The US 10-year Treasury bond is the benchmark for global interest rates and stock markets.  And for the past 30 years it has been heading steadily downwards as the chart shows:

  • US inflation rates finally peaked at 13.6% in 1980 (having been just 1.3% in 1960) as the BabyBoomers began to move en masse into the Wealth Creator 25 – 54 age group
  • Instead of simply boosting demand, as during the 1960s-1970s, they began to work and create new supply
  • This meant supply/demand began to rebalance and interest rates then peaked at 16% in 1981

By 1983, the average Western Boomer (born between 1946-1970) had arrived in the Wealth Creator cohort, which dominates consumer spending, and the economy really began to hum.  There was a final inflation scare in 1984, when US inflation suddenly jumped from 3% to 5%, but after that the trend was downwards all the way.

The Boomers were the largest and wealthiest generation that the world had ever seen.  Their move to become Wealth Creators completely transformed the inflation outlook, as more and more Boomers joined the workforce.  And they transformed the economy by moving it into the NICE era of Non-Inflationary Constant Expansion.

Central bankers took credit for this move, claiming it was due to monetary policy.  But in reality, people are the key element in an economy, not monetary policy.  You can’t have an economy without people.  And sadly, the idea that the US Fed Chairman Alan Greenspan had somehow become a Maestro, blinded everyone to 2 key issues for the future:

  • Life expectancy was rising rapidly, meaning that the Boomers would not normally die just after retirement.  Instead, they would likely live for another 15 – 20 years after reaching age 65
  • From 1970, fertility rates had fallen below replacement level (2.1 babies/woman) across the Western world

This combination of a rise in life expectancy and a collapse in fertility rates was creating a timebomb for the economy.

THE RISE IN LIFE EXPECTANCY AND COLLAPSE OF FERTILITY RATES CREATED AN ECONOMIC TIMEBOMB

Western economies are based on consumer spending.  And spending declines once people reach the age of 55 – they already own most of what they need, and their incomes decline as they approach retirement, as the second chart shows:

  • There were 65m US Wealth Creator households in 2000, who spent an average of $62k ($2017)
  • There were only 36m in the 55+ cohort, who spent just $45k each
  • In 2017, there were 66m Wealth Creators (almost the same as in 2000) who spent $64k each
  • But there were now 56m in the 55+ cohort, who spent just $51k each

The rise in 55+ spending was also only temporary, as large numbers of Boomers have just reached 55+ and have not yet retired.  Spending by those aged 74+ was down by nearly 50% versus the peak spending 45-54 age group.

BELIEF IN MONETARISM LED TO THE DOTCOM AND SUBPRIME DISASTERS 
The dot-com crash in 2000 should have been a wake-up call for the failure of monetarism.  It also, after all, marked the moment when the oldest Boomers began to join the 55+ cohort.  But instead, policymakers thought monetarism could solve “the problem” and cut interest rates to boost the housing market – causing the subprime crash in 2008.

One might have thought – as we wrote in Boom, Gloom and the New Normal in 2011 – that this disaster would have destroyed the monetarism myth.  But no.  Abandoning monetarism would have led to a difficult conversation with voters about the need for everyone to retrain in their 50s, and prepare to take on new, and less physically demanding, roles.

Instead, policymakers tried to replace lost BabyBoomer demand by printing vast amounts of free money via the Quantitative Easing and Zero Interest Rate Policies.  Their aim was to avoid deflation, as inflation had fallen to just 0.6% in 2010 – although why this was a “bad thing” was never explained.  But in reality, they were running uphill, and the pace of the climb was becoming more vertical, as the average Western Boomer joined the 55+ cohort in 2013.

Of course, flooding the market with cheap money boosted asset prices, as they intended.  Stock markets and house prices soared for a second time. But it also created a major new risk.  More and more investors began to panic as they hunted through the markets, trying to obtain a decent “return on capital”.  They assumed central banks would never let markets fall, and so gave up worrying about the risk of making a dud investment.

INTEREST RATES ARE NOW HEADED HIGHER AS PEOPLE WORRY ABOUT RETURN OF CAPITAL
The end of the Bitcoin bubble has highlighted the fact that that risk and reward are normally related.  Most investments that offer potentially high rewards are also high risk – a lot has to go right, for them to make the possible return.  This process of price discovery – the balance of risk and reward – is the key role of markets.

Left to themselves, markets will price risk properly.  But they have been swamped for the past decade by central bank liquidity and their crucial role has been temporarily destroyed.  Now, the fact that the US 10-year bond has broken out of its 30-year downtrend tells us that markets they are finally starting to regain their role.

How high will interest rates now go?  We cannot yet know, and we can also be sure they will not move in a straight line as central banks will continue to intervene.  But as more and more investments, like Bitcoin, prove to be duds, so more and more investors will start to worry about return of capital when they invest.

4% therefore looks like the next level for rates, as we are now trading within the blue bars on the chart.  It may not take very long for this level to be reached, given the fact that the world now has a record $233tn of debt – 3x the size of the global economy.  After that, we shall have to wait and see.

 

FORECAST MONITORING
I strongly believe that forecasts should be monitored, which is why I always review the previous Annual Budget forecast before issuing the next Outlook, and always publish the complete list of Annual Budget Outlooks.

I now plan to begin monitoring my blog forecasts, using the percentage mechanism highlighted in Philip Tetlock’s masterly “Superforecasting” book.  The first forecasts relate to last week’s post on US polyethylene exports and today’s forecast for the US 10-year Treasury bond.  I will change confidence levels as and when circumstances change.

 

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