by Mish

"The Federal Reserve has initiated the fifteenth tightening cycle since 1945 (Chart 1). Conspicuously, in 80% of the prior fourteen episodes, recessions followed, with outright business contractions being avoided in just three cases. What is notable today is that the economy is in the 93rd month of this expansion, a length of time that is well beyond periods in prior expansions where soft landings occurred (1968, 1984 and 1995). This is relevant because the pent-up demand from the prior downturn has been exhausted; thus, the economy is extremely vulnerable to a shock, which could lead to recession. Regardless of whether there was an associated recession, the last ten cycles of tightening all triggered financial crises.

Total domestic nonfinancial debt, excluding off balance sheet liabilities such as leases and unfunded pension liabilities, surged to a record 254.8% of GDP in 2016, 5.6% greater than in 2009 when Lehman Brothers failed (Chart 2). Total debt, which includes domestic nonfinancial, foreign and bank debt, amounted to 372.5% of GDP in 2016, compared with 251.9% of GDP in 2006, the final year of previous tightening cycle, which, in turn, was greater than in any earlier time from 1870 through 2006. The situation in the business sector deserves particular scrutiny. Business debt surged to a record 72.6% of GDP in 2016, for the first time eclipsing the prior peak of 70.2% reached in 2009. With the business sector so levered, not much room for miscalculation exists. As such, the risk is clearly present that the Fed’s restraint will chase out one or more heavily leveraged players, just as was the case in all the previous tightening cycles since the 1960s.

Academic studies reflect that economic growth slows with over-indebtedness. Thus a powerful negative headwind is reinforcing
the present monetary tightening.

Image placeholder title

In the last three months, no growth was registered in total loans and nonfinancial commercial paper. Historically, the three-month growth has not been this weak until the economy is already in recession.

In the first quarter survey of senior bank lending officers, almost 10% of the banks were tightening standards for both credit card and other consumer type loans. This was almost identical to the percentage when the economy entered the 2000 and 2008 recessions. Standards for commercial real estate loans have also been raised and in the first quarter were just below the levels when the economy entered the last two recessions.

In summary, monetary restraint is taking hold in all the different ways of measuring the Fed’s actions in a late stage expansion where historically the final result was either a recession, a financial crisis or both.

Our economic view for 2017 remains unchanged. We continue to anticipate no more than 2% growth in nominal GDP for the full calendar year. The risks, however, are to the downside.

The downturn in nominal GDP growth suggests that a rise in inflation to above 2% will be rejected and that by year end the inflation rate will be considerably slower. In such an economic environment long-term Treasury yields should continue to work irregularly lower over the balance of the year.

Our view on bond yields does not change if the Fed further boosts the federal funds rate this year. Any additional increases will place further
downward pressure on the reserve, monetary and credit aggregates as well as tighten bank lending standards. Such actions will not allow the
economy to regain the economic momentum that was lost in 2016 and in the early part of this year.

Thus, the secular low in bond yields remains in the future, not the past.

Van R. Hoisington
Lacy H. Hunt, Ph.D."

That’s a pretty bold call, but betting against Hunt or on alleged bond bubbles has been extremely unrewarding, to say the least.

The Fed thinks three more rate hikes are baked in the cake over the rest of the year. I highly doubt the Fed gets in even one more hike.

You can take this dot plot of expected rate hikes and throw it out the window.

Image placeholder title

The rate hikes various Fed presidents think will happen are pure Fantasyland material.

Huge equity and junk bond bubbles are in play. The Shiller 10-Year PE is 29.2. The only higher numbers were 1929 and the dot-com bubble in 2000. The bursting of these bubbles will be anything but an inflationary event.

Those looking for a steeper yield curve, might get it, but not the way they expect. When recession does hit or the stock market collapses, the Fed will be cutting rates, not raising them.

Whether or not the secular low in the long bond yield is in, this is not a good time to be shorting long-term treasuries.

Mike “Mish” Shedlock

Lacy Hunt: Secular Low in Long-Term Treasury Bond Yields Remains Ahead

Secular Low in Long-Term Bond Yields Coming Up Hoisington’s bond managers, Lacy Hunt and Van Hoisington, doubt the global economy will rebound soon thanks to low industrial output, heavy debt, and the commodities collapse. No Inflation In Sight, Say Two Bond Masters.

Lacy Hunt on the Unintended Consequences of Federal Reserve Policies

The Financial Repression Authority interviewed Lacy Hunt, Chief Economist at Hoisington Management on Fed policies.

Lacy Hunt on Negative Multiplier of Government Debt

In Hoisington’s Second Quarter Review (not yet posted online), Lacy Hunt takes on the widespread Keynesian belief that government spending boosts real (inflation adjusted) GDP.

Lacy Hunt Blasts MMT and Speaks of Hyperinflation If Implemented

In the Hoisington First Quarter Review, Lacy Hunt blasts MMT as "self-perpetuating" inflation.

Lacy Hunt Chimes in On Money Supply

I asked Lacy Hunt at Hoisington Management for comments on M1, M2, and M3. In a series of emails he expressed his thoughts on money supply.

Bond Market Dislocation: What the Hell is Going On?

The "Bond Freak" is wondering what's going on. I have an answer from Lacy Hunt at Hoisington Management.

Hello Treasury Bears: 10-Year Bond Yield Approaching Record Low Yield

Treasury yields are down again today, the 6th straight day of strengthening inversions. 30-year to FF inversion on deck.

World Dollar Liquidity Crashes as Does Marginal Utility of Debt

Lacy Hunt at Hoisington Management has another sterling post in its third quarter review and outlook.

Entire Yield Curve Inverts, 30-Year Long Bond Yield Dives to Record Low

The stock markets are getting clobbered and bonds are on fire as recession fears escalate.