From Wolf Street, August 1:
Warsh wants the bond market to do its job and look at inflation and the economy — and not at the Fed — and it’s finally doing it.
The 30-year Treasury yield jumped by 7 basis points on Friday, and by 12 basis points during the week, to 5.28%, the highest since July 2006, now 165 basis points above the Effective Federal Funds Rate (EFFR, blue in the chart below), which the Fed targets with its policy rates.
During the FOMC press conference on Wednesday, Fed Chair Warsh repeatedly said that ending “forward guidance” by the Fed was already working, that Treasury yields had already surged since the FOMC meeting in June when he’d scuttled forward guidance, as markets had begun to look at the inflation and economic data, and not at the Fed. Buyers and sellers were doing the hard work, and raised rates and tightened financial conditions, and this “has provided us some comfort that we’ve got the ability and capability to deliver.” In other words, the bond market was finally doing its job.
The dotted line reflects the linear trend for the data in the chart. The double line traces the higher lows since late 2023.
Buyers of long-dated Treasury securities are primarily concerned about two things:
- Inflation, which eats up the purchasing power of their principal, and they want to be compensated via a higher yield for that loss of purchasing power.
- The onslaught of supply that will require new buyers to get pulled into the market, and it may take higher yields to pull these fence-sitters to the Treasury auctions. But rising yields mean lower market prices for bondholders that had previously bought that debt at a lower yield. And new buyers want to be compensated via a higher yield for taking that risk that yields will rise further.
And those risks have been growing, and the Fed has done nothing but cut rates since the fall of 2024, though inflation has been accelerating for over a year, which has spooked the bond market.
The two-decade view shows the last 14 years of the 40-year bond bull market during which the 30-year Treasury yield fell from over 15% in September 1981 to about 1% in mid-2020, when it flipped to the bond bear market that is now wrapping up its sixth year.
The current bond bear market has been a bloodbath, triggering the collapse of several regional banks in 2023 that had loaded up on long-term Treasuries and government-guaranteed MBS in 2020 and 2021. They had believed the Fed’s forward guidance that interest-rate repression would continue for a long time. But the forward guidance was a lie. The Fed ended QE, hiked rates, and started QT in 2022, and long-term yields soared and the market prices of the long-term bonds that the banks had purchased a couple of years earlier collapsed.
The market value of 30-year Treasury bonds that the government sold at auction in mid-2020 has plunged by about 50%.
Of course, investors that bought at the auction can hold those bonds for another 24 years to maturity to get all their money back, but along the way, they’ll collect only 1.3% or so of interest per year for another 24 years, while current buyers would earn 5.28% a year, and when they get their money back in 24 years, inflation will have eaten up a big chunk of its purchasing power. Those bonds purchased in 2020 were horrible deals for the original buyers.
Before Warsh became Fed chair, he blasted the Fed for its forward guidance: Forward guidance had locked in the Fed as inflation was surging in 2021 while the Fed was still at 0% and still doing massive QE – and I called it “the most reckless Fed ever.”
And then when it finally broke loose from its forward guidance and began tightening, it was too late, inflation was out of the bottle, and wasn’t going back in, and some of the banks that had believed its forward guidance in 2020 and 2021 then collapsed in 2023....
....MUCH MORE
