Boom Times Ahead? Not Sure I Believe It. But That’s a Simple(st) Economic Explanation for Current Yield Numbers.

So we have strong GDP growth, rising real rates, and falling inflation.  What is the SIMPLEST explanation for that?

High real rates = “strong expected demand for financing” = “strong expected economic growth (driving demand for capital, labor, etc…).”  I’m not quite sure I believe this myself, but that is the Occams Razor answer.

GDP and Inflation

The Atlanta Fed’s “GDPNow” forecast for the quarter ended September 30 is still at 5.4%.  The “Blue Chip” consensus forecasts are at 3.4% and have been rising towards the (eerily stable) Atlanta Fed’s forecast.  This far into October, the Atlanta Fed is usually pretty on track…

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2023 is 5.4 percent on October 18, unchanged from October 17 after rounding.

This comes as the 10 year bond’s interest rate is zooming up to 5%.  Thats reflect higher Real rates, not higher inflation.   Inflation expectations are fading and actual inflation is trending down to the 2%-3% range the Fed was targeting pre-COVID (ignoring of the lagging “shelter” series with accounts for 40% of CPI).

But What About the Deficit!!! [clutching pearls and fanning self furiously]

What about the counter argument?  “THE FEDERAL DEFICIT IS DRIVING UP RATES!!!!!!!  WE MUST CUT SPENDING!!!

The economics suggest otherwise.  If federal borrowing were truly expected crowding out private sector borrowing, that would drive real rate DOWN and expected inflation UP.

  • …expectations for future real economic growth would fall AND…
  • …expectations for future inflation would go UP (as deficit spending by a reserve currency issuer will show up via inflation not a debt default…)

Federal borrowing is part of the picture, but the moving part in the rates equation is more likely to be expectations for private sector borrowing.  Strong private sector demand for capital would push up real rates with minimal effect on inflation expectations. 

We have real rates going up and expected inflation going down = private sector demand. 

If your macro diet is currently filled with doom-laden warnings about the deficit, you are consuming politics not economics.

This logic above is a great quality test for the rigor, motives and honesty of your favored economic commentator(s).  Are they working from the facts?  Or are they pushing an agenda?

The deficit narrative is mostly politics dressed up to sound like economics.  Very few people selling the “deficit” story are actually serious about the deficit.

  • the real (political) agenda here is “lets cut spending!
  • “spending cuts” is also a fantasy.  It is a political fig-leaf over the real agenda
  • I want more tax cuts => further increasing the deficit.

Everyone is entitled to their personal agenda and politics.  But lets not pretend there is serious economics behind it.  Moreover, you should never invest based on your politics.  Its like betting on your favorite sports team vs “the team that is actually going to win this game.”

Although the your typical investor tends to lean right.  So investing in right-leaning political agendas can work over the short-to-medium term.  As Keynes said, the market can stay wrong for longer than you can stay solvent…

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