Dammit, Janet

“It was really important to spend the money to alleviate that suffering.”

–Janet Yellen, on the $1.9 trillion Covid spending bill that helped fuel the great inflation of the 2020s

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January 10, 2025— Something’s rotten in the bond market.

Since September, the Federal Reserve has cut interest rates by a full point. Typically, when the federal funds rate drops, the rest of the bond follows.

Not this time. Bond yields have risen.

Despite the Fed’s best efforts, and all the hand-wrenching of AI stock chasers, the benchmark 10-year U.S. Treasury rate hit 4.7% this week, and jumped to 4.78% this morning, following blowout jobs numbers that likely aren’t that good once we look past “seasonal adjustments” and get into the details.

A 30-year fixed rate mortgage is back to 7% after dropping briefly under 6% last summer.

What gives?

“Bond yields are attempting a breakout,” notes John Authers in his Bloomberg opinion column, warning “pay attention, or else.”

With apologies in advance, we’re going to lean on John’s excellent work here for a moment.

After a methodical run-through of the typical technical indicators used to measure inflation – yield curve, Fed rate cut futures, Institution of Supply Managers (ISM) forecast among them – John arrives at an explanation for why Treasury yields defying the Fed’s “shock and awe” interest rate cuts.

Here’s Mr. Authers with the smoking gun:

It’s best to look to the “term premium”, an infuriating concept that refers to the extra yield investors require to take the risk of lending long into the future, and with it the risks that interest rates will change over that time.

The point of the concept is to explain any rises or falls in yields that can’t be put down directly to the Fed. Interestingly, after a long period when the term premium was negative, it’s now its highest in almost 10 years. According to the Adrian Moench Crump term premium maintained by the New York Fed that is the most widely followed measure:

Why is it rising? Some political risk is in there. A Republican clean sweep has raised the threat of fiscal irresponsibility; bond markets prefer gridlock. The policy uncertainty that surrounds the return of Trump will naturally prompt investors to demand a higher term premium.

In our brief tutorial with Paul Volcker for the film I.O.U.S.A the gentle giant (he’s 6’7”) Mr. Volcker explained why and how rates rose so steeply during his effort to “choke” inflation out of the system. The prime rate rose from 6.25% in 1976 when the late Jimmy Carter took office. At the peak of Volcker’s battle against inflation the prime had jumped to 21.5% in 1980.

Volcker’s explanation to our little film crew was not that he forced rates up to nosebleed heights, but that he had to chase rates higher in order to finance the government.

As we noted yesterday, Carter presided over a period of extreme disillusionment over the future of the American Experiment. A deep economic “malaise” that was ironically solved by Vocker’s historically aggressive effort to keep the ship of state afloat and restore confidence to consumers and voters alike.

Back then, in what is known as the “Great Inflation”, consumer goods and prices rose an average of 9.6% per year from 1976 until 1982. Our recent bout with inflation did see 9.1% briefly, but for one year… not six.

Under normal circumstances, the Fed’s vigilance over the overnight rate would be enough to both quell inflation fears among consumers, restore some confidence for small business owners in future producer prices and give just enough octane to the juice bowl to keep speculators throwing their capital at a tech boom.

But if Authers is correct, the bond market today is in the early stages of telling us, the more immediate concern is uncertainty over the next Trump administration’s “mandate” and their willingness to turn a blind eye to the national balance sheet.

“Another edifice of the post-Volcker era of stability is cracking,” Authers concludes.

And that’s where the plot thickens. Scott Bessent, Trump appointee for Treasury Secretary, has already come out of the gate swinging.

His beef?

Current Treasury Secretary Janet Yellen’s choice to finance over $28 trillion in U.S. government with 2-year treasury notes – all of which must roll over in 2025, his first year in the hot seat. The chess game between the parties continues.

Below, Grey Swan Portfolio Strategist, Andrew Packer, speculates on Yellen’s motives for such a departure from historical government financing norms. ~ Enjoy, Addison

Janet Yellen: The U.S. Government’s Worst DEI Hire
Andrew Packer, Grey Swan Investment Fraternity

It’s just about Joe-ver. We’re days away from the Biden administration driving off into the sunset, or whatever direction the 46th President’s hospice care is relative to the White House.

As we reflect on Biden’s years of inflation, fueled in part by spending bills named the “Inflation Reduction Act,” it’s important to note that the U.S. government has been rigged for a crisis not long after Donald Trump returns to office.

Why? Janet Yellen, the departing Treasury Secretary, is the reason.

She’s deliberately booby-trapped the economy over the past year. And if things don’t go well, this sucker could blow.

Make no mistake: This is deliberate. Yellen is smart. She got her BA at Brown, her MA at Yale, and taught at Harvard and U.C. Berkley before moving into the bureaucracy of the Federal Reserve.

President Obama tapped her to lead the Fed after Ben Bernanke. In that role, Yellen showed tremendous caution, taking her time to gradually raise interest rates a quarter point at a time.

But it’s her recent actions at Treasury Secretary that pose a huge problem. Yellen took over in 2021. Interest rates were still at zero. Investors, particularly institutional investors, were still risk-averse.

The Treasury had a fantastic opportunity to issue 50-year bonds at a relatively low rate. But Yellen didn’t follow through and make a tough choice.

Instead of charting a new course, Yellen has focused the Treasury on meeting its funding needs with short-term bills.

Interest rates have been trending higher, which is a problem. For most of 2023 and 2024, the real issue is that short-term bills, thanks to the inverted yield curve, carried a higher cost than longer-dated securities.

By focusing on issuing short-term bills, the U.S. government has an increasing cash flow problem. Larger and larger amounts of money are coming due each month. A stronger mix of longer-dated securities would alleviate this rollover problem.

What’s truly bizarre is that Yellen made these moves when Biden was still running for re-election. And Yellen didn’t change course after Kamala Harris stepped in following Biden’s withdrawal. That’s why this appears to be genuine incompetence and not just a political maneuver to harm the incoming Trump administration.

Meanwhile, as we enter 2025, five-year bonds from the pandemic low yields of 2020 are now starting to roll over at rates close to 4.5%, compared to 0.1% when they were initially bought. That’s a massive jump in borrowing costs for Uncle Sam.

Adding in the high costs of issuing short-term debt during an inverted yield curve and refinancing pandemic-era low yields, it’s clear that Yellen’s short-term focus is costing the U.S. billions of dollars in extra interest it wouldn’t have to pay otherwise each year.

It’s no wonder that there are now estimates that Uncle Sam will have to shell out $2 trillion in interest payments on the debt soon after hitting $1 trillion in annual payments for the first time.

Like many other members of Biden’s cabinet, Yellen was likely chosen for her party loyalty and for ticking the right diversity boxes.

As corporate America and the incoming Trump administration look to scale back from DEI—diversity, equity, and inclusion—standards and move back to the American historical trend of meritocracy, Yellen will go down in history books for her incompetence in overpaying to fund the government.

Future Treasury Secretaries who screw up likely won’t be able to screw up on the scale as Yellen has in just four short years (although they’ll probably try).

It didn’t have to be this way.

Time will tell how Donald Trump’s Secretary of the Treasury pick, Scott Bessent, will fare. But he’ll likely be dealing with a crisis sooner rather than later. And a debt crisis can quickly spiral out of control in unforeseen ways.

Given the rising mix of short-term debt, it could truly create a real crisis. After all, finance textbooks and theories state that U.S. T-bills are the only truly risk-free asset.

Sadly, that thought may face a real test in 2025, and become the top Grey Swan event of the year. ~~ Andrew Packer, Grey Swan Investment Fraternity

Regards,

Addison Wiggin,
Grey Swan

P.S.  We stop short of calling Yellen’s short-term financing scheme political sabotage. After all, if your politics include a decade of ZIRP and successive QE efforts, over $6 trillion in government spending to address the, ahem, economic crisis precipitated by the pandemic, and sending the Fed into the red for the first time in its history, why not try to inflate the government debt and finance it with two-year Treasuries?

There were only two flaws with her plan: 1) the global bond market doesn’t seem to like the plan and 2) 77 million voters prefer not to mix their financial outlook with woke activism.

P.P.S. We grabbed a snippet from the conversation raging in our inbox since Scott P. puzzled over our apparent support of Trump’s blustery approach to his second term. For entertainment purposes only, of course:

Ken L. writes:

You state that Trump goes after everyone that does not agree with him.

And exactly how do you define what The Dem’s have done, starting with Obama saying more than once, he has the power of the pen & paper?

Biden (and the rest of the Democrat party California, NY, NJ, Illinois) has abandoned the rule of law for their own version! Cities burning, violence and murder vs Jan. 6th? One group ended up with a tax free status, the other group ended up in prison?

Isn’t that exactly what you blame Trump for? Your “community” are surely critical thinkers, it seems maybe the trouble is connecting the dots or afraid to state a position.

Should I believe you or my own eyes! Bottom line; you don’t go to a Brothel expecting to find a Nun! [ ie: Washington DC ]

Triple P.S. Mary L. writes with a very pertinent concern about having $500k to invest just a few years before retirement. We refer her to the Grey Swan model portfolio, available to annual members of the fraternity. The model is a mix of dividend and speculative stocks designed to both preserve and grow capital even in an inflationary environment.

Mary also asked what we’d do if we were elected 47th President of the U.S.

Probably, demand a recount.

As always, if you’d like to participate in the political tit for tat alternatively blaming each party for destroying the government’s finances, by all means, send your own comments on the Grey Swan here: addison@greyswanfraternity.com.