1% is a big number for U.S. Treasury yields. Since March, every time the yield approached that level, it pulled back. That suggests bond investors are willing to buy bonds at a 1% yield. They accept that return only because they believe there’s nothing else to compete with it.

That was true in March, when the stock market was collapsing. Today, the stock market is at new all-time highs. There are a lot of different assets offering better returns than 1%.

Federal Reserve Chairman Jay Powell and Treasury Secretary Steve Mnuchin both testified yesterday that they believe more stimulus is necessary. They both understand small businesses may not make it through winter without support. The pandemic isn’t over yet. Its ability to influence consumer behavior will take time to diminish. At the same time, both Mitch McConnell and Nancy Pelosi are eager to get a stimulus package passed.

Here’s a quote from Mnuchin: “More fiscal response is needed. What’s more important is what we can pass quickly on a bipartisan basis to target the most difficult parts of the economy.”

Additional stimulus would be positive for every risk asset. There will be less need to hide out in the security of the bond market.

Rising yields increase the cost of servicing the debt. That’s bad news for the government.

Debt servicing costs haven’t been a problem over the last year. Interest rates dropped to zero. Treasury yields are close to historic lows. Together, those factors had a big effect. The federal deficit tripled this year, but the cost of servicing the debt declined by more than 10%.

That was a wonderful result, but it works only if bond yields stay low.

Every time the Federal Reserve has adopted quantitative easing (QE, or money-printing), bond yields have risen. That’s because the Fed has tended to buy short-dated bonds with the money it printed. It allowed the longer maturities to sell off. That increased the yield.

The Federal Reserve looks likely to expand QE, but the government cannot afford for Treasury yields to rise. That increases the potential the Fed will attempt to buy both long- and short-dated bonds. That practice is called yield curve control. The last time the Fed tried it was during the Depression. Back then, the Fed froze the return on bonds so it could inflate the debt away.

The U.S. dollar broke downwards yesterday. That’s because foreign investors are fearful about the Fed’s intentions. Stocks are rising for the same reason. Investors need to have a hedge against the declining value of the currency. Stocks generally keep up with inflation, but hard assets like gold tend to do even better. Accordingly, gold rebounded yesterday.

Everyone knows the government cannot afford to pay back the debt. The only way is to inflate it away. The feds have no choice but to reduce the purchasing power of the dollar.

We’ve already seen what popular protest looks like. That was when the government was supplementing incomes. If the feds ever made a substantive move to make the sacrifices necessary to pay down the debt, there would be a depression. That means inflation and yield curve control are inevitable. The only question is when. 

That’s why the 1% level is so important for Treasury yields. If yields rise very much above that level, that will force the Federal Reserve to act. The rebounds in stocks, gold, and bitcoin are pricing in this conclusion already.

All the best,

Eoin Treacy