Did the Promise of Fiscal Stimulus Just Pop the Bond Bubble?

Yesterday was “Reversal Tuesday.” Stocks rallied on the promise of government stimulus. The dollar and the bond market also turned around. In his podcast, Peter Schiff said the bond market was the one to watch because it’s possible that the promise of more stimulus could have finally pricked the overblown bond bubble.

President Trump floated the idea of a payroll tax cut. There is also talk of bailouts for oil companies and other industries hit hard by the coronavirus, such as airlines and cruise companies.

Of course, as Peter pointed out, the promise of government fiscal stimulus comes with more monetary stimulus.

Because how else is the fiscal stimulus paid for? It’s paid for by the Fed. The Fed ends up doing more QE to buy all the bonds that have to be sold to finance the stimulus.”

If Trump were to push through a payroll tax holiday through the end of the year, it would amount to about $300 billion. That is an enormous amount of fiscal stimulus in a very short period of time.

This raises an interesting question: if the US economy is really in such amazing shape, as Trump and others in his administration have claimed, why do we need a massive stimulus program?

Peter said he thinks the stimulus is really aimed more at the stock market because the administration is tired of waiting for the Federal Reserve to come through with even deeper interest rate cuts. Trump has been badgering Jerome Powell to cut deeper for months and has even advocated for negative rates. The Trump administration knows if it comes with more fiscal stimulus, it will force the Fed to provide monetary stimulus in order to monetize the accompanying debt.

Peter said the stimulus won’t help the economy.

You don’t help the economy by running deficits, printing money. I mean, if that worked, all of these banana republics would have booming economies. They don’t.”

The real result of the stimulus will be bigger budget deficits. And don’t forget deficits are already at levels not seen since the Great Recession. That will mean more quantitative easing. The Fed will be forced to buy up Treasuries to monetize the debt and keep interest rates from pushing up.

More deficits. More money printing. That is not good for the economy.”

Expectations of stimulus caused a rally in the dollar and the bond market. Bond prices fell and yields increased, pushing back above the all-time lows we saw earlier in the week. The yield on the 10-year dropped below 0.4% at its low point. On Tuesday, it was back close to 0.8%. This is still exceptionally low, but it’s a hefty single-day increase. It was a knee-jerk reaction. People just assume stimulus will be good for the economy and good for the dollar. But Peter said the opposite is true.

This is decisively bearish for the US dollar and bullish for gold. The knee-jerk reaction is the opposite of what should actually be happening, which is typical for the markets.”

Another potentially ominous sign is a blow-off top in the bond market. We may have just seen the highs in bond prices in a bull market that is about 40 years in the making.  Peter said it will be interesting to see what happens through the rest of the week. If bond prices continue to fall and yields rise, it will solidify the case that we just had a blowoff – “A climactic end to the biggest bull market turned into a mania ever.”

If this is the case and we’re about to see rising interest rates, it will be a significant problem for a country as deeply in debt as the US. And of course, a stimulus program with more deficit spending will mean more bonds flooding the market which will push prices down further and drive interest rates up even more.

Peter also said it would make sense that bonds would be peaking just as we’re about to get a big acceleration in inflation.

This fiscal stimulus and monetary stimulus are precisely the type of policy-mix that would cause this to happen.”

Peter said its too early to say for certain that the bond bubble has popped.

This has been a massive bull market and the graveyards are littered with people who have tried to call the top in the bond market, but I’ll have to say that it looks suspicious that this could be it. But we need to look at a few more days to see if we can really validate that as a blow-off top.”