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The Fed Must Cap Real Yields: We think the following debate below is critical, an important juncture is coming at us all. Above all, we love when washout technicals line up in front of a policy response. The Federal Reserve must cap real yields in 2021 in order to preserve the economic recovery and attempt to fend off inequality. Their first weapon of choice is found in a roll-out of “calendar guidance.” Offering investors a well defined path focused on the certainty on asset purchases. All attached to a future time frame or date. If that fails, they will propose a twist (buy longer dated bonds, sell short ones) or YCC (yield curve control, simply cap 10s).
The Impact of High Rates: “A rise in real rates would give me concern that the amount of accommodation we’re providing the economy is reducing, and that might warrant us considering a policy response…“
– Neel Kashkari, President of the Federal Reserve Bank of Minneapolis
Everyone thinks we are heading for a 2013 style taper with higher real bond yields. The picture of a growth recovery (BlackRock’s Rick Rieder now talking up 7% GDP) where bond yields surge far higher than inflation expectations, that’s the consensus. This vision is laying a hammer on gold – a real yield nightmare. But with inequality being a significant eye sore for the Fed, higher bond yields relative to the rest of the world will simply strengthen the USD, suck capital back into the USA. The global wrecking ball will once again – be reborn. The negative economic feedback loop back to the U.S. is well documented. Strong greenback fueled manufacturing jobs losses most likely cost the Dems the 2016 election. The Fed must conduct monetary policy on planet Earth surrounded by other countries, NOT isolated on Mars. Likewise, with the U.S. debt profile (State, Federal and Corporate), $10T larger than it was a decade ago, each 50bps of real yield expansion comes with a gale force headwind equivalent to 150bps higher rates. Above all, today, too much debt sits below 2%, an extra $50T relative to 2018. In 2021, duration capital losses are – COLOSSAL – with higher bond yields. This is a possible inferno the Fed doesn’t want to toss a match on. The Federal Reserve cannot repeat the mistakes of 2011-2013, they must cap reals before the taper stage, if they want to extend the economic recovery that is. Thus, the convexity with gold is very attractive today. Every leg lower will act like a sling shot higher once the Fed makes their move. They must start to lay out calendar guidance, hint YCC as a future possible weapon on March 17th. We see large upside for gold, next 5 weeks.
The Cost of Rising Yields: “A 50 basis point increase in the cost of funding for the U.S. Government is equal to the cost, the annual cost of the U.S. Navy. A 30 basis point increase is equivalent to the cost of the U.S. Marine Corps.” – Louis-Vincent Gave
Rates Impact: The UK government has just quantified a 1% rise in yields as costing £25bn in extra interest expense (OBR) which is just over 1% of GDP.
Inequality Issues Rising, a Problem for the Fed
Gasoline is testing its five year highs and Core CPI is down. Say what? How can that be? Is the government manipulating inflation measures so it can keep its money printing presses running hot? Of course! But there’s more to the story than that. As to highly questionable lower inflation readings, it’s true. The components have changed over the decades such that if one were to calculate CPI using the 1980 formula, it would be more than twice as high as the current reading! But there is another less nefarious (or blindingly stupid) reason. An increase in gasoline prices is a tax on consumer demand. A person making $45k a year only has so much money to spend. And every dollar made is spent. So if an extra dollar goes to gas, that is one less dollar to a component of Core CPI. So higher gasoline prices take demand away from other goods and services. Higher gasoline prices exert deflationary pressure on other goods and services.