Wall Street was absolutely abuzz. The day before, it all seemed to be going just fine. Then, bam, a hammer blow to the face. At least that was how it was described by the financial press. The government had gone way too far and now it was going to have to pay. We were all going to pay.
No one could say what consequences it would bring.
On Wednesday, August 10, 2011, Uncle Sam offered a hefty $24 billion slice of new benchmark 10-year notes. The market gave up a sizable $77.4 billion in bids culminating in a high yield of just 2.14%, at the time a record low (the median was just 2.101%). This was a huge sigh of relief.
You might not remember, but just five days before Standard & Poor’s had downgraded the US government’s credit rating. Losing Triple-A status for the first time from one of the major credit agencies was an enormous blow, even if hardly unexpected.
Following the textbook Keynesian response to the 2008 “financial” crisis and its Great “Recession” (I use quotes because the event was a global dollar shortage not some financial irregularity created by overuse of subprime mortgages and we still haven’t yet recovered from the contraction it brought so it couldn’t have been a recession), the US government ramped up even more fiscal tactics.
Reckless spending is, of course, a bipartisan failure. Left unchecked, it won’t matter which party or affiliation, politicians will buy as many votes (and kickbacks) as they possibly can. That’s a feature, not a bug.
For many years it was said the bond market had performed the civic duty of keeping the government honest. Bond vigilantes, it was said, had roamed the corridors of power wielding figurative hand grenades they needed only to threaten to lob at whichever session of Congress should it fail to maintain a near enough balance of the books.
This was a fiction, of course; anyone who remembers the seventies and eighties knows only too well the out-of-control rhetoric over the out-of-control deficits spanning several administrations. The Great Inflation’s end couldn’t even stop the spend-spree. While Uncle Sam’s debts surged even more under Reagan than anyone else before then (peacetime, of course), interest rates overall fell anyway.
Why so much fixation, then, on Treasury supply?
The answer, as always, Economists. They refuse to consider interest rates a function of anything other than the Federal Reserve and issuance. Occasionally, as they have post-2008, they’ll point to regulations. It is the only way to fit interest rates in a DSGE model or similar.
Independence on yield curves blows up the models. So, they stick with the regressions over reality (see: Ronald Coase’s Nobel Prize lecture).
A bond yield isn’t fundamentally growth and inflation expectations to these academics, the way they see them it begins with the Fed and adds premiums based on the fine balance between how much the government sells at auction and how much the government demands “real money” buyers like pension funds and even some banks hold.
So it was in August 2011. S&P downgrades Uncle Sam and everyone holds their breath given the sizable auctions scheduled for the following week. Though the 10-year went off without a hitch, the 30-year…would not.
The headlines immediately screamed about the catastrophe. It had tailed badly, suggesting the market was demanding an enormous premium just to bid on such impossibly foolish long-dated instruments. With the government running deficit after deficit, the Fed “cranking up the printing press” (twice, by then), Treasuries were doomed.
Three decades into the future? That paper would surely be worthless.
Secondary market prices got whacked on the high tail. The 30-year yield had dropped to 3.54% on the 10th when the 10s auction went off without issue. Not long after Treasury published the results of its “catastrophic” sale on the 11th, rates had backed up by a whopping thirty basis points. By the close of business, it was 3.82% and pulling up yields all across the curve with it (the 10s went from 2.17% to 2.34%).
Surely this was the beginning of the end.
You know where this is going. Not only was it not the end, the fuss didn’t last beyond that one single day. On Friday, August 12, bonds were heavily bid once more, the 30-year yield shedding ten bps (same for the 10-year). A week after that, by the 19th the long bond rate was 3.39% - sixteen bps below where it had been before the start of the “horrific” auction.
And it wasn’t done there, either. Uncle Sam’s lengthiest debt would see its yield drop under 3% in a matter of weeks and largely remain there for several more years.
Downgrades. Fiscal insanity. None of it mattered. What did was growth and inflation expectations. Full stop. You can make a better argument that the more the government did as “stimulus” the more it drove demand for its debt by driving down growth and inflation expectations Japan-style.
While the media was all abuzz over the S&P downgrade, the Federal Reserve was trying to figure out instead how after two QEs which “printed” $1.6 trillion in “base money” the entire global system was right then afflicted with profound illiquidity, and criminally in the same way as three years earlier. Whereas the public focused on the one thing, the market quite understandably fixated on that other; and I don’t mean the Fed and its clueless academics.
The costs to the global economy have been incalculable. This second monstrous worldwide monetary break, especially coming so soon after the first one, finished off every last chance for global recovery. Even the Chinese were unable to emerge unscathed; in fact, the 2011 crisis and its aftermath is the whole reason why China is suffering under Xi Jinping rather than technocrat Li Keqiang (who mysteriously died last month; there’s a lot going on in China right now, and all of it flows directly from this stuff, too).
Because of all that, and thinking about interest rates from a fundamental rather than supply standpoint, you wouldn’t be shocked to find out the even broke-r US federal government is able to sell boatloads of 30-year long bonds at rates that are scarcely higher than they were during the “catastrophe” of August 2011.
As I type, the interest rate for the 30s is just 4.62%, or a little over a percentage point more than twelve years ago. And that’s not even the most astounding part.
Consider that back in ’11, ST interest rates were at that time zero or close to it. Ben Bernanke couldn’t figure out economic recovery, so there they sat. This meant the yield curve all the way out to the end was significantly steep; investors were getting about 350 bps above short-term rates to buy and hold the bonds for maybe even thirty years.
In between then and now, government debt has – what word can you even use here that would be anywhere close to accurate? – surged, skyrocketed, insanely exploded, rising from $14.3 trillion in Q2 2011 when that much had set off all the vigilante alarms to, not a typo, $32.3 trillion as of Q2 2023 – and that’s before another trillion got added during this past quarter.
More than that, ST rates are up better than five full percentage points. The Federal Reserve has boosted its RRP over the last eighteen months all the way to 5.30%.
Plus, another debt downgrade, this one from Fitch just a few months back.
How in the world has the thirty-year bond only added a little over a percent in interest over the dozen years with all that? Investors right now are accepting three-quarters of a percent less in return to hold “worthless” government paper for three decades compared to what they get, right now, in ST money markets.
Astonishing doesn’t even begin to describe it.
Just last week we went through an August 2011-style “horrific” 30-year bond auction, too. It was, like before, all over the financial media. Every talking head was incessantly talking about all the same issues from inflation to, of course, supply, supply, supply. The 2011 experience was never brought up once, though.
And just like ’11, where the 30s yield went up with the auction they came right back down. It is lower today than before the sale was bid. Perhaps 30-year bond auctions are just a little more volatile than of so much presumed substance. Or maybe certain sections of commentary are seeking to use that volatility to “validate” pre-existing positions that can’t be validated any way else.
In big picture terms, the market remains utterly convinced the 2020s are, sadly, going to resemble far too closely the 2010s and nothing like the 1970s (forget the 1980s or 1990s). Because there had been no boom last decade, that was why long rates never strayed too far at any time no matter what happened along the way. In fact, what did happen, like the monetary crisis in and after August 2011, it kept happening too frequently.
The global economy kept mean-reverting to its putrid, no-growth disinflationary state where it stayed for the entire time between “subprime mortgages” and COVID.
One “easy” way for the current economy and monetary system to get back into their 2010s “groove” again, to revert back to post-2008 type, that would be for a renewed worldwide recession (quite a lot of the world is already there) accompanying another substantial bout of illiquidity – just like 2011-12. Following a year, 2023, when banks started to fail but the mainstream instead picked a soft landing narrative anyway, you might have noticed lately too many things are “suddenly” going wrong.
Oil is crashing, for one, in spite of Saudi Arabia’s best efforts. Deflation is showing up in price numbers, even consumer prices. The macroeconomy is sending those signals one more time.
The most “horrific” 30-year bond auctions can’t even stay on the front page for more than a day, a few hours. The fundamental truth is nothing has materially changed to economic and monetary potential since August 2007, the substance of growth and inflation expectations. What did make it seem radically different was nothing more than, yes, transitory Economics drawn from overreactions to the coronavirus.
With that supply shock almost fully in the rearview now, it’s time to get back to the mean. Rates, money, macro, regrettably all of it.
