U.S. Budget Deficits,
Debt and the Return of Bond Vigilantes
By the
Curmudgeon with Victor Sperandeo
Record U.S. Budget Deficit and Interest on National Debt:
The U.S. budget deficit soared by 40% in the 1st quarter of
the governments fiscal year. Between October and December 2024, U.S. federal
government spending exceeded revenues by $711 billion and set a record.
Spending soared by more than 10% to ~ $176 billion.
Interest on the national debt was $20 billion or a little
over 13% of total government spending.
At $36 trillion, the stated U.S. debt easily exceeds the size of the
U.S. economy. In 2024, the debt is
projected to be $29.167 trillion and is climbing parabolically as per this
chart):
What stock market pundits dont seem to realize is that with
interest rates on U.S. notes and bonds on the rise and approaching 5%, and
possibly headed higher, the debt service costs will increase tremendously. That will make it even more difficult to
reduce sky high U.S. budget deficits and debt servicing costs.
The Return of Bond Vigilantes:
Martin Barnes, a former chief economist at BCA Research, told
Barrons
this week that he expects bond vigilantes [1.] to return, forcing
the U.S. government to pay a fiscal risk premium on its debt. Its unknown when
they will exact that price, even though U.S. total government debt exceeds 120%
of GDP which hasnt set off alarm bells yet.
.
Note 1. The term bond vigilantes
refers to investors who discipline excessive government spending by going on a
buyers strike, thereby demanding higher U.S. debt yields. In the early
1980s, when strategist Ed Yardeni coined the term, bond vigilantes surfaced
when U.S. budget deficits increased.
Since then, episodes of fiscal excess regularly gave rise to questions
about when those vigilantes might return.
.
The bond market is likely to price in more uncertainty
because of the inherent contradictions among many of Trumps policies, the
volatility around their application (for example tariffs), and still-too-large
budget deficits, according to Steven Blitz, chief U.S. economist of TS
Lombard.
Blitz thinks 10-year Treasury yields could climb to 6%,
a level not seen since mid-2000. Thats especially true if the Fed ends its
rate cuts and lifts the fed-funds rate to 5% to 5.25% in two years, from the
current target range of 4.25% to 4.5%.
U.S. note and bond markets are waiting to see the impact of
Trump's tariff, immigration policies, spending cuts and tax reductions. Disappointments in any of those could trigger
the vigilantes. Persistent wrangling over the U.S. debt ceiling, further
downgrades to the U.S. credit rating or a fall in foreign demand for U.S.
Treasuries due to reasons like sanctions and wars could make matters worse.
"There are many possible sparks," said Ray Dalio,
the founder of macro hedge fund firm Bridgewater Associates, in an email to Reuters.
.
..
Victors Comments on U.S. Note and Bond Yields:
In my opinion, U.S. Note and Bond yields are far too low considering
the level of U.S debt to be auctioned continued gargantuan government spending.
The net result is likely to be declining Treasury note/bond prices and higher
yields.
Several factors point to 7%-to 8% yields on 10-year T-Notes this
year and certainly beyond. Thats largely based on the Trump
administrations stated fiscal policies, which would increase inflation and
the budget deficit. However, President
Trumps pronouncements are either exaggerated, wrong, or he is intentional not
telling the truth when talking to the public. Also, he may change very quickly,
and Congress may not approve his agenda (it cant be all based on Executive
Orders).
Robert Rubin, Bill Clinton's Treasury
Secretary and a former co-chairman of Goldman Sachs, said the bond market
"could very quickly make it very difficult" for Trump to do what he
wants if a steep rise in interest rates triggered a recession or financial crisis.
"Unsound conditions can continue for a long time until they correct,
rapidly and savagely. When the tipping point might come, I have no idea,"
he said.
While a recession would certainly lower U.S. yields, the
Congressional Budget Office (CBO) assumes no recessions in the coming
decade. Not counting the 2-month COVID
caused GDP decline in 2020, there has not been a recession since the last one
ended in June 2009. One might ask if
the business cycle has been repealed?
Comparison of U.S. Note/Bond Total Returns:
Until recently, the total return on 5-year T-Notes did
not suffer an annual loss from 1970 to 1994 (and then again in 1999).
Total returns on the U.S. notes during the great inflation from
1968 to 1981 were positive due to the yields being high enough to offset the
declines in price.
The 30 year bond total
returns from 1977-1980 were: -0.69%, -1.10%, -1.23%, and -3.95%, according
to Ibbotson Associates, which has discontinued publishing this data in
2023. Sad as they had compiled those results since 1926.
In comparison, the iShares 3-7 Year Treasury Bond ETF (IEI)
declined in price from 12/1/20 to 12/1/24.
According to Blackrock,
its 3 and 5 year total returns through 12/31/2024 were -1.31% and +.003%,
respectively.
Moreover, the % of yearly note 5-year T-Note futures prices
declined four consecutive years from 2021-2024. Futures are a much
better guide than using spot prices, as they take into
account inflation and the maximum tax rate of federal income taxes paid
on yield.
Using the iShares 20+ Year Treasury Bond ETF (TLT)
for a guide to U.S. Treasury bond declines ...in the last four years TLTs
price decline was -42.23%! The 5-year
chart of TLT below shows the price is testing a bottom it made in November
2023:
.
..
U.S. Inflation Trending Higher Since Sept 2024 Jumbo
Fed Rate Cut:
In an apparent slap in the face to Fed Chair Jerome Powell,
U.S. inflation has risen in each of the last three months since the September
2024 50bps rate cut which we opined was not needed. Heres a one-year CPI chart courtesy of Trading
Economics:
Its hard to believe the Fed will achieve its 2% inflation
target any time soon and therefore will likely be on hold for the foreseeable future.
.
..
Victors Conclusions:
From June 1971 to June 2024, U.S. debt grew at a compounded annual
rate of 8.81%. At that rate, the national debt will rise from $36.3 trillion to
$84.5 trillion in 10 years!!!
The CBO says it will be +$60 trillion without a recession or
tax cuts! A year ago, CBO projected it at
$54 trillion.
Until we see significantly less government spending -not just
proposals and amorphous talk - U.S. debt markets will continue to erode as the bond
vigilantes return.
End Quote:
After Trump was elected President in November, market
sentiment is implicitly related to a song from the 1987 movie Mannequin
by Jefferson Starships great singer Grace Slick with Mickey Thomas. Its
titled, NOTHING GONNA
STOP US NOW. The lyrics have a strange association today:
l Looking
in your eyes I see a paradise
l This
world that I've found is too good to be true
l Standing
here beside you, want so much to give you
l This
love in my heart that I'm feeling for you
l Let 'em say we're crazy, I don't care about that
l Put
your hand in my hand baby, don't ever look back
l Let
the world around us just fall apart
l Baby,
we can make it if we're heart to heart
l And
we can build this thing together
l Standing
strong forever
l Nothing's
gonna stop us now
.
Stay healthy, success and good luck.
Till next time
..
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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