In his interview with the Hollywood Reporter's Michael Wolff, Donald Trump's chief strategist, Steve Bannon made one particularly notable statement. When discussing his vision for the economy, he answered with the following explanation of how he views the interplay of monetary and fiscal policy under president Trump:
“Like [Andrew] Jackson’s populism, we’re going to build an entirely new political movement,” he says. “It’s everything related to jobs. The conservatives are going to go crazy. I’m the guy pushing a trillion-dollar infrastructure plan. With negative interest rates throughout the world, it’s the greatest opportunity to rebuild everything. Ship yards, iron works, get them all jacked up. We’re just going to throw it up against the wall and see if it sticks. It will be as exciting as the 1930s, greater than the Reagan revolution — conservatives, plus populists, in an economic nationalist movement.”
There is just one problem with Bannon's comprehensive vision to inject $1 trillion in the economy: absent a central bank backstop to soak up the soaring deficits, rates will explode uncontrollably as the furious bond vigilantes - awoken after nearly a decade of being frozen in carbonite - return and wreak havoc after years of impotent inactivity, sending yields soaring, in the process making any fiscal stimulus plan impossible, while the economy tumbles into a stagflationary recession.
Which brings us to the latest note by SocGen's Albert Edwards, in which he rhetorically asks if "a continued US Treasury bond rout will mean Trump is in for a big surprise?"
Needless to say, Edwards thinks the answer is yes. Here's why.
Was it really only one month ago that I reviewed our secular bullish call on long-term government bonds? A sell-off that was already underway since July has turned into a rout since Donald Trump’s election. Most commentators now believe the 35 year secular downtrend in bond yields is over and that US yields will rise further, causing havoc in financial markets. This is already apparent with the dollar’s surge and resultant weakness in emerging market currencies, most particularly the renminbi. At some point very soon the bond sell-off will even adversely impact equity markets!
Indeed, and as we noted earlier today, the tipping point may have already arrived. While we wait for confirmation, this is what Edwards thinks will happen next:
In the very near term a fragile, highly indebted US economy will suffer a traditional end of cycle acceleration in consumer prices, and more importantly wages, which the Fed simply cannot ignore. I think it is entirely plausible that bond vigilantes could force them into two rate hikes in the first half of next year, with more being quickly discounted. Even if the Fed refuses to tighten, monetary conditions will tighten dramatically anyway as bond yields and the dollar surge, exacerbating the profits recession. This very long economic recovery will then suffer a very traditional death.
This is oddly reminiscent of a very similar and just as skeptical note from Goldman Sachs released previously, and which predicted that any variation of Trump's policies will lead to a global slowdown, and eventually recession, no matter how generous the stimulus. Perhaps Trump's administration is merely a carefully planted pretext by the Fed to unleash the next - and final - step of QE and/or helicopter money. Because Bannon's plan of injecting a $1 trillion fiscal stimulus will certainly not work without the Fed's blessing, especially at a time when foreign central banks have been forced to sell a record amount of debt as we highlighted earlier this week.
So how does it all end according to SocGen? Badly.
Over the next 12 months little will happen on the fiscal side in the US as any stimulus is slated for 2018/19. Meanwhile in the near term the oil price will drive a pick-up in headline US CPI inflation into the 2½-3% range, forcing wage inflation decisively higher. Bond vigilantes could easily decide the Fed is way behind the tightening curve and the current bond rout could then extend all the way to the long-term trend line.
A move in US 10y yields to 3¼% is entirely plausible and would still not negate the long-term bullish trend. Indeed in the next recession I still expect 10y yields to ultimately fall to minus 1% as helicopter money is adopted to finance Trump’s double-digit fiscal deficits.
Of course, the real purpose of this exercise has little to do with the economy or interest rates, and everything to do with the Fed's one and only mandate: making sure artificially propped up stock markets never have a chance of fair price discovery, somewhere around 60-70% lower, because if the biggest bond bubble in history is about to burst, that would mean a complete wipe out of equities as well. And that is never allowed to happen.