Rule-Changing Time

This is important.

I’ve been writing the last few months about how the bond market is attractive, and it keeps getting worse. You probably think I am a fool. Well, you get to a certain age, and you don’t care what people think. I still like bonds, and I doubt I will have to wait much longer.

As you probably know, the Trump administration has an interest in getting yields down. Bessent is monkeying with repurchases to try to accomplish that, but the market is laughing at his efforts. He will have to raise the stakes, or he will have to do… something else. What could that be? Yield curve control (YCC), for starters.

If you’ve been reading me for a while, you know I have been talking about this eventuality since 2008. I predicted that our finances would deteriorate to the point where the Federal Reserve would need to step in and cap interest rates across the curve. Right now, the government is getting a margin call; this is what it looks like. You are seeing it in real time. Not a lot of fun, least of all for Bessent. You can be sure that Bessent picked up the bat phone to call Warsh. 

This is serious business. The bond market is acting so funky that if it actually crashes, the US is functionally insolvent, and we turn into an emerging market country. The US cannot allow that to happen. Of course, in the same breath, Trump is promising to hand out more than $1 trillion in free money. If that’s not nonsense, I don’t know what is.

As you can probably tell, this is unsustainable.

Consequences of YCC

People have been joking for a while that Trump likes to shop at Banana Republic (actually, I think he likes to shop at Nordstrom Rack). This is real banana republic-type stuff, and it’s a minor miracle that neither stocks nor the dollar have crashed here.

Some other consequences of YCC: Gold will go to infinity, and the dollar will go to negative infinity. I would recommend getting some exposure to both. Stocks are a bit more complicated. I think the first move is higher, and the subsequent move is much lower.

I said this was important. It would actually be the most consequential thing to happen to modern finance in 100 years. From a Wall Street standpoint, it would probably put a lot of bond traders (and vol traders) out of business. But the consequences extend far beyond that. The yields on 10-year notes and 30-year bonds are the most important prices in the economy—if you manipulate them, there will be distortions.

Real yields are high right now, but we will be sure to get inflation and negative real yields, and you remember what happened the last time we had those. I am not one of these mouthbreathers that says “hyperinflation” every other word while gripping my mouse with sweaty palms; but yes, hyperinflation becomes a possibility, over time. Crazy stuff.

Unlimited Firepower

My radar is up, but I am probably early on this, as I am on a lot of things, but you can be sure that the authorities will do something. They can’t not. Mortgage rates are now over 7%, and if you let housing go, the economy is going to be in real trouble, which has political implications. If everyone wants to get reelected, then something must be done, and that’s where the incentive structure lies. 

I mean, not to get into politics too much, but Trump has no one to blame but himself. The Trump and Biden administrations have piled on a lot of debt, and that is before any grown-ups try to do anything about entitlements. And if you peg the yield curve, there is no incentive to do anything about that either. There is no incentive to attack the debt at all.

I hope I am wrong. But my experience has shown that when things move too far in one direction, the authorities change the rules. Remember when they banned short selling in the financial crisis? The market went down anyway, in the long run, but they blew up a lot of hedge funds that day. You can’t get too comfortable betting against the government—the US government, anyway. 

Everyone fancies themselves George Soros, that they are going to break the bank, when the reality is that the US government has unlimited firepower. This is a tough position to be in if you are a bond trader. The trend is your friend, but if you’re short, and they do YCC, it’s going to end your career. Don’t doubt Bessent for a second—look at what he did to the yen. Finally punished all the carry monkeys, who were betting that he wouldn’t do it… and he did it.

I will get to my point: Bonds are a compelling value here with or without YCC. Even if rates stay steady from here, you’re earning an enormous coupon. But if Warsh or Bessent act, it could be the trade of a lifetime. And stay long gold.

Poll

Dumbest Thing I Saw This Week

And I have nothing more to say about that.

Jared Dillian, MFA

Postscript: THE AWESOME PORTFOLIO launched last week to great fanfare. It’s selling like ice cream in Pawleys Island in the summer. I suspect there are some people who haven’t bought it yet. This is what I am hearing: People are sitting down and reading it in one sitting, then going out and buying 5–10 more books for friends and family. So don’t miss out, and order it here.