This is a very, very strange moment. For the first time in decades, markets are genuinely nervous about the fiscal situation in Washington. And yet politicians seem far less concerned about it than during the last big government shutdown fight in 2013.
The yield on U.S. Treasuries, especially longer-term ones, keeps on rising. The benchmark 10-year Treasury yield hit 4.56% yesterday, a fresh sixteen-year high. Was this because of strengthening economic data? No. We learned yesterday that consumer confidence fell more than expected last month, while new home sales--the strongest part of the frozen housing market--also declined.
Indeed, the new debate on Wall Street is whether yields will hit 5% next. If they do, mortgage rates will top 8%. "I think we are at the point in the cycle where yields are going to back up until something breaks," a strategist with John Hancock warned yesterday, summarizing sentiment. And yet this is all happening as economists expect weak fourth-quarter GDP, and revisions tomorrow may reveal GDP has already been more lackluster in recent quarters than previously thought.
"There's little fundamental we can point to that would justify the move," wrote J.P. Morgan's fixed income strategists about the continued upward pressure on yields. In fact, of the jump in yields this month, "the fundamental factors from our model can only explain 50% of the move," they wrote yesterday, while higher inflation expectations can explain another 20%. "Thus...something outside of these drivers" is causing the upward pressure, they conclude.
That "something" would appear to be the sea-change in Treasury demand, where the three "price insensitive pillars of demand" over the past decade--the Fed, U.S. banks, and foreign investors--have all stepped back. At the same time, the supply of Treasuries has exploded, from $5 trillion pre-financial-crisis to $25 trillion on the marketplace today.
As a result, the market is now testing where the "clearing" price of Treasuries will be as it eyes yawning U.S. budget deficits for the next decade--and beyond. Why buy Treasuries at 4.5% today, if you can wait and get 5%, 6%, or even 7%, as J.P. Morgan CEO Jamie Dimon suggested could be next on the horizon?
The quickest way to change this dynamic would be to rein in the market's sense that the supply of Treasuries will continue to overwhelm demand. Say, if lawmakers could manage to "bend the curve" so that the 6-7% budget deficits CBO foresees from here on out were more in the range of 2-3%. That's what makes it so odd that we're hearing so little about this right now as we hurtle towards a government shutdown.
Our guest today, strategist Andy Blocker, has heard it called the "Seinfeld Shutdown"--a show about nothing. "Some days it is about out-of-control spending, some days it's border security, other days it's the war in Ukraine or Speaker McCarthy, Hunter Biden, or Jack Smith," he observes. "Groups like the Freedom Caucus are not monolithic in their policy demands or political needs."
This is so vastly different from 2013, when the "Tea Party" rose to power precisely to rein in government spending (and to oppose major new programs like Obamacare). The news coverage back then was filled with dollar figures that were being tussled over; $1.2 trillion in cuts over 10 years! Tea Party demands CR cut spending below 2013 levels! GOP moderates push back on spending cuts! There was even a fight over whether the stopgap bill should keep spending at $967 billion or $988 billion.
This time around, the only dollar figures I can even find are buried in news stories, or not mentioned at all.
Blocker says the House Freedom Caucus wants to reduce spending by $120 billion more than the caps Speaker McCarthy previously agreed to with President Biden to raise the debt ceiling. Those caps--effective for two years--would effectively keep just military and other discretionary spending (which together only amount to about a quarter of total government spending) flat. But it's unclear whether this fight is over spending levels at all, given that the Freedom Caucus labeled its message "No Security, No Funding," suggesting the border wall is really their top priority right now.
Point being, none of this sounds like a major initiative to change the fiscal status quo. And until it does--or unless the economy gets so bad that the Fed starts buying tons of Treasuries again--don't expect markets to back off of testing just how high America's borrowing rates may have to go.
See you at 1 p.m!
Click HERE to sign up for this newsletter in one easy step.
To hear this as a podcast, subscribe to "The Exchange" and pick "From the desk of..."