In a recent podcast, Peter Schiff warned that we could be on the verge of a further breakdown in the bond market and that a bear market in bonds could also maul US stocks and the dollar.
Financial commentator and investment guru Jim Grant has similar concerns. In a recent interview on Odd Lots Podcast, Grant said he thinks we’re at the beginning of a long-term trend of a weak bond market with higher interest rates that could last decades.
The Federal Reserve has pushed its fund rate to over 5% to fight inflation, but Grant called the central bank “dogmatic” and its inflation-fighting toolbox “rusty.”
There’s a bureaucratic dogmatism in the Fed. They’ve got these algebraic models, my goodness, how formidable they look on a blackboard, but they don’t actually function very well so far as the future’s concerned. And the Fed was in fact, dogmatic through 2021 into 2022 buying mortgages recently, I think up to March 2022. So you asked about their inflation-fighting tools? They’re rusty.”
Grant was asked why we haven’t seen interest rate hikes have more impact on the economy. Housing prices have dropped, but not substantially. Americans are still piling up credit card debt. The economy appears to be limping along just fine.
Grant said that he thinks something is going to break — it’s just a matter of time.
I was of the view that try as Jay Powell might to emulate Paul Volcker, Mr. Powell is not working with Paul Volcker’s economy. There is much more debt, therefore much more fragility.”
Grant cited the big increase in private credit as an example.
People are head over heels over private credit. They contend that this is a not quite Nvidia-quality breakthrough in the history of finance. But it’s up there. And, but you know, private credit is a manifestation of the imperative to build leverage — whether it’s on the federal level or the corporate level, not quite so much, in recent years, on the individual level. So there’s a lot of leverage. And I would say Tracy with respect to the paradox of nothing breaking much yet, just be patient. I expected it might.”
There are indeed signs of cracks in the bubble economy. The Fed’s interest rate hikes have already precipitated a financial crisis. The central bank managed to paper over that problem and get it out of the headlines with a bailout program. But it didn’t solve the problems. Banks continue to tap into the bailout loans as they struggle in this high-interest-rate environment. Meanwhile, there are big problems in the commercial real estate market, and economists at the Fed recently released a note revealing that an unprecedented number of distressed companies could collapse due to the recent increase in interest rates.
Grant pointed out that what is inevitable is always certain. But it’s not always punctual.
I look back on some of my work there and I was rather impatient for the inevitable difficulties and crises attending upon this credit creation jag. I thought certainly it was gonna happen like Tuesday or so. So it’s like the elapsed time between the first signs of house prices going way above trend on the one hand and the onset of the housing-related credit difficulties of 2007, 2008 and 2009. That period of six years was approximately 20 years in journalistic time if you were a little bit too insistent upon.”
Jim was asked when we hit a tipping point when financial solutions to financial problems are no longer viable. He said, “A tipping point was six years ago.”
It was a long time ago, but it did not tip. So why can’t it go on forever, I don’t know? They’re always these excesses that do crop up. They are met with additional stimulus intervention, manipulation. And still we go on. Who was it who said there is a deal of ruin in a country? I guess it was Adam Smith. And there’s a great deal of ruin, so to speak, in finance and manipulated finance. And one of the singularities of the present time is the American position in international finance. You know, this country emits the reserve currency, which means that we consume much more than we produce. We finance the difference with dollar bills that only we can lawfully print at a most reasonable price of like nothing. And we remit the dollars to our creditors, mainly in Asia, say, and those dollars don’t leave the country because they come back in the shape of Treasuries and mortgages purchased for the portfolio interests of our accreditors. So that is kind of a new thing in the long historical sweep. It’s not so new in terms of years, but in terms of phenomena, the reserve currency country being a chronic big debtor, that’s kind of a different thing. Reserve currency country living on the kindness of strangers, so to speak. That’s not exactly writ. The more one learns, the less dogmatic one becomes about timing, certainly.”
Grant addressed the recent run-up in stocks despite the high-interest rate environment and hawkish Fed rhetoric. He said it’s due to “the muscle memory of a generation of 0% interest rates and all-you-can-eat credit.”
The great all-you-can-eat credit buffet table was open for business for 10 years. Interest rates fell from 1981 until a couple of, actually a couple of weeks ago. It’s called 40 years. So that’s a lot of muscle memory. Central banks have intervened predictably until fairly recently when markets shuttered. Look what happened in 2019. You know, the repo market, this obscure recondite thing caught a head cold in September and the Fed resumes QE and said it’s not QE. Yeah, it was QE. So naturally people assume that the upside is the side to be on. It takes a true contrarian, almost a bloody-minded contrarianiess to butt one’s head against that. But it’s a living. So why do people do it? Because A) because cyclical memories are short and cycles are recurrent, and B) because it has ‘worked’ — that phrase ought to be in quotes.”
Grant said he thinks we’re about to enter “a long cycle of rising interest rates” and a “generational” bear market in bonds.
The great question of whether rates are mean or reverting? So what characterizes interest rate movements is their generation length phasing, not necessarily cycles, but there are phases.
Interest rates fell for the last quarter of the 19th century, rose for the first 20 years of the 20th, fell from 1920, ‘46 rose in ‘46 to ‘81, fell from ‘81 to, call it, 2021. So at each juncture there was some mark of excess, some mark of speculative excess blow-off. Certainly in 1981, you know, a 20%+ funds rate seemed excessive. A 14% yield in 1984 in long bond when the CPI was printing at four or five, that seemed excessive. 10 percentage points of real yield — that seemed a lot.
So I speculate that we are embarked on a long cycle of rising rates. And I say that first of all, for reasons of pattern recognition, there’s no theory behind it. But I observe that in 2020 and ‘21, some unimaginably large number of debt securities were priced to yield less than nothing. Bloomberg keeps this particular figure. And I bet still, perhaps you could check me on this, I bet still there’s like a hundred billion of bonds priced to yield less than nothing worldwide. But there were $18 trillion, I think at the peak.
The most extraordinary expression of unqualified bullishness on an asset class because it had the name of “bonds” which had been falling in yield, rising in price. So no, it would not surprise me at all if we were embarked on something resembling a generation length bear market in bonds, meaning rising yields and falling prices that would fit the form.
