Democrats and Republicans Don’t Care About You And The Bond Market Doesn’t Care About Them
Hopefully the title made you laugh a bit but sadly enough it is the truth. Right now all we see on the news is talk of the debt ceiling and the oncoming crisis if we don’t raise it or the eventual destruction if we do. Both sides of the aisle just want to make the other side look bad but in the process they end up all looking like idiots. To better explain what I mean let me pose a question: Which of the following two scenarios is sustainable? 1-Never limit spending, add more entitlement programs, let the government run everything. 2-Cut spending while the economy is slowing down from the weakest recovery in the past century. My answer is neither, and yet that is essentially what both sides are trying to do. Congress and the President are doing a great job of showing how little they care about you and instead how much they like fighting with each other. (Click on image to enlarge)
We need some type of sensible long term plan that actually does something and holds people accountable. The basic outline would go something like this. We go over current spending and see what actually contributes to the economy and what does not. If it does not, or if we can not prove it either way, we can start to cut or at least put plans in place to cut over the next X amount of years. In many cases you could put in a timeline of 10-20 years and till see great long term benefits. However if the spending can be shown to create worthwhile and not just bureaucratic jobs then we keep them and possibly even spend more on them if they scale. If anyone in Washington was able to be objective on this we could really clean up a lot of the budget without sinking the economy.
The next thing that we could do is to make a smart stimulus bill. This will never happen because politicians want votes and not progress but the idea has a lot of merit. Basically instead of just throwing money at pork as in the famous unread and totally inefficient stimulus bill when Obama first came into office we would instead spend X amount on infrastructure. The countries electricity grid, bridges, and roads are in really bad shape. If we spent money here we could quantify the amount that we spend as well as improve and stimulate the current economy. This creates jobs and yet as opposed to entitlement programs like welfare or healthcare rebuilding a bridge or road has an end point. Its not a spend forever idea but instead a spend now on things we need idea. (Click on image to enlarge)
Is This What The United States Will Look Like August 2?
But enough with the useful policy. What happens if we raise the debt ceiling? Does the world grind to a halt? Is it Armageddon 2011? And what about the budget, don’t interest rates skyrocket further worsening our debt problem? And isn’t the US Dollar going to 0? No, the world doesn’t grind to a halt, Armageddon 2011 does not happen, and borrowing costs do not skyrocket. The only people that say borrowing costs will skyrocket are people trying to get on TV. Here’s a hint people CNN, MSNBC, FOX, CNBC, etc don’t know what they are talking about. Why do you think they are on TV and not running an investment management company?
First lets look at borrowing costs. Markets are usually forward looking and with all the attention that the debt ceiling is getting they, meaning investors, definitely know that there is a high probability of a technical default. In this scenario you might expect interest rates to skyrocket, at least that is what the media seems to think will happen. Lets go look at some charts. First is the yield on 90-Day Treasury Bills. You might think that if the government might default on August second that investors would be especially worried about the short term. As you can see not only are rates rediculously low but they HAVE BEEN GOING DOWN for a few months. Yes, instead of going up from historically low levels they are in fact headed lower. (Click on chart to enlarge)
90-Day Treasury and 90-Day LIBOR yields
Maybe investors aren’t worried about the next 90 days but they have to be worrying about the next two years don’t they? Maybe the default won’t hurt us too much in the very near term but over the next two years or so it might kill confidence in the US and its ability to pay its debts. Well if you look at the chart below of the yield on the 2-Year you will see that again not only are rates at/near historic lows but have in fact been trending lower since this sideshow we call Washington does what it does best, which is nothing useful. (Click on chart to enlarge)
2-Year Treasury Yield
OK so maybe the next few years are going to be fine. After all the US economy can’t die inside of two years can it? Well even the message of the 30-Year bond is saying that this is all much ado about nothing. The 30-Year yield is low and has not been able to break above 4.9% and has actually been headed lower since all the talk started to pick up a few months ago . (Click on chart to enlarge)
30-Year Treasury Yield
If you take a step back and take all of this in you will see that the bond market considers the US Government money good. No, they don’t love a huge deficit, a lack of a long term plan, or anything of the sort. But the bond market does understand that we are a long ways from Armageddon and that in the meantime we can make debt payments. One thing a lot of people forget is that we not only create our own currency but in fact are THE reserve currency of the world. While long term it might not be the best plan we can always pay off debts by just creating more money. Taken to its extreme this is of course bad but in the meantime it goes a long way to allay the fears of investors.
So the next time that you hear about how this or that is going to shock the markets do some research instead of repeating the false hype. If the market is scared you will see it like we did during the 2007-08 crisis or back in the dot com crash or even more appropriate would be the epic move higher of yields back in 1994. Right now it is obvious to us that the markets are not so worried about what is going on in the United States and instead are extremely concerned about what is happening in Europe. Instead of technical defaults where we have to prioritize payments like in the United States, Europe is facing the very real possibility of actual defaults where the money is never paid and investors have to settle for 0% of their money back. Now that is a debt crisis.
Happy Trading,
Disclaimer-In our model portfolio we are long TLT the 20+ Year Treasury ETF.
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so who is not importing anything anymore? How does this affect shipping stocks? Why has the seasonality been so pronounced for so long? Don’t corporate purchasers look at the data and try to game shipping costs by ordering a few months earlier? And finally how is global trade going? As we can see it has improved but have the markets gotten ahead of themselves?
