Exactly how the US recession of 2019-2020 will be caused

There will be a recession in 2019-2020. The landscape is easy to follow and understand.

First, everyone needs to remember the worst stock market performance in the month of December occurred in 2018. The reason for the December collapse has all to do with interest rates. The easiest interest rate to peg the recession trajectory is to the 30 year bond yield. Between November-December, the 30 year bond yield hit 3.50%. The 30 year bond at 3.50% is what everyone needs to keep their eye on. The 30 year bond yield at 3.50% is the figure that billion dollar hedge fund manager Jeff Gundlach “king of bonds” believes is the watermark. The US economy simply has to much debt to handle a 3.50% interest rate on the debt.

Reasons for the 30 year bond yield hitting the 3.50% was due to the FED raising the FED funds rate and the process of quantitative easing.

The FED has two tools that manipulate interest rates. The most historically common is simply raising and lowering the FED funds rate. The second is the balance sheet tool. The balance sheet tool is also known as quantitative easing when the FED is growing their balance sheet and quantitative tightening when shrinking their balance sheet. This tool was introduced to handle the great recession in 2009. Quantitative easing is used to boost asset classes by introducing capital. However, introducing QE to the market is worrisome because it can erode our currency in an inflationary manor. Hence the reason the FED is going through a QT phase to protect the US dollar’s value.

In December we saw the 30 year bond touch 3.50% due to the FED raising the FED fund’s rate and due to QT. Since December the FED has stopped raising the FED fund’s rate and has stated they are prepared to stop the process of QT because manipulating the FED fund’s rate is no longer a strong enough tool to control long term interest rates like the 30 year bond.

Originally the FED stated we were going to go through QT on an autopilot method of $50B per month in order to shrink the balance sheet and protect our currency. They have since done a 180 degree turn and are ready to quit QT if warranted.

So what will ultimately lead the FED to stopping QT and perhaps entering QE once more? That answer will be faced in September 2019. In Sept. 2019 the government’s fiscal calendar begins. The US government will have to face the challenge of raising at a minimum $1.2T in government bonds to finance our government deficits. Meanwhile we are still in a phase of QT at the tune of $600B per year. The combination of trying to sell record amounts of debt at US bond auctions at almost historically low interest rates to the bond purchaser’s won’t provide enough return for the risk bond purchaser’s will have to take on. Thusly, low bond purchasing action at bond auctions means the  bond’s will have to offer a more attractive interest rate. This action will increase the 30 year bond yield above 3.50%. This level again will strangle the US economy because of our high debt levels.

How will the FED react? They will react with the second tool-the balance sheet. The FED will have no choice but to stop QT and enter into another round of QE to artificially suppress interest rates. QE brings more US dollars into the market place ultimately eroding the US dollar  because of the law of supply and demand. This then becomes an inflationary issue that will show its ugly head in 2019-2020.

The only unanswered question that I still have is- When we re-enter QE will this scare the world from buying US bonds forcing the FED to purchase even more through QE? How much in US bonds will the FED have to to purchase through QE to keep the 30 year bond beneath 3.50. Eventually all of this will have to be answered.

Advertisements

Leave a Reply

Your email address will not be published. Required fields are marked *