Submitted by Taps Coogan on the 1st of March 2018 to The Sounding Line.
David Stockman, former US Representative and Director of the Office of Management and Budget under President Ronald Reagan, recently spoke to CNBC to issue the following warning about a ‘monumental yield shock’:
Stockman: “He (Fed Chairman Jermone Powell) is missing three giant skunks sitting on the woodpile right in front of us. Number one is an epic monetary fiscal collision that… I haven’t seen in my lifetime and I’ve been involved since 1970 on capital hill… Starting in October fiscal year 2019, the federal government is going to borrow $1.2 trillion, which is an astronomical number for ten years into a business cycle expansion. At the same time, the Fed is on automatic pilot. Everybody says they are going to be shrinking the balance sheet. They’ve pivoted to QT, quantitative tightening, for the first time in 30 years and they will be dumping 600 billion of existing bonds into the market at the same time. So you have $1.8 trillion of government debt looking for a home in fiscal 2019. I don’t see how the market will clear anything close to 2.90 on the 10-year. There’s going to be a monumental yield shock that will take the market to 3% and 4% and probably overshoot beyond that because there’s no help coming from the other central banks around the world. The ECB is going to the sidelines.”
Question: “David, why is $1.8 trillion scarier than the net issuance of a trillion dollars a few years ago that the market absorbed at historically low interest rates?”
Stockman: “Because the Fed was buying bonds hand over fist… They bought $3.5 trillion worth of bonds, drained it out, and it wasn’t just the Fed, it was every other central bank in the world. You’ve seen the numbers. $15 trillion of debt, much of it US government, or GSE debt, has been drained out of the market into the central banks during that period. Now, we’re in a totally different ballgame. We’ve had a pivot to QT. It will spread worldwide and the pricing in a QT market is dramatically different than a QE market.”
As we have discussed here at The Sounding Line, the current economic expansion is already the third longest in US history. Making it through the current two year federal budget without a recession will require longest economic expansion in US history. If a recession does begin this year or next, the already huge increase in deficit projections arising from the recent budget deal will grow much larger. Washington is choosing to dramatically increase deficit spending very late into an economic expansion, while the Fed is reducing its treasury purchases, and when the national debt is already very high. It is a very risky gamble that the US will enjoy the longest economic expansion in history and not entire a recession for years to come.
There is more to the interview, so enjoy it below:
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