July 1, 2010 – What is the Bond Market Really Telling Us?

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2) What is the Bond Market Really Telling Us? Everywhere I turn these days, I hear a rising clamor and rancor to cut the spending that is creating deficits that will lead to the death of us all and destroy the lives of our grandchildren. CNBC reporter rick Santelli walked off camera maniacally screaming 'stop spending, stop spending,' while commentator Larry Kudlow religiously devotes a full hour to the topic every day. My interest piqued, and to attempt to bring some clarity to readers who must be as befuddled as me, I decided to find out what this borrowing is all about. And what do I find in my mailbox, but the chart below from my friends a Clusterstock. If a picture is worth 1,000 words, then this one is worth 2,000. Out of a current projected budget deficit of $1.3 trillion, $700 billion, or 54% comes from the Bush era tax cuts, $320 billion (25%) from a tax revenue fall off caused by the Great Recession, $200 billion from the wars in Iran and Iraq (15%),  and $50 billion (4%) is generated by Obama's recovery measures. The TARP and the bailout of Fannie Mae and Freddie Mac are so small, they don't even register on the chart. All of the angst, complaining, moaning, blustering, and carping is about the 4%. You often see this in politics, where the debate gets focused on where the problem isn't, not where it is, and is a big reason why I'm not in that business. Markets have a fascinating way of seeing straight though this impenetrable fog. So while the noise out of Washington is trying to convince us that these deficits are ruinous, the ten year Treasury bond yields we saw yesterday at a stunning 2.97% are telling us that, in fact, they are no problem at all, and that the government can now borrow nearly infinite amounts of money at the lowest interest rates in history. There are some other really interesting things that this chart and the bond market are telling us. The Bush tax cuts expire next year, and a recovering economy will bring a return of tax revenues, eliminating 79% of the deficit. The scheduled withdrawal from Iraq next year will cut another 7%. This assumes that Obama is unable to get a single additional piece of legislation through the congress, a distinct possibility if he loses control of congress in November. This is the writing on the wall the bond market is attempting to focus our blinkered eyes on. If anyone else has another set of believable numbers that reaches a different conclusion, I am all ears. And what happened to Franklin D. Roosevelt's grandchildren, the last president to preside of massive, depression fighting government borrowing? That would be me and my generation, and I think we've done pretty well.

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