One of the questions I am often asked is surely the US government or the Fed will step in to stop yields rising too much. And usually I answer this question - with yes that true but that is why you need to own gold, as a hedge against exactly that. And that is a nice, simple answer, but could also be wrong. I could see another reason why long dated US yields rise, one that would closely echo the 1970s.
One of the more weird features of the current inflationary period we live in has been the total lack of improvement in the US government fiscal position. IMF is forecasting big deficits as fare as the eye can see. The contrast with Japan or the UK is striking.
And the yield premium over JGBs keeps falling.
But there is another, political, way to think about US treasury yields. Back in the 1960s and 1970s, yields were constantly going higher.
But unlike now, debt to GDP ratios were falling in the 1960s and 1970s. That is yields kept going up, even as the “creditworthiness” of the US was improving, while US yields today stay stable, despite the US government ability to pay declining.
As we have seen in recent years, the US government has used trade flows (via tariffs) as political weapon, financial flows (via sanctions) as a political weapon, and military dependence as a political weapon. We are also beginning to see oil and natural gas flows as a political weapon. So, logically, we should also see bonds and bond yields as a political weapon. In simple terms, owners of capital demand higher yields from the Democrats. Generally speaking, we tended to see bigger falls in yields in the 10 Year Treasury with Republican presidents, and yield rises under Democrats. Under President Trump, 10 year yields have generally behaved well over his entire term.
As mentioned in a previous post, there is a conservative political strategy called “Starve The Beast” which entails cutting government revenue, which then ensure that Democratic administrations must cut spending - a policy that worked well with both Clinton, and Obama - but one that Biden conspicuously ignored. Starving the beast strategy would probably accurately reflect the second Trump Administration - large scales tax cuts, plus the gutting of the IRS would be in line with this. The Democrats recognising that they were getting played, have joined in the tax cutting frenzy.
Since the 1980s, until Biden, the Democrats feared the bond market - and have broadly enacted Washington Consensus policies. But as we have seen with Biden, and now with Trump - there seems to be no fear. Or perhaps the Democrats have their own starve the beast strategy - spend aggressively, and let the Republicans be the ones to cut spending.
The UK is an intriguingly example. In 2022, Liz Truss announced an aggressive budget, and yields surged, and she was ejected from government. Since then, more conservative budgeting has happened, and yet yields have continued to climb. Is this because Labour is in power? Is it because the Greens and Reform are leading the polls? I don’t know, but I do not think the US political environment is too different - both the Democrats and the Republicans look fiscally irresponsible.
I guess what I am saying is that, markets could give up on US treasuries if President Trump announces a fiscally aggressive policy, or, should the Democrats starting doing well politically, bond markets should begin to act skittishly to try and convince them to enact austerity. Either way I cut it, short TLT still looks good politically.
