Greenspan Predicts Bond Yields Rising As High As 5%
While the world has learned to take Alan Greenspan’s forecasts with a grain of salt, earlier today the former Fed chairman was on Bloomberg TV with another bombastic prediction, warning of a substantial surge in US long-term interest rates should “inflation take hold.”
In the interview, Greenspan said that “if the early stages of inflation, which are now developing, would take hold, you could get — fairly soon — a fairly major shift away from these extraordinarily low yields on 10-year notes, for example,” Greenspan said in an interview on Bloomberg Television on Monday. “I think up in the area of 3 to 4, or 5 percent, eventually. That’s what it’s been historically.”
Greenspan emphasized his often-repeated point that such low rates are unsustainable in the longer run, and said that he sees nascent inflation as the possible end to the bond bull market. “We’re moving into the very early stages of inflation acceleration,” Greenspan said. “That could be the trigger.”
To be sure, Greenspan admits that such a substantial rate move will not happen without substantial side-effects, and he warned that challenges lie ahead as longer-term rates adjust upward toward a more historically normal level: “It’s a problem, as in going from where we are now to 4 or 5 percent,” he said. “There’s a whole structure of adjustments which have taken place, basically since 2008, which have to be unwound, and that’s not going to be done without a problem.”
The biggest problem, as Greenspan explained in another interview in July, is that surging inflation – on both the short and long end of the curve – would almost certainly lead to stagflation:
Three fourths of the major economies, OEC economies for example, have, over the last five years, have had a less than a one percent annual rate of upward growth. The economy can’t go anywhere under those conditions, and we’re getting a state of stagnation which is not only evident in the United States but pretty much throughout Europe and the far east. And as a consequence of that, it’s very difficult to see where the next step is except what I’m concerned about mostly, is stag-flation, meaning I think we’re seeing the very early signs of inflation beginning finally to pick up as the issue of deflation fades.
Since stagflation is traditionally a concurent indicator of recession, Greenspan was then quizzed if he expects a US recession in the next 12-24 months, to which he refused to provide a clear answer:
It’s very difficult to say. In fact, I don’t think you can describe the world economies in terms of the old conventional issue of inflation, recession, and the like. What we are dealing with is a population that is aging very rapidly, and that is inducing a major increase in so-called social benefits, what we in the United States call entitlements. And that is dominating the whole financial system, and until we come to understand that we have got to slow this rate of growth, which in the United States has been 9% per year since 1965, we are now down to the point where it’s taken so much savings out of the economy that we’re not getting enough investment, but that has very little to do with whether we’re going in a recession or not. I think we’re just in a stagnation state.
While Greenspan may well be right in his assessment, one area where we clearly disagree is his take on rising wages, which is also a prevalent sentiment among the investing community. Back in July Greenspans said that “we’re beginning to get a pickup in wages beyond the rate of growth of productivity, and that is usually the best indicator.”
Actually that is incorrect: as we showed on Friday, the one place were wages are rising, and are doing so at a record pace, is in pay for managerial, supervisory workers, those who are already highly-paid, and where the marginal change in wages does not result in a substantial impact on the economy.
At the same time, wages of non-supervisory, production workers have been largely unchanged over the past two years, and when adjusted for core inflation, have barely experienced any growth.
And then there is the question of just how a 5% interest rate across total US debt would be internalized: as the following chart from Bridgewater shows, a 5% rate across the hundreds of trillions in total US obligations would lead to nothing short of a massive shock to the sytem.
In any event, a modest move may have started already, with 10Y yields rising today to 1.82%, back to a five-month high after the Federal Bureau of Investigation reaffirmed that Democratic candidate Hillary Clinton didn’t commit a crime in handling her e-mails as secretary of state, a move of such a magnitude would involve trillions in mark-to-market losses as both Ray Dalio and Goldman warned recently.
In the interview Greenspan also said that he would like to repeal the Dodd-Frank Act, the post-crisis financial regulation measure that he said is reducing liquidity in the financial system, and replace it with a large equity-to-asset ratio requirement for financial intermediaries, according to Bloomberg. “I would very much like to go back to square one, repeal Dodd-Frank,” Greenspan said, adding that he’s “thinking of 20 to 30 percent capital requirements.”