The bond dam

The U.S. published its inflation report for the month of April yesterday. Headline CPI was up 3.8% YoY. Core CPI (excluding Energy& food) was up 2.8%. In terms of headline CPI, this is almost 100% more than the Fed target measure. You can see that in the top chart below. But perhaps that was during Powell era. The senate just confirmed a new sheriff at the Fed, Kevin Warsh, which may or may not think the same way. But even the sheriff has a boss, and in this case, the boss is the bond market. Generally, It’s a quiet and soft spoken boss, but when it speaks, the message is clear, and demands action. Take a look at the bottom chart now. The 30 year US treasury yield is playing again with the 5% mark. Last time we were here, it was almost 20 years ago. We were about to go through the Great Financial Crisis, and the longest yield printed 5.4%. The budget deficit in 2007 was $163Bn, or 1.1% of GDP. And CPI was growing around 2.8% and was considered hot. Today our budget deficit is $1.8Tn (10 times more than 2007) and it’s almost 6% of GDP. Our government debt was $9Tn then, vs $40Tn today. Imagine a dam holding more water than it’s supposed to. The pressure on the walls increases as water levels (deficit) keep rising. Difficult to see if we’re close to the breaking point, but we know it’s not far. The question for Mr Warsh and Mr Bessent is: how do you release pressure in this bond market?

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