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Bloomberg Audio Studios. Podcasts, radio, news. Matt Giannone, your research suggests that given the 10- year bond yield relative to nominal GDP growth, the current sell-off cannot be called the " revenge of the bond lynchers," at least not yet. Matt is with us now to tell us more. Congratulations. How would you then characterize this sell-off with yields reaching multi-year highs?
I think if you look at the world in general, there are different explanations for what's happening. If you're looking for one explanation for the rise in bond yields around the world, we discussed this last time, it's probably the unwinding of yen carry trades . As the Bank of Japan raises interest rates, all those hedge funds and speculators who borrowed money in Japan at zero interest rates are now closing their positions.
They bought up a lot of government bonds, and that, I think, explains the global rise in rates. Here in the United States, I would say that the more important explanation for what is happening is that we are seeing a real economic boom. The economy is growing rapidly. Consumer spending remains at a very high level.
Baby boomers are retiring and continuing to spend money. Capital investment is growing rapidly, and as you said, AI hyperscalers and others continue to borrow more and more. And, of course, the deficit remains extremely large. So I think the optimistic view , if it's appropriate, on rising U.S. bond yields largely reflects the strength of the economy, and that's why TIPS, the real rate, is actually outpacing the rise in nominal yields, not inflation.
Can you find positives in what is happening in other places, such as France, Ede? Yes, no, I don't think you can find anything positive in the situation in France. I mean, France is starting to resemble the Greek debt crisis. The Greeks survived that debt crisis in 2010 . Bond yields jumped as high as 40%, finally catching the attention of policymakers, and as a result, bond yields in Greece are now lower than in France.
So, Ed, do you think they're getting close to the danger zone? To the point where you suddenly find yourself in a "death loop" where higher returns beget even higher returns in the absence of some fiscal solution. Well, we are definitely heading towards the danger zone. I would call this a spectrum of bond yield scenarios.
On the positive side of the spectrum—better-than- expected economic growth , leading to a rise in the neutral interest rate. Remember, at the beginning of the year, Fed officials said that the federal funds rate was still somewhat restrictive. Now new Fed Chairman Warsh recently said that the 25 basis point rate hike in September was an elimination of the stimulus dose.
So, suddenly Fed officials are saying that the real rate is higher, and I think that's due to stronger economic activity. But look, another factor, of course, is oil prices. They have risen significantly today, and the yield on bonds, French bonds, has almost reached 5%, or 4.9% the last time I saw it.
Um, and meanwhile, US bond yields are inexorably moving towards 5.5%, and then we'll start talking about where we'll stop—between 5.5% and 6%. And you make a lot of great arguments. One of them is that the " bond avengers" have not yet come out with pitchforks over the US budget deficit. They are more responsive to the strength of the US economy, the borrowing boom we are seeing through AI, and also higher oil prices.
Is this...This can be viewed both positively and negatively. The downside is when they start to worry. And if there is an additional round of bombing before the election, after the election, if there are ongoing war-related costs, on top of any deficit-increasing compromises, how high can they go if the “ bond vigilantes” really start paying attention to the deficit?
Well, if they started really focusing on the deficit, they could go higher relative to nominal GDP. One way to assess the impact of the bond market on the economy is to look at the yield on bonds, the 10-year bond, which is almost 5.5% relative to nominal GDP growth on an annualized basis, which is about 6-6.5%.
I would say that the concept of "bond avengers" becomes a real problem if we see bond yields reach 6% and above, because I think once you exceed nominal GDP, you start to slow it down. The economy is now less sensitive to interest rates. The consumer, I mean, a lot of baby boomers retiring—the rates are going up.
This is positive for them given the returns on money market funds, and the AI lending market, as you said, is still very liquid. Perhaps AI borrowers have become the new sovereign bonds in the sense that investors feel more confident owning them than French or perhaps even US government debt. Getting to the heart of the problem, what needs to be done to slow all this down ?
What should the Federal Reserve do? How far are they willing to go? How decisively do you think they are willing to act? Yeah, well, you know, the Federal Reserve matters , but it's not as big as it used to be. This is partly because the economy is less sensitive to interest rates. But let's face it , the problem is fiscal policy.
Scott Bessent knows this, and he feels trapped because the only solution he has is what we are seeing in France right now , and Bessent's bazooka would mean buying up a lot more Treasury bonds and issuing a lot more Treasury bills. This could calm the situation down, and it's something he might have to do if the situation really gets out of hand.
He effectively admitted that he couldn't control what was happening, which suggests that he wasn't very convinced that using a " bazooka" would help. for all this to stop. And define what it means to “get out of control”—at what levels do you think Treasury could intervene? Well, again, I think this is all relative to nominal GDP.
I would say it's not just about level, but also about speed. If we get to 6% very quickly, I think we could see real cracks in the financial system. And that will likely force the Fed to start thinking about liquidity tools. If we get to this gradually, I don't think it will do much harm, but right now all the attention is on the debt growth.
That's why we became more cautious in the market in mid-September, because we began to notice that due to higher and longer-lasting oil prices, stronger- than-expected economic growth and demand for credit, we could have problems in the bond market, and we do have them. Ed, just see you later. This problem continues to grow. Do you have any, do you have any research?
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