Reality Catches up to the Bond Market

Bond yields soared on Friday with the !0-Year U.S. Treasury yield rising 14 bps to 4.6%. Meantime the yield on the 30-Year Treasury hit 5.12%, its highest since 2007. Globally it was the same story, as Japanese yields are at their highest level since 1997 and government disarray in the U.K. is sending yields soaring there.

What’s going on? Three critical factors are coming together: rising inflation, government deficits, and an AI capital spending boom. Triggered by soaring oil prices caused by the Iran War, the U.S. consumer price index (CPI) is now 3.8% over year ago levels, and the producer price index (PPI) is now 6% over the same period a year ago. To be sure, core inflation at the CPI level is lower at 2.8%, but the core PPI is now running at a high 5.2% rate. More concerning is the likelihood that over the near-term, inflation will move higher, not lower. This clearly is not an environment for rate cuts.

Second, huge fiscal deficits are the order of the day. The U.S. continues to run a $2 trillion deficits around 7% of GDP, and with tariff refunds and higher defense spending it will go higher. Although the rest of the G-7 is doing much better, ex-U.S. the G-7 is running a deficit of 2.4% of GDP.

Last, the AI boom in the U.S. is sucking capital in from all over the world. Witness Alphabet’s recent $60 billion global offering. Here are the AI companies that used to supply capital to the rest of the world; they are now massive users of capital. Hence real rates have to increase and in the short run the massive expansion of data centers will put upward pressure on the price of inputs, ranging from memory chips to electrical equipment and construction labor.

 

This is the environment that incoming Fed Chair Kevin Walsh is facing. It is hardly an environment to cut rates. Indeed, with the two-year note now yielding 4.08%, well above the current midpoint of the Federal Funds rate of 3.63%, the market is now pricing in a rate hike. Those who say that Warsh will follow Trump’s orders to cut rates will soon be disabused of that notion. Kevin Warsh does not want to be remembered as the Fed chairman who looked inflation in the eye and blinked.

 

Finally, it is important to recognize that the recent rise rate is taking place in the context of a structural bond bear market. (See: https://shulmaven.blogspot.com/2025/01/we-are-in-early-stages-of-bond-bear.html ) Bond bear markets, just like bond bull markets last a long time. The last bond bear market lasted 35 years, from 1946 – 1981. We are now only in the sixth year of the bond bear market that began in 2020, when the 10-Year U.S. Treasury Bond bottomed at 0.56% in August of that year. So, buckle up, we are still early in a very long cycle.

We are in the Early Stages of a Bond Bear Market

Bond market cycles last a long time. For example there was a bond bull market from 1920-1946 when long term U.S. Treasury yields declined from 6% to 2.3%. Thereafter a 35 year bear market ensued to September 1981 which took the yield on 10-Year U.S. Treasury Bonds to 15.84%. This was followed by a 39 year bull market that ended in August 2020 with the 10-Year U.S. Treasury yield trading at a meager 0.56%. It seems clear to me that with the 10-Year bond closing this week at 4.76%, we have been in a bond bear market for over four years. 

Thus if history is any guide, we are only the the early stages of a bear market that could last another two decades. Of course, as in any bear market, there will be rallies along the way, the the path for yields will be decidedly upward.

The fundamentals underpinning the bear market include monumental budget deficits throughout most of the world's largest economies, unfunded pension plans, a still smoldering inflation, and, at least in the near term, the global electorate's preference for populist politics that is working to deglobalize the world economy.  Further, if you add to the mix the need for enormous expenditures to harden infrastructure for weather events and the costs associated with energy transition, all the forces are in place for higher inflation and higher yields.

As far as the stock market goes, stocks can and have risen in the early stages of a bond bear market. That certainly has happened over the last four years. However, as high interest rates begin to bite, the stock market will no longer have a bond bull market at its back to support a near record price-earnings ratio for the broad market.  

The views outlined here are consistent with an earlier blog in 2022 outlining the prevalence of 13-year cycles. (See: https://shulmaven.blogspot.com/2022/05/the-useconomy-is-entering-new-thirteen.html) Also see my recent short term outlook       (https://shulmaven.blogspot.com/2024/12/2025-revenge-of-bond-vigilantes.html)

My Review* of Neil Howe's "The Fourth Turning is Here: What the Seasons of History......"

 America in an Era of Crisis

I received this book as a gift. 

America is in crisis. Nothing seems to be working with dysfunction everywhere from Congress to the post office, to the airlines, to the housing market, to medical care, to the lack of civility and to extreme weather events. All of this is a symptom of what author Neil Howe calls the onset of the fourth turning. Howe builds on his earlier book written with William Strauss entitled “The Fourth Turning” which appeared in 1997. In that book the authors coined the term “millennial generation.”

 

According to Howe Anglo-American history going back to the War of the Roses follows a predicable 80–100-year Saeculum which is broken up into 20–30-year blocks. For example, the 80-year blocks of 1780-1860-1940-2020 would constitute three turnings. Each crisis era was forewarned by a war. The Revolutionary War crisis was preceded by the French and Indian War, the Civil War crisis by the Mexican War, the Great Depression/World War II crisis by World War I and the current crisis by 9/11 and its aftermath.

 

Thus, according to Howe, we will soon be entering the fourth turning which he estimates to start around 2033. Unfortunately, the fourth turning is usually accompanied by a major war or a civil war. As a result, the recent ugliness is only a precursor of worse things to come. However, once the crisis has passed a new dawn awaits us, as in the end of World War II.

 

Within each 80-year block there are four eras defined by the change in generations. The recent history looks like this in Howe’s terms:

Boom 1943-1960, High.

Gen X 1961-1981, Awakening.

Millennial 1982-06, Unraveling.

Homeland 2007-2033? Crisis

 

Each generation gives rise to a protype character. By Howe’s reckoning there are heroes, artists, nomads, and prophets. It is the heroes that resolve the crisis era that become the leaders of the next high cycle. Think Eisenhower, for example.

 

In Howe’s view the next Saeculum will be characterized by the rise of community over the Individual. The unmet tasks of the prior era will be handled by a far more egalitarian society. Taxes will be higher on the wealthy, but entitlement spending will be under control and government finally figures out to deliver services more efficiently with high investment in climate mitigation and drastic reforms in zoning that would once again make housing affordable. In other words, a very efficient social democracy.

 

I noticed a few errors in the book. The Four Freedoms were a product of World War II not World War I and the Treaty of Detroit was made in 1950, not 1946. Nevertheless, Howe gives us a new interpretation of our history and his insights are extraordinary.

*-Yet again Amazon is late in posting my review. Amazon just posted it at America in an Era of Crisis (amazon.com) Sep 28