Full transcript
0:00Hi, welcome back to the channel. Over
0:02the past few weeks, we've been talking
0:04extensively about the increasingly
0:06difficult situation developing in the US
0:08bond market. America's national debt has
0:10now exceeded $40 trillion. The federal
0:13government is running an annual budget
0:15deficit approaching $2 trillion.
0:18Interest payments have surged above $1.3
0:21trillion. And long-term US government
0:24borrowing costs have risen to levels
0:25that we haven't seen for almost two
0:27decades. But now we've had another
0:29extraordinary important development
0:31because Federal Reserve Chairman Kevin
0:34Walsh has just delivered his strongest
0:36warning yet about inflation and Wall
0:39Street interpreted that warning very
0:41clearly. US interest rates could be
0:43about to go up again. Following Walsh's
0:46speech at Jackson Hole, the probability
0:48of a September interest rate rise jumped
0:51dramatically. The 2-year Treasury yield
0:53surged, the dollar strengthened, and
0:56suddenly the US government appears to be
0:58facing an extremely uncomfortable
1:00problem. Because at one end of the bond
1:02market, long-term yields are being
1:04pushed higher by concerns about debt,
1:07deficits, inflation, and extraordinary
1:09amount of new borrowing. And at the
1:11other end, short-term yields are being
1:13pushed higher by expectations that the
1:15Federal Reserve may have to increase
1:17interest rates. So, where does the US
1:20Treasury go now to borrow cheaply? And
1:22is America caught in what we could call
1:24an interest rate trap? Now, before we
1:27get into all of the details, if you're
1:29enjoying these economic updates, could
1:30you please give this video a thumbs up?
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1:40you could do that, then that would help
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1:43put a smile on my face. Now, let's start
1:45with Kevin Walsh. Walsh was speaking at
1:48the Federal Reserve's annual Jackson
1:50Hole Symposium in Wyoming. This was
1:53particularly significant because it was
1:54his first appearance at Jackson Hole
1:56since becoming chairman of the Federal
1:58Reserve. Investors were desperately
2:01looking for clues about what the Fed
2:03might do at its next meeting on the 15th
2:05and 16th of September. And although
2:07Worse didn't actually promise an
2:09interest rate increase, his message was
2:12considerably more hawkish than many
2:14people expected. He reiterated that the
2:16Federal Reserve's inflation target is 2%
2:20and he made it clear that the target
2:22remains firm and fixed. Walsh
2:24essentially said that if the Fed isn't
2:26confident that inflation is moving
2:28clearly and quickly back towards 2% then
2:31the Federal Reserve still has some work
2:34to do. Now, in normal life, that
2:36sentence doesn't sound particularly
2:38dramatic, but in the strange language of
2:40central banking, that is a warning
2:43because the Federal Reserve's main
2:45weapon against inflation is interest
2:47rates. If inflation isn't falling
2:50quickly enough, then rates may have to
2:52rise, and the bond market reacted almost
2:56immediately. The yield on the 2-year US
2:58Treasury jumped sharply following the
3:00speech. And this particular yield is
3:03important because 2-year government
3:04bonds are extremely sensitive to
3:07expectations about Federal Reserve
3:08policy. If investors think interest
3:11rates are going to fall, the 2-year
3:13yield generally moves down. If investors
3:15think interest rates are going to rise,
3:18then the 2-year yield will move up. And
3:20following Walsh's speech, it went up.
3:22Before Jackson Hole, the market was
3:24pricing roughly a 1 in3 probability of
3:27an interest rate rise in September.
3:30after Walsh spoke that moved to around
3:3260%. So we've gone from probably not to
3:36this could actually happen and that's an
3:38extraordinary turnaround from where
3:40markets thought we were heading only a
3:42short time ago because investors had
3:44previously been discussing rate cuts.
3:47How quickly would the Federal Reserve
3:49reduce interest rates? How many cuts
3:51will we get? How low will rates
3:53eventually go? That conversation has now
3:56changed. The question is no longer
3:58simply when the next cut arrives. The
4:00next move could potentially be an
4:02increase. And the reason is inflation.
4:06Inflation has obviously come down
4:07dramatically from the extraordinarily
4:09high levels that we saw following the
4:11pandemic. Headline CPI reached more than
4:139% back in 2022. The Federal Reserve
4:17then embarked on one of the most
4:18aggressive interest rate hiking cycles
4:21that we've seen in decades and
4:23eventually inflation came back down. But
4:25the problem is that we didn't come all
4:27the way back down to the target rate of
4:302%. And that final part of the journey
4:32is proving extremely difficult. Recent
4:35CPI figures have shown some improvement,
4:38but the Federal Reserve's preferred PCE
4:40measure is considerably less
4:42encouraging. Headline PCE inflation is
4:45still running at around 3.7%.
4:48Core PCE, which strips out food and
4:50energy, is around 3.3%. So, we're not
4:53talking about runaway inflation. We're
4:55not back at 9%, but we're also not at
4:582%. And that creates an enormous problem
5:01for Kevin Walsh because he's a
5:03relatively new Federal Reserve chairman.
5:05Donald Trump spent years criticizing
5:07Jerome Powell and demanding lower
5:10interest rates. So, when Walsh came into
5:12the job, everybody was inevitably asking
5:14questions of how independent he would
5:16be. If inflation remained stubbornly
5:18high, would wash really increase
5:21interest rates? Would he genuinely
5:23defend the 2% inflation target or would
5:26political pressure encourage the Federal
5:28Reserve to tolerate slightly higher
5:30inflation? Jackson Hole appears to have
5:33given us that answer. Walsh is
5:35effectively telling the market 2% means
5:382%. And if rates have to rise to get us
5:41there, they will rise. That may help
5:43establish his credibility, but it
5:46creates a massive headache for another
5:48part of the US government, the Treasury.
5:50Because while the Federal Reserve may
5:52need interest rates to be higher, the US
5:54Treasury desperately needs borrowing
5:57costs to be lower. America's total
5:59federal debt has now exceeded $40
6:02trillion. Back in 2002, it was around $6
6:06trillion. When Donald Trump entered the
6:08White House for the first time in
6:10January 2017, it was below 20 trillion.
6:14So, in less than a decade, the debt pile
6:16has more than doubled. And the more
6:18important point isn't simply that
6:20America owes $40 trillion. The important
6:23point is that it's still adding to that
6:26debt pile. The Congressional Budget
6:28Office is forecasting a deficit of
6:30around $1.9 trillion for 2026. In simple
6:34terms, the government is spending almost
6:37$2 trillion more than it's collecting.
6:40And that gap has to be financed, which
6:42means more borrowing, which means
6:44issuing more Treasury securities. But at
6:47exactly the same time as America needs
6:49to borrow enormous amounts of money, the
6:51cost of that borrowing has gone up. This
6:53is probably one of the most important
6:55charts in the whole US economy. Federal
6:58interest payments have surged. Gross
7:01payments over the last 12-month period
7:03have risen to above $1.3 trillion. The
7:07net figure used in the federal budget is
7:09lower, but it's still above $1 trillion.
7:12For decades, America could carry an
7:14enormous debt pile without paying an
7:16enormous interest bill because interest
7:19rates were incredibly low. Following the
7:21global financial crisis, the Federal
7:23Reserve reduced rates to almost zero.
7:25Bond yields collapsed and America could
7:28refinance its borrowing extremely
7:30cheaply. That world has disappeared. Old
7:33debt is constantly maturing. And if the
7:35government doesn't have spare money
7:37sitting around to repay that debt
7:38permanently, it has to refinance it.
7:41Imagine an old Treasury bond paying 2%
7:44it matures the government needs to
7:45replace that funding it will now have to
7:48pay 4% 5% or potentially even more than
7:51that. Suddenly exactly the same amount
7:53of debt becomes considerably more
7:55expensive and that's effectively what is
7:58gradually working through the US
7:59government finances. Cheap debt is
8:02maturing and expensive debt is replacing
8:04it. And at the same time the total debt
8:07pile is increasing. So, we've got more
8:10debt multiplied by a h higher average
8:13interest rate, which ultimately equals a
8:15much larger interest bill. And this
8:18brings us to the long end of the bond
8:20market. The 30-year US Treasury yield
8:22recently moved above 5.3%.
8:25That was its highest level since 2007.
8:28And if you're Scott Bessant sitting in
8:30the Treasury Department, that is
8:32something you absolutely do not want to
8:33see because long-term Treasury yields
8:36don't exist in isolation. They're
8:38effectively the foundation stone for
8:40borrowing costs throughout the American
8:42economy. Things like mortgages,
8:44corporate borrowing, infrastructure
8:46financing, and of course, government
8:48borrowing. And this is why the Treasury
8:50has become increasingly active in the
8:52bond market. Bessant recently announced
8:54a significant expansion of Treasury
8:56buybacks involving longerdated
8:58government securities. Individual
9:00operations in part of the long end are
9:02being increased to at least $4 billion
9:05per operation. Now, officially, Treasury
9:07says these operations are designed
9:09primarily to improve liquidity. Older
9:12Treasury bonds can become less liquid
9:14than freshly issued securities. Buying
9:17some of these bonds back can make the
9:19market function more efficiently. That
9:21is a perfectly legitimate explanation.
9:23But you don't need to be a conspiracy
9:25theorist to notice the timing. Long-term
9:28yields surged and then the Treasury
9:30announced bigger purchases of long-term
9:33bonds. When somebody enters the bond
9:35market and buys bonds, demand increases,
9:38bond prices rise, and because bond
9:40prices rise and yields move in opposite
9:42directions, yields fall. Following the
9:45announcement, the 30-year Treasury yield
9:47dropped by around nine basis points. So,
9:50the market did notice, but this doesn't
9:52solve America's fundamental problem.
9:54Treasury buybacks don't make the $40
9:57trillion of debt disappear. They don't
10:00eliminate the annual deficit and they
10:02don't change the fact that America has
10:04to keep raising enormous amounts of
10:06money. They can change the composition
10:08of securities outstanding. They can
10:10support liquidity. They can potentially
10:12reduce some of the pressure at
10:14particular maturities, but they can't
10:16repeal the basic laws of government
10:18finance. If you're spending considerably
10:21more money than you're collecting, you
10:23have to fund the difference. And this is
10:25where things get really interesting
10:27because the temptation for the Treasury
10:29is obvious. If investors are demanding
10:31more than 5% to lend you money for 30
10:34years, do you really want to lock that
10:36rate in for three decades? Or do you
10:38borrow for shorter periods and hope that
10:41interest rates fall? That can make sense
10:43if rates come down, but it creates
10:46refinancing risk because shortdated debt
10:49comes due for repayment much more
10:51quickly. And when it matures, you have
10:53to refinance at whatever rate exists at
10:55that point. So imagine the Treasury
10:57avoids locking in the expensive 30-year
10:59yield today. It borrows short instead.
11:02If rates fall over the next couple of
11:04years, then that's fantastic. Treasury
11:06refinances at cheaper rates. But what
11:09happens if inflation doesn't fall? What
11:11happens if Kevin Walsh actually
11:13increases interest rates? What happens
11:16if rates remain elevated for the next
11:18few years? Suddenly avoiding today's
11:20expensive long-term borrowing doesn't
11:22look quite so clever. You've simply
11:24pushed the problem into the future. And
11:27that's why Walsh's Jackson Hole speech
11:29matters so much. Treasury strategy works
11:32much better in a world where interest
11:34rates are going down. But the Federal
11:36Reserve has just reminded everybody that
11:39they might actually go up and therefore
11:41the United States now potentially faces
11:43pressure at both ends of the yield
11:46curve. The long end is saying you're
11:48issuing enormous amounts of debt. Your
11:50deficit is enormous. Inflation is still
11:52elevated. And if you want us to lend you
11:54money for 30 years, we want more than
11:565%. Meanwhile, at the short end, Kevin
12:00Walsh is saying inflation is still too
12:02high and we may need to tighten monetary
12:05policy. So where is the genuinely cheap
12:07money? That's the trap. And there is
12:10another important part to this story.
12:12Demand. America doesn't simply need to
12:14issue Treasury bonds. Somebody has to
12:16buy them. American banks buy treasuries
12:19as do pension funds, insurance
12:20companies, money market funds, and
12:23overseas investors. And foreign
12:25investors currently hold more than $9
12:27trillion of Treasury securities. But the
12:30latest data showed foreign securities
12:33declining in June. That doesn't mean
12:35that foreigners have suddenly abandoned
12:37America. They haven't. Foreign Treasury
12:39holdings are still higher than they were
12:4012 months ago. But when you have an
12:42issue that needs an enormous amount of
12:44money, demand matters. If treasury
12:46supply increases faster than investor
12:48demand, the way you normally attract
12:50more buyers is by offering them a better
12:53return. In other words, higher yields.
12:55And higher yields mean higher borrowing
12:58costs, which means more interest
12:59expenditure, which increases the
13:01deficit, which means more borrowing,
13:03which means more debt. And you can see
13:05how the cycle starts feeding on itself.
13:08Now, none of this means that the United
13:09States is about to go bankrupt. I think
13:11that's incredibly important point to
13:13mention. The US controls the world's
13:15dominant reserve currency as the world's
13:17largest economy. It's a massive tax base
13:20and the US Treasury market remains one
13:22of the deepest and most important
13:23financial markets on Earth. The question
13:26isn't can the US borrow. The much more
13:29interesting question is what is the
13:31price of that borrowing? Because being
13:33able to borrow money and being able to
13:35borrow money cheaply are completely
13:37different things. If the average cost of
13:39servicing a $40 trillion debt pile rises
13:42by only one percentage point over time,
13:46mathematically, you're talking about
13:47another $400 billion of annual interest
13:52every year. Now, that wouldn't happen
13:53overnight. The ent entire debt pile
13:56doesn't repric simultaneously. But as
13:58securities mature and are refinanced,
14:01higher rates gradually work their way
14:03into the average cost. And that's why
14:05this situation deserves our attention.
14:07The Federal Reserve is trying to solve
14:09an inflation problem. The Treasury is
14:12trying to solve a borrowing cost
14:14problem. Unfortunately, the solution to
14:16one may make the other worse. Kevin
14:19Walsh may need higher interest rates to
14:21push inflation back towards 2%. Scott
14:24Bessant needs lower yields to stop
14:26America's enormous interest bill
14:28becoming even bigger. The government is
14:31still running an enormous deficit, so it
14:33needs to issue more debt and more supply
14:36potentially puts additional upward
14:37pressure on yields. These policies are
14:40starting to pull in opposite directions.
14:42And that means September is become
14:45incredibly important. Walsh hasn't
14:47promised an interest rate increase.
14:49There is still economic data to come.
14:51things like employment, wages, consumer
14:54spending, inflation. If inflation
14:56improves significantly, perhaps the
14:58Federal Reserve leaves rates where they
15:00are. If the labor market deteriorates
15:02substantially, that would also make a
15:04rise more difficult to justify. But if
15:06inflation remains stubbornly above
15:08target, a quarter point increase now is
15:11clearly on the table. And even if we
15:13don't get an increase in September,
15:15Walsh has delivered another important
15:17message. Interest rate cuts are not
15:19guaranteed. higher for longer is still
15:22possible and the next move could
15:24potentially be up. And when you're the
15:26biggest borrower in the world, that
15:28matters. America needs lower borrowing
15:30costs to make its $40 trillion debt pile
15:32easier to manage. But it may need higher
15:35interest rates to bring inflation under
15:37control. And those two objectives are
15:39obviously in opposite directions. And
15:41that's why the United States may now be
15:44caught in a genuine interest rate trap.
15:46Hopefully, you've enjoyed today's video.
15:48you found it useful, informative, and
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