economic growth might be measured higher, because the government will do their best to underreport CPI inflation, but in reality, fiscal stimulus doesn't boost the long run growth rate unless a country is severely underinvested. 

In the long run, government spending doesn't boost economic growth.  GDP growth is mainly a function of 2 things:  population growth and productivity.  Developed world population growth is quite low, and so is productivity growth.  

In the 1980s and 1990s, you had faster CPUs.  In the 2000s, the internet.  Over the past 10 years, you haven't had any technological breakthroughs which increase productivity.  Smart phones, electric cars, green energy, AI, etc. are not game changers.  They are micro things which don't affect the macro environment.  

And these huge fiscal deficits create mountains of government debt, which puts a huge burden on the central bank.  The Fed has to keep interest rates low, the system as it is now cannot support normalized interest rates.  Financial repression is not transitory, but is permanent, because the global economy is hooked on negative real yields.  Inflation can get high and the Fed will keep saying its transitory and the US government will manipulate the CPI even more to keep the inflation "under control".    

So even with higher inflation, yields can't go much higher.  The system would implode if they ever tried to normalize.  In December 2018, Powell tried to be tough guy and a 20% drawdown in the SPX stopped him dead in his tracks.  He folded like a cheap lawn chair and started cutting rates within 6 months at the mere sign of slowing growth, with nothing close to recessionary conditions.  

The Fed cares about financial markets, not inflation.  They are scared to death of another 2008.  Even the taper tantrum of 2013, which was a nothing burger, still haunts them.  I'm sure Powell had nightmares about the market reaction to his last rate hike in 2018.  The Fed is owned by the financial markets.  They are market slaves, not market leaders.  

Their default move when in doubt is to print.  They are a one trick pony.  And they are lauded when they print a bunch of money and stocks go up, and criticized when they tighten and stocks go down.  With that kind of market feedback, of course they are going to be dovish, because that's what market participants want.

In the short term, bond yields are being kept down by all the excess liquidity in the system, which is lifting all boats.  In the long term, bond yields will be kept down by slowing population growth, too much debt, and lack of productivity.  

Stock market is stuck in a low vol, tight range.  Just like 2017.  I am a buyer of any small dips down towards SPX 4120-4130.  I expect a grind higher during the summer, with brief bouts of selling where dip buyers will jump in quickly to stop the bleeding.  With the Fed dumping pure ethanol into the punch bowl, and at a furious pace,  the party will be going on for a while.  Its already the biggest bubble ever, and it looks like it will get so big that it will shatter all bubble records, never to be beaten.  Market is setting up for a monster parabolic move higher in the last few months of the year.  

SPX Chart from January 2017 to February 2018: