Let’s take a look at the bond market.

This is the U.S. 30-year yield …

This has moved 48 basis points in 16 days.  The chart of the 10-year yield looks similar.  It’s moved 52 basis points since the beginning of the month.

Why?

Is the market suddenly becoming concerned with overindebtedness?  Related to that, are the bond market vigilantes finally showing up to punish the egregious deficit spending and government handouts in an economy that’s running at “above trend” growth.

Is it a bet that inflation will reignite under the policies of the next administration?

The sharp rise in yields isn’t specific to the U.S.  It’s global.  But then again, so is the overindebtedness problem.

But, if we look at these three points denoted on the chart above, each has a commonality:  The Israel-Hamas War.

The Yom Kippur War started on October 6, 1973.  It began by a surprise attack on Israel by Egypt and Syria.

Almost 50 years to the day (50 years and one day), Hamas launched a surprise attack on Israel last October.

That’s point number 1 on the chart.

And with that attack on Israel, suddenly there was risk that retaliation could devolve into direct confrontation with Iran, and ultimately a global war.  It was a global war flashpoint.

Where does capital tend to flow in times of heightened risk?  U.S. Treasuries (bond prices up, yields down).

In this case, it went the opposite way.

Over seven days, the 10-year yield went UP 50 basis points, crossing the 5% threshold.  It fell only when the Fed relented and signaled the end of the tightening cycle, because a 5% 10-year yield had tightened financial conditions — unwelcomed by the Fed.

How did other markets respond to the attack in October?  Gold went up 11% in ten days. The S&P 500 went down 5%, before bottoming on the Fed signal.  Oil went up 10% and then down 10%.

Let’s look at point number 2 on the chart.  It’s April.

What happened in April?

Escalation.  Israel conducted an airstrike on the Iranian consulate in Syria killing the leader of the Iranian Revolutionary Guard.

Over the past year, we’ve looked several times at this chart of the Fed’s New Financial Conditions Index.    

We had the September inflation report this morning (CPI).

Investor’s Business Daily said it was “hot” and a “gut-check for the Fed,” implying it will test their resolve on the policy path (i.e. perhaps dial back on rate cut expectations). 

So, what was the number? 

It was 2.4%. 

As you can see in the chart below, it’s the lowest since February of 2021, continuing the clear trend lower.  That’s good. 

And if we look at the real interest rate (inflation adjusted), it remains near the highs of this recent tightening cycle.  This means the Fed is still putting significant downward pressure on the economy — highly restrictive policy, even with the recent 50 basis point rate cut. 

But if interest rate policy is still historically very restrictive, which gives the Fed plenty of room to cut rates, why did famed macro investor Stanley Druckenmiller and former Treasury Secretary Larry Summers both criticize the Fed last week for the large rate cut?

Druckenmiller, in fact, argued the Fed’s policy wasn’t restrictive.  And that would imply no rate cuts needed.   

He said GDP is running “above trend” around 3%, corporate profits are strong, equities are at all-time highs, credit spreads are tight and gold is on highs.

Things are good.  Why cut? 

Why?  Because we shouldn’t be satisfied with a 3% economy, after we’ve expanded money supply by 40% and continue to run crisis-level budget deficits. 

The potential output for the economy should be much better than 3% real growth.  More importantly, much better than 5% nominal growth.

Remember, the government debt has doubled, relative to the size of the economy since the Great Financial Crisis.

We are at Great Depression/World War II level debt.

The only solution is to inflate the debt away. 

That has to come through hot nominal growth.

Instead, the Fed has held down the economy with highly restrictive policy. 

Still, the economy has mustered 3% real growth.  That’s “average” in average times.  Dumping $6 trillion onto the economy and running crisis-level deficits aren’t average/normal.  We should be getting a much bigger bang for our buck.  The level of real rates is evidence.

What is “hot nominal growth?”  The last time we had this level of debt, (chart above), the economy grew at an average nominal rate of 19% (in the early 1940s).