Short Note 28 February 2017
Buffett:”And then what”?
The immediate future of the 10-yr US Treasury bond, currently yielding 2.3%, is very important for the next US and global act. Will it drop further, hang around present levels or rise decisively through next year? And what would do it?
Warren Buffett was being questioned about this on CNBC yesterday, and his reaction was interesting. The focus was on the Fed, and what it would do next. And here Buffett raised a few interesting issues.
He expects the other major players (Europe and Japan, but the ECB more particularly) to remain supportive, low for long with short-term interest rates, and their growth and capital market dynamics to keep their bond rates low, too (their average just over 1%, call it 1.3%).
With the 10yr US bond yield at 2.3%, the spread (the yield difference with Europe) is about 1%. When you ask where the Fed is going, Buffett suggests you ask after every guess “And then what?” He seems to feel that is exactly what is steering the Fed at present.
US growth may be nicely recuperating, unemployment 4.8% and inflation pressure rising slowly, but if the Fed were to be too singly focused on that, and start raising US rates more quickly, what else would happen?
For one thing, that spread with Europe would widen, making US bonds relatively more attractive, pull in more capital and raise the Dollar. And then what?
From a US growth point of view, and also bearing in mind any destructive aspects of coming trade policy changes, the Fed might not want to harvest a runaway strengthening Dollar. So easy does it?
Does that mean the ECB is riding the Fed bareback rather than domestic factors guiding it? That is too unsubtle. But will the Fed be watching this very carefully? You bet, is the suggestion.
Not mentioned, but focused on by many others trying to understand why the 10yr US bond is stuck around 2.3%, seems to have something to do with market views about Trump and US fiscal policy. Bonds seem to say that this is not going to be a runaway train either. And anyone who thought it would be, and sold on that basis thinking yields would be going higher, have been squeezed badly.
These fiscal perceptions could still change. Trump makes enough noise to suggest as much. But Congressional opposition or a lack of getting programs rolling for now suggest otherwise?
Thus both from the monetary and fiscal side, from the Fed through the full gambit of US politics, there are enough forces on the loose to keep us all very busy. And the US bond yield in suspended animation. And Buffett just as much in the dark as to “why?” as the rest of us (as he is quick to admit, apparently having been unloading US bonds for some time, being a determined bond seller, but not understanding who could possibly be buying, with the outlook being what it is).
The US bond yield might break either way some time, if the balance of forces shifts. The smart money thought it had seen that happen some time ago. But perhaps it hasn't happened yet? As to when it could, and how much, remain tuned...
And then what…?
Bruggemans & Associates, Consulting Economists