Peter Schiff: The Bond Market Is Broken

A lot of pundits and analysts insist inflation isn’t a problem because the bond market isn’t signaling any inflation concerns. But in his podcast, Peter Schiff argues that you can’t rely on this bond market to tell you anything. The bond market is broken, thanks to the Federal Reserve. It’s rigged and it’s sending false signals.

US stocks continue to make new highs as the markets anticipate not only an effective coronavirus vaccine, but also a new round of fiscal stimulus.

Even if the vaccine works, we’re going to keep getting monetary stimulus and fiscal stimulus, and that is really what is driving the stock market.”

This, coupled with dollar weakness, has also pushed gold prices back up over the last several days.

Inflation is the driver. It’s what’s driving the stock market. Because the stimulus is inflation. That is what it’s all about. It’s printing money to monetize government debt to artificially prop up asset prices. And that is what is driving investors into gold and will drive them into gold in a bigger way in 2021.”

In his previous podcast, Peter talked about the fact that the Fed is trying to fight inflation with inflation.

Maybe you can fight fire with fire, but you can’t fight inflation by creating more inflation. And the markets still haven’t come to grips with this. Even though you’re hearing a lot of talk about inflation, it’s mostly to dismiss the concerns.”

Many mainstream analysts insist we don’t need to be concerned about inflation because the bond market isn’t signaling a problem. Interest rates remain relatively low. Even though the yield on the 10-year Treasury has gone up a good bit in recent weeks, it remains below 1%.

So, it’s hard to say a 10-year yield below 1% is a warning sign for inflation. 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%? Therefore, the bond market is not showing any signs, any worries, about inflation. Therefore, we don’t have to worry because the bond market gets it right.”

In the past, it has certainly been the case that bond prices dropped and yields rose as a harbinger of inflation. Inflation is a major concern to lenders. The interest rate should reflect the expected rate of inflation over the term of the loan. If the lender expects a high rate of inflation over the next 10 years, she will want to be compensated for the decrease of purchasing power of her money over that time by a higher rate of interest. If lenders expect higher inflation, they will build those expectations into interest rates.

Since we’re not seeing a huge spike in bond yields, most analysts assume inflation must not be a concern. But 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.”

As we reported recently, the Fed now owns a record 16.5% of US debt. In the last 12 months, the Fed has 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%.

Central banks aren’t concerned about losing money on a loan. They aren’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.”

The Fed’s presence in the bond market also drives speculators into the market. They can buy dips in the market knowing that if worse comes to worst, they can always 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.”

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.

The bond market is broken. You can’t look at the bond market.”