Lacy Hunt: Bond Bull Market Will Endure As Debt Strangles Economic Growth

Despite the 10-year yield’s reluctance to hold above 3%, bond bears have been reluctant to throw in the towel completely, with Bill Gross recently changing his view to allow for a "hibernating" bear market in 2018 (he expects the 10-year with fluctuate between 2.80% and 3.25% for the remainder of the year). DoubleLine's Jeffrey Gundlach has also backed away from his bearish outlook, recently declaring that the 10-year will remain "contained" if 3.22% isn’t broken by the 30-year.

Meanwhile, Hoisington Investment Management’s Dr. Lacy Hunt has been one of the few unabashed Treasury bulls operating in the market, refusing to cut back on duration as his peers warned that all hell would break loose as soon as the 10-year closed above 3%.

Of course, the aforementioned chaos hasn’t materialized, and Hunt’s view has been proven correct again and again. At the root of Hunt's position is a bearish outlook for the US the economy as it begins to buckle under the weight of rapidly rising indebtedness and demographic headwinds like falling population growth.

While short-term fluctuations in interest rates are difficult to predict, Hunt points to the work of Milton Friedman, which shows that reductions in monetary stimulus lead to lower long-term interest rates as growth and inflation fall.

What Friedman had in mind is that, when the Fed engages in a tightening of monetary policy – what he called a liquidity effect – this tends to raise the short-term rates, but it begins to restrict the flow of money and credit. If this liquidity effect is repeated several times, it will eventually produce a countervailing income effect in which the rate of increase in interest will be slowed as the economy begins to moderate its rate of expansion.

And if the monetary deceleration extends for a protracted period of time, ultimately the inflation rate will fall. Hence Friedman’s conclusion: Monetary decelerations ultimately lead to lower interest rates, not to higher interest rates.

The problem with increasing debt, Hunt explains, is that it leads to diminishing returns. In the beginning, debt can be a boon to growth, but as the debt burden expands, and a rising share of national income is dedicated to servicing it, the benefits quickly begin to diminish. Economic activity begins to weaken, causing growth to slow, inflation to recede, and long-term interest rates to fall.

And so, while massive increases in debt can lead to a transitory boost in economic activity, this effect is relatively short-lived. And, ultimately, higher debt undermines economic growth. So over the longer term, extreme indebtedness leads to weaker economic activity, which, of course, is consistent with lower inflation and lower long-term bond yields.

Hoisington is a strict duration manager. Despite Hunt’s bullish view, the fund isn’t presently positioned for maximum duration, though Hunt says they’re already in excess of 20 years. However, his view has its limits. If the fund wanted to, it could go out and buy all the no-coupon 30-year government paper in the market. But it hasn’t, because, as Hunt explained earlier, secular trends often take years to unfold.

The problem with the US economy is that forgiving debt, as some on the far left have suggested, would destabilize the financial system. Meanwhile, allowing the Federal Reserve to print money without restrictions - an attempt to inflate away the debt (as well as the hard-earned savings of middle-class Americans) -  would stoke inflation, but do little to benefit growth, making life harder for most people.

Well, there are people who have called for a so-called debt jubilee. The problem is that you bankrupt your financial institutions because they hold so much of it. There’s really no way to write it off. That’s the bottom line. There is no way to do a reset. You could go down the false road of changing the Federal Reserve Act allowing the Federal Reserve to print money. But the only way money printing works is if you increase the use of debt capital, which further triggers the law of diminishing returns. You will get a side effect of inflation, but you won’t boost real growth. And so, in essence, you’re just going to make people more miserable than they already are.

The only tenable solution to the debt problem, in Hunt’s view, would be a prolonged period of "living within our means." Of course, austerity measures have helped mitigate debt crises in the European Union. But after so many years of deficit spending, it’s unlikely that the US would accept it.

In search of an answer, Hunt looked back on similar periods in US history: The US government took on a massive amount of debt in the 1820s and 1830s while building the railways and canals. Back then, it was the California Gold Rush that helped the US economy dig itself out of debt by bolstering growth to such a dramatic degree.

And today, the federal government is busy slashing revenues - as the Trump tax cuts did - while also increasing spending on the military and infrastructure. While these measures might bolster growth in the short term, over the coming years the growing debt burden will strangle the US economy, Hunt says.

And unless the US economy is lucky enough to experience another "gold rush," it will likely continue to struggle with this intractable debt problem - that is, until something breaks.

Listen to the full interview below:

Comments

TheBigCluB Mon, 05/28/2018 - 17:15 Permalink

living with in our means?? we tried that in 2007..

and those in the big club went squealing like the pigs they are to the money changers and got bailed out in the tune of trillions.. 

so this concept has been tried and failed..

next?

InnVestuhrr revolla Mon, 05/28/2018 - 22:36 Permalink

We are wise to all of you goat-fucking sub-human vermin worshipers of the vile islamic cult peddling the anti-Israel & anti-Jew propaganda.

It is understandable how inferior you feel after having been beaten repeatedly, in spite of outnumbering the Israelis many fold, humiliated and exposed for the inferior defective sub-human primitives that you are.

In reply to by revolla

Bam_Man MK13 Mon, 05/28/2018 - 18:11 Permalink

Well, since banks are passing along ZERO in the way of higher rates to their depositors, that is exactly where we are at right now. If you want to earn interest on your IRA (and not risk principal in the stock market), there is nowhere else to go other than US Treasuries.

In reply to by MK13

Bam_Man Mon, 05/28/2018 - 17:23 Permalink

Of course Lacy Hunt is right. This tightening cycle will be FAR more abbreviated than Gundlach or Gross think.

Something even Dr. Hunt fails to mention is that this tightening cycle is historically unique, in that banks are passing exactly NONE of the higher rates along to their depositors. This has NEVER been the case in the past. It is ALL 100% of it being sucked out of the economy in the form of higher lending rates, without ONE CENT of offset on the deposit side.

Bam_Man Pernicious Gol… Mon, 05/28/2018 - 17:36 Permalink

Yes, that's correct.

With over $2 trillion in excess reserves sitting at the Fed, the banks don't need your deposits and won't pay you ANYTHING for them. Say thank you to Ben Shalom "The Courage to Act" Bernanke.

My point is that in prior tightening cycles, at least the increase in interest paid on deposits slightly offset the higher rates being charged for loans, thus allowing the tightening cycle to have a longer life. Not so this time.

In reply to by Pernicious Gol…

GreatUncle Bam_Man Mon, 05/28/2018 - 21:23 Permalink

It was always on the cards "contract time" + 10 years to be safe = 2018 was the start.

The size is far greater than any imagine because we are talking total global GDP numbers not pifling single nation values. Imagine a nation defaulting bad enough ... now consider the one and only total global default.

Never happened before as far as I know except maybe the "known world under the Romans was a global economy".

In reply to by Bam_Man

Son of Captain Nemo Mon, 05/28/2018 - 17:28 Permalink

I don't know who the fuck "Lacy Hunt" is... But living within our means was so 2010 nearly 2 years after the taxpayer bailed out the most insolvent banks over the solvent ones to create a magnitude of debt that can never be paid back to it's creditors!

Ergo Lacy... You ain't given em the skinny of just how bad Venezuela looks right now on steroids or destroyed through a nuclear holocaust that more then likely WILL BE U.S. when the American people realize we're on our 6th "default" in 10 years and the welfare, pension, social security magic won't be comin NO MORE... NO MORE!...

hotrod Mon, 05/28/2018 - 17:30 Permalink

I think it is toooooo late for, in our means.  Too many promises already made.  it truly is inflate or die.

Without the constant increases of price, due to money growth, debt would implode as there would be no way to pay it back.

USA cant even balance the budget as debt requires so much service.  Trillion dollar deficits for now on.

I work with a number of federal and state workers in their 50s that are receiving their retirement pensions and also work. One of the guys was a flight attendant on air force one for 3 presidents.  Retired at 50.  Amazing all the benefits the people get.   I am just a private sector flunky trying to get to social security.  My point is ALOT of promises already made.

Let me Add this.  All 8 of the retired federal, state, and county people I work with that are in their 50s will more than likely receive their very high retirement benefits for longer than they worked at their job.  They only work with me up to 25- 30 hours a week for supplemental income and something to do.  I feel like the dumbass private sector employee waiting until I am 68 for SS.

Let it Go Mon, 05/28/2018 - 18:08 Permalink

If people turn their backs on bonds because they will get paid back with worthless currency at the same time they cannot get reasonable returns on physical or normal financial investments they could place their assets in short-term cash bank accounts, high-risk stocks, or hoard it. This could result in a lack of investment capital and the formation of a "liquidity trap" where central banks have difficulty stimulating the economy.

While a liquidity trap can and often does lead to no growth and deflation it is not a certainty. The wild card, in my opinion, is related to the diminished confidence so many people have towards fiat currency. The fear money was about to become worthless which is explained in the article below could unleash inflation across the globe.

 http://Liquidity Trap's Wild Potential To Unleash Inflation.html

m111ark Mon, 05/28/2018 - 19:07 Permalink

There is no other explanation for DR hunt who spouts the same old deep state meme, it's all our fault for borrowing so much money. Stating not the obvious that the governments response when their special programs (cash for clunkers and first time home buyers tax credit) in which consumers failed to "borrow" (go into debt) enough money into existence to restart the economy. So what was the governments response... QE, in other words, print enough "money".  STRIKE THAT It would have been better if the treasury simply printed the money and spent it, at least they would not have increased the  public debt. But NO!!! instead they printed bonds, which the banks bought with FED created "money" then the FED took those bonds off their hands. So not only more debt was created but more interest as well.

What a system.

The only logical thing to do -- the FED simply "loses" those bonds. No debt! No interest! Just money in the hands of consumers.

 

Econogeek Mon, 05/28/2018 - 19:39 Permalink

What this summary doesn't say is that the kiss of financial death is an inverted yield curve. 

QT operates at the front end -- lots of quick bang for the buck -- and the only place to confirm the slowdown and to express fear is to buy the long end, and gold.

Reserve currency, cleanest dirty shirt -- in my view a rising dollar will just add to the Fed's problems by speeding the slowdown.  Aka, deflation, here and overseas. 

I think the Euro hasn't got a chance against the dollar, not yet, maybe not ever.  Other currencies are way far  into the future.  The one-world types may succeed with their SDRs if the system truly fails.

Pre-system-failure, 10yr back down to the ones, gold and energy will do well.

My view, and almost everything I have is on it.

Roger Ramjet Mon, 05/28/2018 - 19:41 Permalink

The only caveat regarding Friedman's thesis (that bond yields fall once the Fed begins to tighten) is that it probably did not assume that the sovereign would be running trillion $ plus deficits into perpetuality.  If the economy falters, then the deficit will only increase at the same time 70 million baby boomers retire.  Regardless of the economy or Fed policy, a lot of debt will have to be issued at whatever rate the market will demand.  And that could be at a much higher rate than anyone recons.  Just saying.

Betrayed Mon, 05/28/2018 - 21:04 Permalink

The only viable solution is ROPE and LAMPPOST'S.

Then a Jubilee. Then confiscate all the gold and wealth from the Zionists  and their enablers.that stole it.

Put that wealth into the Treasury and issue gold backed Dollars.

Problem solved and Justice is served.