@theMarket: Bonds Indicate Growing Dissatisfaction With Monetary & Fiscal Policy

While the stock market has declined only a few percentage points from its all-time highs, bond markets worldwide are reacting differently to higher oil prices, inflation, and government debt.

 

Japan's 10-year sovereign bond yield is almost at 3 percent, and the 30-year is above 4 percent. Australia's 3-year surged as much as 20 bps to 5.05 percent — it's highest since 2011 — and New Zealand's 2-year jumped 25 bps. Europe's yields are no different, but it is here in the U.S. that most concerns investors.

 

One could characterize the back up in bond yields and fall in bond prices across the globe as a buyers' strike from fixed income investors. Clearly, higher oil prices are part of the equation. Both WTI and Brent crude prices topped $100 a barrel this week.

 

Inflation, as I predicted, is moving higher, as reflected in the Producer Price Index (PPI), with the main culprit being August's increase in energy costs. Year over year, the PPI advanced 5.4 percent. The Consumer Price Index was not much better. It was a hotter number than most expected. As I have cautioned readers, that rebound in inflation will continue through at least September, if not longer. I can easily see inflation at 3.75 percent by the end of the fourth quarter.

 

We all know why oil is where it is, so I won't waste space recounting those facts. On top of that, the Trump administration's new and existing tariffs have driven up the price of everything — especially groceries. Diesel fuel, a major cost in transporting goods, is now above $6. This week, it didn't help that the president is promising $5,000 to every American if they deliver a GOP majority in both houses of Congress. That will add more than $1 trillion to our debt load.

 

This is at least the fourth time Trump has promised cash to Americans, and while the party faithful may believe him for a fifth time, few else will take him seriously. However, even suggesting it in the face of $40 trillion in national debt caused yet another spike in bond yields. The benchmark U.S. 10-year Treasury was above 4.93 percent while the 30-year hit 5.34 percent. Bond investors are clearly demanding higher real returns on their bond purchases, and they are getting them. Both the 10-year and 30-year auctions this week proved that. Given inflation forecasts, I expect more of the same.

 

So far, the U.S. Treasury Secretary Scott Bessent's attempt to rein in long-term bond yields has failed. At the same time, betting markets are wagering an 80 percent probability that the FOMC will raise rates after its Sept. 15-16 meeting. There is also a 90 percent chance that if not September, December will see a hike. That may happen, but I don't see how that will help the situation and may cause more problems in the months ahead.

 

Since the rise in inflation has been caused by the Iranian war, increased government spending, and higher tariffs, raising the short-term Fed funds interest rate will not address any of these issues. I suggest readers read my recent columns on bonds for further explanations.

 

At most, a Fed hike might reduce credit on the margin, which would impact AI, the very lifeblood of the equity market advance year to date. The AI revolution requires capital, and a hawkish move by the Fed will only curtail that borrowing (or at least make it more expensive).

 

Thus far, September is shaping up to be a difficult month for stock investors and certainly for those who hold bonds as I cautioned. This week the S&P 500 Index fell four days in a row only to bounce on Friday.

 

Life will get even more difficult if the Fed raises rates next week, but it is between a rock and a hard place. If they do nothing, bond vigilantes will likely keep dumping bonds because the Fed is sitting on its hands while inflation runs rampant.

 

If they do decide to hike rates, the stock market will most certainly take a real hit, as expectations for continued rises in equity earnings will need to be throttled back. The return of 7-plus percent mortgage rates will also not sit well with Main Street, nor will the fact that wages over the last six months have not kept pace with inflation.