Back in 1990, I bought my first house. My mortgage rate was 10% for a 30 year loan. The yield on the 10 Year Treasury Note was a bit over 8%.
Rates haven’t been that high since.
Yet, here we are in 2022, on the heels of an inflation report indicating that the inflation rate year over year for the last twelve months is 7.5%. This is the highest level since 1982, when the yield on the 10 year note was well over 10%.
The current yield as of Friday is 2.03%.
In other words, the markets are massively distorted.
This was the concern I had when the Federal Reserve introduced quantitative easing in 2008 to fight the financial crisis. Their biggest fear was deflation, which was the issue of concern during the Great Depression.
On the back of that quantitative easing, Congress passed a stimulus bill of nearly $900 billion, a huge amount at the time.
Our national debt was about $10 trillion, and this increased to $20 trillion by the time Obama left office in 2016. The annual budget was about $2.5 trillion, but in 2021, DC spent over $6 trillion.
Here’s the problem… this isn’t sustainable. When inflation is running at a clip this far above long term yields (over 500 basis points currently), investors are going to dump treasuries.
Have a look at the chart of the 3 month Eurodollar futures below…
Eurodollars are dollar-denominated deposits held in foreign banks. Back in 2017 and 2018, when the economy was doing well, the Fed was in a tightening mode.
Eurodollar futures prices were in decline, as the Fed ended up hiking rates six times at 25 basis points per hike, to slow down what it perceived was an overheating economy.
The economy started to slow in 2019, and then in early 2020, Covid-19 hits the world.
After boosting the money supply by about 27% in 2020-2021, a record. Adding that liquidity to the checks handed out by DC, and you had an obvious recipe for inflation.
The Fed ignored it as it started to heat up last summer, suggesting it was transitory.
Well, here we are. Many would argue that the 7.5% inflation number reported severely understates the actual pain Americans are feeling in their wallets.
Gas prices have nearly doubled and are at eight year highs. Home prices and rents are soaring. Food prices are up 15-20%. Used car prices are up over 40%.
That doesn’t feel like 7.5% to most people.
The Eurodollar market started to really react in December, but that reaction has accelerated.
Goldman Sachs is now forecasting that the Fed may hike rates as many as seven times in 2022 alone.
At the same time, there is concern the economy is ALREADY slowing. The Atlanta Fed’s GDPNOW forecast for Q1 2022 growth is a measly 0.7%. And, it appears that most of the GDP growth in the last two quarters was a result of inventory building by businesses, not consumer spending.
If consumers have already been pulling back, then expect less inventory building in this quarter.
I always felt that the sugar high produced by all the stimulus in 2021 and Fed money printing would turn into a massive hangover.
We’re about to find out how bad that hangover is going to be.
This is
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