The trade dispute is officially a trade war. You’d never know it from looking at the stock market. The bond market, however, is a different story.
Tariffs will clearly add to inflationary pressures. But, even before the “trade wars are good, and easy to win” gaffe, the Fed and a bevy of inflationary economic reports had been working the short end higher.
As we’ve maintained [see: Inflation…Goalseeking] stock valuations aren’t adverse to rising inflation. It was only those rises above the Fed’s official 2% target which produced downturns between 2009-2017.
And, even though the 10s2s spread has generated plenty of trepidation, it was rapid spikes in the spread — not the inversions themselves — which did the most damage.
The Fed has little to fear from inversions except, as is the case with QE, the difficulty in walking them back without popping the equity bubble they’ve blown. The general perception is that inversions usher in recessions, but surely the Eccles brain trust has a solution to that pesky problem.
No, the issue the Fed is grappling with these days is how to get the rest of us to believe that higher inflation and higher interest rates don’t really matter. A scant 7 years ago, when the Debt Ceiling Crisis of 2011 and US downgrade were the news of the day, the S&P 500 plunged over 22%. Total interest expense on the $14.8 trillion in government debt was $454 billion.
Interest expense this year will total about $520 billion on $22 trillion in debt. The doubling in short-term and floating rate debt funding and the sharp decrease in rates on long bonds (averaged 5.8% in Sep 2011) has allowed interest expense to increase only 15% while the amount of debt grew 46%.
But, any way you slice it, $520 billion in interest expense is a tough pill to swallow — especially when we’re running a $1 trillion deficit. Japan, here we come.
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