Peter Schiff: The Bond Market Is Rigged!

You may have noticed that the financial media has started talking about inflation. But by and large, it’s not a warning. It’s reassurance. Many analysts are dismissive of any concerns raised about inflationary pressure. They often claim the bond market isn’t signaling inflation. But as Peter Schiff points out in a clip from a recent podcast, the bond market is rigged.

The narrative is that the bond markets aren’t signaling much concern about inflation. Treasury yields have risen in recent weeks with the 10-year rate now above 1%. As Peter pointed out in a more recent podcast, the upward trend does indicate some investors are starting to get nervous about inflation, and at some point, we could see “an explosive move up in interest rates.” But so far, the broader market hasn’t caught on. Even though the trend is up, yields remain historically low and they don’t exactly scream “inflation problem.”

After all, if investors were concerned about inflation, why would they be willing to loan money to the US government for 10 years at 1%?”

Typically, inflation is a major concern for lenders. If you plan to lend somebody money for 10 years, you have to consider what that amount of money will buy when you get it back. In effect, you’re giving up the opportunity to buy something with your money today in order to lend it to somebody else. You’re willing to do this because the borrower is paying you for the service of loaning him that money. But if inflation is going to eat away your purchasing power over time, you will want to charge a higher rate of interest to compensate for that loss.

So, the interest rate the lender charges typically reflects the expected rate of inflation over the term of the loan. If a lender expects higher inflation, he will build those expectations into interest rates. And from the borrower’s point of view, she’s fine with paying the higher rate because she knows that she’ll be repaying the loan in the future with money that has less value than it does today.

Since we’ve not seen a huge spike in bond yields, most analysts assume inflation must not be a concern. But given the massive deficits and the ballooning money supply, why are the markets downplaying inflation? Peter said they’re missing the elephant standing in the middle of the living room.

That is the Fed! And actually, there are a few elephants in the living room in the form of other central banks that are distorting the bond market. The bond market is not working the way it has in the past because the Fed is artificially manipulating interest rates. The biggest buyer is the Federal Reserve.”

When the Fed buys bonds, it isn’t worried about losing money on a loan. The Federal Reserve isn’t lending money in the way an actual lender does. The Fed isn’t making a business decision. It’s making a political decision.

The Fed is trying to affect policy. It’s trying to influence the economy, stimulate the economy, prop up the stock market. That is the purpose of the Fed buying Treasury bonds. So, the Fed is not looking at Treasury bonds yielding under 1% and thinking, ‘Wow, this is a lousy buy. Why do I want to buy these bonds at less than 1% and hold them for 10 years? We’re going to take a big loss.’ The Fed doesn’t care about losses. The Fed doesn’t have to work for its money. It creates it out of thin air. What do the guys at the Fed give a damn how much they lose by buying these low-yielding bonds? And so when you have the Fed in the market, the whole thing is distorted.”

And the Fed has become a major player in the bond market. As we reported recently, the Fed now owns a record 16.5% of US debt. In just one year, the Fed doubled its holdings of Treasuries, adding a staggering $2.4 trillion in US government bonds to its balance sheet – most of that since March. The Fed’s total share of US debt has spiked from 9.3% in Q1 to 16.5%.

It isn’t just the Fed itself that distorts the bond market. The central bank’s presence creates an environment ripe for speculators who are just in it for the short-run.

Whenever there is a sell-off in the bond market and you see a backup in interest rates, what happens? Speculators who can borrow money real cheap, also thanks to the Fed, come into the market and buy the dip. Why do they do that? Because they know they can sell to the Fed. They can flip the bonds back to the Fed because the Federal Reserve is trying to keep a lid on long-term interest rates because the economy is so loaded up with debt – and again thanks to the Fed. The Fed has to keep interest rates at rock bottom so people can afford to pay. Also, the Fed is trying to maintain these excess stock market valuations. And the key to the overvalued stock market is the overvalued bond market because we keep comparing stocks to bonds, and so to make that comparison favorable, the Fed has to keep the bond market propped up and keep interest rates down.”

Speculators don’t buy bonds because they think they’re a great long-term investment. They have no intention of holding them until maturity. They’re buying to flip to the Fed.

On the other side of the equation, the Fed has to keep bond prices high (and therefore yields low) in order to create enough demand on the open market for the US Treasury to sell enough bonds to finance the massive budget deficits. With the Democrats controlling both houses of Congress and the White House, it seems likely the borrowing and spending will increase in the coming months – certainly not slow down.

So that’s what’s going on in the bond market. You have speculators who are front-running the Fed. They have no intention of holding the bonds to maturity. And then you have the Fed that will hold to maturity and isn’t concerned about how much money it loses to inflation.

In a nutshell, the bond market is completely rigged.