With two little girls, and two full-time jobs, my wife and I run so many errands on the weekends it sometimes runs us ragged.
We do weekly grocery trips for the family. We take our three-and-a-half-year-old to her swimming lessons.
Pretty soon, we’re even going to have to start taking our seven-month-old for haircuts … her lessons … and gosh knows what else.
This Memorial Day weekend, like usual, I grabbed the keys and headed for the driver’s seat. But it’s not because I think my wife’s a bad driver. It’s something more subtle, maybe subconscious — I like being in control of my own destiny.
What does all this have to do with who’s driving interest rates?
Simple: When it comes to interest rates — the most important single factor that could make or break our economy — we are no longer in the driver’s seat!
We’re asleep at the wheel. Worse, we’re not even behind the wheel. It’s foreign investors and central banks who are in the driver’s seat of our financial destiny.
More on that in a minute. Meanwhile …
The Fed Has Just Lobbed a Hand Grenade
Into America’s Bond Trading Rooms
I’m talking about the meeting minutes from the Fed’s May 10 gathering.
These records come out three weeks after every policy meeting. And until recently, they’ve been full of happy talk about how “well contained” inflation is, how housing will have a nice, “soft landing,” how all is hunky-dory. There have even been hints of a rate-hiking pause.
But not this time! The minutes were chock full of aggressive inflation warnings. Four of my favorite excerpts:
“During the twelve months ending in March, overall inflation rose at a slightly faster pace than that in the preceding twelve-month period.”
“Meeting participants expressed some concern about recent price developments and their implications for inflation prospects. Core consumer inflation lately had been a little higher than expected.”
“The recent decline in the dollar was another factor that could add to inflation pressures.”
“On balance, participants judged that inflation expectations had risen somewhat — a development that would have to be taken into account in policymaking and warranted close monitoring.”
But that’s not all. The Fed actually discussed a half-point rate hike. This is the first time in years that there’s been such talk!
The Fed has been asleep for so long that I’m skeptical it will actually follow through and do what it should. But I sure hope I’m wrong. At this point, the markets could use some direction from the backseat. Especially because …
The Road Ahead Is So Rocky
We’ve mortgaged ourselves to central banks and private investment firms in Beijing, Tokyo, Singapore, Frankfurt, London, and the Middle East. We’ve sold the soul of our economy. We’ve made a devilish pact.
Just look at the percentage of our Treasuries that are held by international investors. In the past two decades, it surged from just 16% to 52% at the end of 2005. And it’s even HIGHER now — around 55%!
I’m not xenophobic. It’s a free global market. Anyone can buy and can sell our bonds. But having a massive foreign investor base makes us incredibly vulnerable as a nation.
When most of our debt was parked in U.S. pension funds, mutual funds, and bank vaults, it wasn’t as critical if the dollar declined or rose in value.
But these days, the landscape is completely different: Domestic investors have lost real money on 30-year bonds lately — about 5% so far this year. That’s bad enough.
But foreign investors have been losing even more:
- Investors in Japan have lost almost twice as much as their U.S. counterparts.
- Meanwhile, Europeans are down more than 12%.
- In England, they’ve lost almost 13%.
Why are foreign bond holders getting hit harder than domestic investors? Because foreigners need to convert their currencies into dollars to buy U.S. bonds. It’s just the opposite when they sell — they have to convert those dollars back into their own currencies. If the dollar drops while they’re holding the bonds, they’ll get fewer yen, euros, or pounds back in the end.
We’ve already heard several countries grumble about their losses. In the past, Russia, South Korea and Japan have all periodically said that maybe it’s time to diversify out of U.S. Treasuries.
That was just talk. Now, though, hard numbers are confirming that they’re actually taking action:
- Japanese Treasury holdings have slumped by several billion dollars over the past few months.
- China still has about 60% of its $875 billion in foreign reserves socked away in U.S. Treasuries. But a key Chinese economist, Zhang Shuguang, recently said dollar assets are “too high.” Bureaucrat-ese for “Dump U.S. bonds?” Maybe.
- And overall, foreign purchases of U.S. Treasury debt totaled $3.1 billion in March. That’s down dramatically from the 2004 peak, which was just over $50 billion! It’s also the lowest level of buying in three years.
Are foreign bond investors going to just dump everything tomorrow? Not likely. But you can see why I believe there’s a real long-term threat here.
Strangely, Washington politicians are more worried about China’s growing military might. What they’re ignoring is: China’s growing power to wage economic warfare.
And even if we never get into a shooting match with our overseas creditors, we can’t continue giving them a raw deal without some consequences.
Foreign investors won’t stand for a namby-pamby Fed … they won’t sit by and watch as we let the dollar plumb new depths … they’ll buy fewer new bonds … and sell more of their existing ones.
In the short term, a number of bumps in the road can move interest rates — economic data, Fed comments, or action in the stock market. But over the longer term, I think our biggest concern is not the road. It’s who’s behind the wheel.
Bottom line: We’ve seen an awful lot of turmoil in the interest rate markets lately. And we could see one heck of a crack-up if the bond market sell-off accelerates.
I’ll be keeping my eyes peeled for more signs along the way, and you’ll be the first to know when I see something.
Until next time,
Mike
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MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.
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