Lance-O-Pedia Episode 14 - Bond Vigilantes
Lance: Back in 2013, a short 13 years ago, like you were talking about, it was less than 416 billion. It's too high then, but it was 416 billion. So it's more than doubled in 13 years.
Garrett: The older I get, the more I'm fascinated by comparisons like this. I mean, for comparison, I remember early in my career the TARP bailout was 700 billion, I believe. So we're spending more per year in interest than the entire TARP bailout was for the financial crisis in 08. All right, welcome back to Lanceopedia. I'm Garrett Layell with Lance Browning. And, Lance, I was just saying before we got started here between from politics on the last one today we're going to talk about bonds. Are you trying to get rid of your entire YouTube and podcast audience? I can't.
Lance: Pretty. But yeah, here a little bit. Okay.
Garrett: Yeah, I can't. Two more boring topics. Go back-to-back. So, you got your work cut out for you to keep us engaged.
Lance: Yeah. If you can survive this, you can survive anything. Okay. So last time, last visit, we talked about politics, obviously. You know, we're all very passionate about things like, you know, religion, college football, politics. I get that. Okay. In the moral of the story, the theme from Last Last, our last episode, Garrett, was the market doesn't care. Well, Lance, what if? What if the Democrats take this or the Republic Republicans hold this, or this one gets in or this one doesn't get what's gonna happen? We're doomed. The sky's falling. The world's ending. No, the market doesn't care. Okay? And I had a sign last time that I kept holding up saying the market doesn't care. So today we're gonna talk about not the stock market, but the bond market, okay? So try to survive. Try to make it through here and you're gonna see this little picture of rioters outside. It's called the bond vigilantes. Right, Right. And so this was a term that got coined back in, I'm going to say early 80s probably by an economist by the name of Ed Yardini, who's brilliant, who's still on the scene and doing things. And so we have these terms, folks, and for our listeners and viewers, we have these terms in our industry that Garrett and I use. And there's a lot of industry terms. We've got a ton of them. Most of them I cannot repeat on a public podcast. Okay.
The legal department will not let me say most of the things we have, but we do have some phrases here. And Today we're gonna talk about what are called bond vigilantes. Bond vigilantes are large institutional investors who sell government bonds to protest fiscal or monetary policies they believe are reckless, inflationary or unstable. Okay. All three of these, I would think, certainly apply today. And here's how they work, here's kind of what happens. So large institutional investors like pension funds, insurers, hedge funds, sell their government bonds or they refuse to buy new government bonds as these things auction through. Okay. What results in what you're seeing, what you've really seen over the last 7ish months of this year.
You've seen falling bond prices and rising bond yields. And this is kind of analogy I give to people. So bond prices and interest rates are inverse correlated. They move in opposite directions. So I got a fat kid and a skinny kid on a seesaw. One end goes up, one end goes down. So if you see bond prices falling, interest rates or bond yields will go up. And when you see this, heavy selling drives bond prices down, which you've definitely seen the last seven or eight months, and it drives yields up, you've very much seen that. The result of that, though, Gary, is going to be higher borrowing costs. So higher yields force the government to pay more interest when issuing new debt. Okay. Basically, long story short, what happens is these borrowers, so if you're buying a government bond, you are taking an IOU from the government. You’re saying, hey, I'm going to fund your debt. I'm going to be the bank here, I'm going to fund your debt and you're going to pay me back principal and interest. Treasury. U.S. treasury bonds are widely regarded as the safest investment on earth. I don't have a problem with that definition. I don't have a problem saying that. But what you're seeing is these borrowers, particularly these big institutional borrowers, are saying, you know, hey, U.S. government, hey, Washington, D.C. we're not gonna fund your drunken sailor ridiculous spending and debt and borrowing. We're not gonna fund that at 2 or 3%. Yeah. We're gonna need 5% or maybe a little more to fund your champagne taste on the beer budget, so to speak. Okay. And the hope is that the financial pressure can compel lawmakers (I'm talking to you, Congress) or central banks to scale back spending or tighten monetary policy. And you're starting to see a little bit of that reaction from the Federal Reserve. We just had another rate hike from, from Kevin Warsh. So you've seen that. And so bond vigilantes, they're not really an organized group. They're not going to have like membership cards or lanyards or anything. But they don't necessarily coordinate. They act independently, but they're reacting to the same economic risks in the same data. And you saw this real world, you saw this in the early 1990s with a massive sell off in US treasury bonds. And that helped push the Clinton administration to prioritize strict deficit reduction. You actually saw during the Clinton administration, you saw balanced budgets. Who knew we could do that? You saw budget surpluses. Who knew we could do that? Okay, so when I hear these talking heads or these politicians say, oh, no, that's impossible. No, it ain't. They just don't want to do it. And so you saw that in 2022 with British bonds, with UK bonds, you saw that as well during 2022.
So next slide, you're going to see global public debt. This is government debt, what we would call sovereign debt. Global public debt surpasses $100 trillion in 2024, Garrett. That is a massive number. Okay? And let's look at our culprits. You think, oh, that's these third world countries, that's these banana republics. Now see a little bit in Latin America, in the Caribbean, you see a little bit in Asia. See a little bit, very little bit in Africa. The bulk of this debt is developed countries. That's going to be the west, that's going to be United States, it's going to be Europe, that's going to be Japan. Okay? $100 trillion of sovereign debt, okay? And you're seeing these yields, bond yields go up because of that. You've got an oversupply, too much borrowing of government debt, of government bonds, $100 trillion globally. Okay, who are the main culprits? Well, us. Okay, so of that hundred trillion dollars, the us we're 5% of the world's population. We're $40 trillion of that hundred trillion dollar debt. We're 40% of global debt, of sovereign debt, with 5% of the global population. So if that tells you anything kind of where we are, that's what's going on.
So we talked last time, last episode about how the market doesn't care. The bond market, the market, stock market doesn't care. The market doesn't care. So today we're talking about the bond market does care, okay? And you're seeing that, you're seeing that kind of revolt with bond buyers, okay? So sovereign debt, obviously out of control in America. Out of control. We talked about this a Little bit during the halftime report. But we talk about total consumer debt, individual debt, not government debt, but mortgages, car loans, student loans, credit cards, da, da da da da. Okay, so total consumer debt in the United states is about 18.77 trillion. On this slide, we'll call it $19 trillion. Okay, so consumer debt is a little bit less than half of sovereign debt.
And you'll hear a lot of whining and a lot of hand wringing and a lot of sky is falling. Chicken Little talk about this debt. That is a massive, huge number, Garrett. That is a huge number. Here's the thing though, and we talked about this again at the halftime report where, okay, debt is really, really high. It's the highest it's ever been in history. Good with that. I'm good with. I can agree with that. But so are assets. You got to look at both sides of that balance sheet. So household assets, real estate, stocks, bonds, gold, silver, whatever. Assets, things we own tangibly are the highest they've ever been as well. So that ratio of debt to assets is still relatively low even with this explosion in debt. Okay, now what we've seen since 2022, early 2022, when Jerome Powell, I call him Darth Powell, when Darth Powell and the Fed went nuts, raising interest rates, okay, you see these borrowing costs go up dramatically. Dramatically. We'll talk a lot about that in a second. So as you see more and more and more debt, the bond market does care. All right?
And this should scare you a little bit. Okay, so what you're looking at is a ratio of US Debt, borrowing, sovereign debt to GDP. And those of you that have been watching us paying attention a while, GDP is the bottom line report card on the US economy. And we talked in the last episode about third quarter GB GDP. The Atlanta Fed is saying, GDP is going to be in the 4% range, which is really, really strong. Okay, so you're in a growing economy, growing pretty steadily economy. But what the deal is though, so is debt. And right now you're looking on this chart here, you're looking at a little north of 120%. So debt, the US government debt, sovereign debt is about 120% of the size of the whole economy. That's a problem. And again, the bond market does care. Right?
Garrett: Well, see, and I remember looking at this chart, I remember when my clients were freaking out, where we see this chart sort of starting to curve up very substantially around 2008, 9, 10 and gets up to that hundred percent mark. I remember my clients freaking out about that for the 2013-2020 run where we were right there, around 100%. And that would be a nice 25% improvement from where we're at. Near a 20%. Yeah,
Lance: we would love to be in that environment now, wouldn't we? Yeah, yeah. We didn't know, we didn't know any better back then, Garrett. We should have told him, you ain't seen nothing yet. Right? And so here's the thing, and here's why this is such an issue. Okay? So let's look at the top seven, top seven federal spending categories. Okay? Government spending, U.S. government spending. Obviously, baby boomers getting older, they're all hitting Social Security, Medicare at the same time. So it would stand to reason 22% of the federal budget is Social Security benefits. That makes sense. Okay. 90 million baby boomers hitting the system at the same time. A lot of expenses. But look at number two, net interest in that
Garrett: slide.
Lance: Net interest, this covering. I didn't say anything about principal, Garrett. I said the interest on the national debt. Okay. So debt is high as it's ever been. And yet as the bond market and policymakers, the Fed and whatnot, are increasing the borrowing costs. Help me out
Garrett: on
Lance: that. Okay,
Garrett: well, and interestingly enough, if I can interject here, I just said we were, you know, it's, we need about a 20% reduction in that to get it back to in line. That's pretty much the difference. 2013 to 2020 interest rates were nearly zero. Now they're not. So that's a, I'm not saying it's going to account for all of it, but that's a big chunk of that, that spike from 100 to 120%,
Lance: correct? Yep. And so it just a little, little review from things we've talked about in the past. So the Federal Reserve, that's Kevin Warsh, who's the new Fed chairman. We did a podcast on him a few episodes ago. Kevin Warsh has raised interest rates. So the Fed controls very, very short term interest rates, fed funds rate, overnight rate, basically short-term CDs, T bills, money market savings accounts, that's going to be the Fed space. What they control over, okay, that's going to be in their line of sight, the marketplace. When you get further, further out on that treasury yield curve, 2 year, 5 year, 7 year, 10 year, 20 year, 30 years on the federal, on that, all that yield curve, government bonds, the market determines that. And that's back to. Here we go. The bond market cares. And so you're seeing net interest rapidly gaining.
Okay, as far as spending goes, that's a big deal. So Social Security, the biggest, obviously, but gaining very quickly coming down the stretch. Here's net interest on the debt, not principal payments. We abandoned that hope a long time ago. But interest payments on the debt. Okay,
Garrett: yeah.
Lance: As interest rates are going up. Okay, yeah, that's a problem. Medicare's third, health care, things like Medicaid, fourth, national defense fifth. Oh, by the way, we're fighting a war. All right, Income security, that's going to be like emergency aid. And number seven, veterans benefits. Okay, so you're seeing, and I think that veterans benefits, that's a lot. As the, the, the World War II generation, Korea generation, as they've been passing away, and more and more the Vietnam generation is passing away, you've got a smaller portion pool of veterans. Okay, because, you know, Gulf first, Gulf War, second Gulf War. We've all had friends. I've got family members, my boss. All, all were in, in those conflicts. But that, that, that they were volunteers. They weren't drafted. Okay. World War I, World War II, Korea, Vietnam. They were drafted. They didn't have a choice. Okay, so you're seeing. So the veterans fee is a little bit smaller, but again, I keep going back to the interest on the debt. That is huge. That's a problem. Okay, so basically we're spending about $1 trillion. On your next slide, we're spending about $1 trillion a year.
A year on interest, not principal-interest- on the debt. Okay, okay. All right, and we'll talk about that a little bit. So it was a trillion dollars, just interest to now, currently, back in 2013, a short 13 years ago, like you were talking about, it was less than half of. It was less than 416 billion. It's too high then, but it was 416 billion. So it's more than doubled in 13 years. All the while, rates are going up.
Garrett: The older I get, the more I'm fascinated by my comparisons like this. I mean, for comparison, I remember early in my career, the TARP bailout was 700 billion, I believe. So we're spending more per year in interest than the entire TARP bailout was for the financial crisis in 08. I mean, I don't feel like I should be old enough to say things like that.
Lance: We are, brother. We are. We are. Believe me, we are. We are. Yep. And so kind of your next slide is going to be revenue breakdown by category. Okay. So kind of, kind of do the math here. Okay, so we're in fiscal year 2025. All right. We just finished 26, we're headed into 27. But fiscal year 2025, the U.S. government collected $5.23 trillion in total revenue and tax receipts. Okay, back in 25, that was a record high. And that was a 6.4% increase over 2024. When we see 2026's data, which should come out any minute now, you're going to see, I think another record. So the problem isn't revenue. We're bringing in record amounts of revenue into the coffers in the federal treasury. That's not the problem and that's not what the bond vigilantes are screaming about. Okay. And so you can see a breakdown. Individual income taxes, 51%. I'm self-employed, believe me, I get that one. Payroll taxes, corporate income taxes, customs tariffs, which by the way, you're going to see that share of the revenue start to decline as that's run into some court challenges. And the next size, taxes, other fees, about 3%. So share of total revenue, 5.2, $3 trillion in revenues. And we're spending a trillion dollars on interest on our debt. That's a problem, Garrett. That's a problem.
And what you've seen, I like this chart. This is from Lord Abbott through Bloomberg. But let's just go back to January, February, okay? Prior to this, everything kind of blowing up, pun intended, In Iran, bond yields, 10-year treasury bond yields had dropped below 4%. We were 3.7, 3.75, something like that. You see this chart on the left, that blue line? Those are yields on government debt, particularly the 10-year treasury bond. Okay. That thing has skyrocketed since March. Just in the last seven, eight months, that yield has gone from sub four high threes to low fives. Ten year, I was just looking, it's around 5.2, 5.3. Okay. So if you're an investor, that's not necessarily a bad thing. If you owned bonds before these rates spiked up, you've gotten your brains beat out. Okay, you're going to be okay, but it's not been a fun ride. Okay? If you're investing now, you're getting some pretty good rates. Okay? The problem is if you're the person paying back these debt, paying these interest rates, that is the government, I mean, use taxpayers. That's a problem. That's a big problem.
Garrett: Yeah,
Lance: the bond market does care, right? Okay. So you've seen a big spike up in rates. A lot of volatility, but a big spike up in rates. And you've seen, and we've talked about this A lot. One of our big four economic indicators that we, we reference in a lot of our, our, our podcasts, a lot of our stuff we put out. One of the big ones is going to be the yield curve. And we saw from 20, 22, 23, 24, we saw the longest inverted, or as we would say in East Texas-bassackwards-, yield curve in history. Okay. The ship is kind of righted now. You've got a normally sloped yield curve. In other words, long term interest rates are higher than short term interest rates. That's normal. The problem isn't the slope that it's normal. The problem is it's sitting high. Okay? We're starting from a high level and going higher, not starting from a low level and going a little higher. So that's a problem there. Again, that yield curve's normal. That's a good thing. But the problem is the level that it's normal at, if that makes sense. Okay.
And so here's what's funny. Okay, so bond yields are a lot higher. They've gone up substantially. Okay, so what that tells us. We were just talking about the seesaw, the fat kid and skinny kid. Okay? The world, as investors have said, no, you know what? We don't want U.S. government bonds. We don't want your debt. We don't want your IOUs. Okay? If we take them, we're going to pay you a lot less for them, and you're going to pay us a lot less interest. Okay? So, and I'm be honest with you, Garrett. I did not have rising guilts on my bingo card for 2026. I did not see that one coming. That really, really surprises me. And I didn't see the Fed raising rates either. I felt like Trump would get rid of Jerome Powell. I had that on my bingo card. I was right about that. In Trump's immense frustration with Powell for not lowering interest rates, I think Trump was right about that. But you know who appointed Jerome Powell to be head of the Federal Reserve? Trump. Okay, so Trump says, okay, Powell, you're out. You're fired. As we'd said, the Apprentice. Right? So we're bringing in. We're bringing in Kevin Wash. Okay, Kevin, go get him. You know, go fight, win. Go, tiger. You got this. Oh, by the way, I need you to cut interest rates. What's happening? Rates are going back up. We just raised interest rates again. So bonds have gone down. Okay. Didn't have the no bingo card. Here's what's interesting, though. If people don't want to own our debt, they don't want to hold our IOUs, Why has the dollar gone up? So, the marketplace is saying, no, no, we don't want your bonds, we don't want your debt, your IOUs, but we do want your currency. That's interesting.
Garrett: That's very interesting.
Lance: You would think those two would go in correlation, and they have not. Okay. And the other thing that's kind of surprising, you would have thought in correlation was if we're concerned about debts and deficits and worth and all that, the dollar shouldn't be up, bond prices shouldn't be down, and gold should be up. That didn't happen. The dollar's going up, gold has gone down. After a war started. Like I say, I didn't have that on my bingo card. We'll see how that turns out. But just a lot of weird things going on, a lot of strange, kind of unusual things going on a little bit.
Okay, now this came up last August and it will come up again. Okay, so this will be just. We'll hold a, hold, hold a quick class here. Talk about. There's a. There's a phenomenon called the yen carry trade, yen carry trade. The yen is the currency of Japan. Okay? And if debt to GDP and sovereign debt was going to force America back to the Stone Ages, it would have already happened in Japan. We don't have any problems compared to what Japan's got going on. Okay? So there's a phenomenon called the yen carry trade. The yen carry trade is an investment strategy where traders borrow money in Japanese yen, their currency, at very low interest rates. Japan's sovereign debt, their government bonds are at or near zero. So you borrow from the bank of Japan, Japanese government at 0%. All right? Then use those funds to come over the United States and buy higher yielding foreign assets, I.e. government bonds, and you pocket the difference. Great strategy. Works wonderful. So here's how it works. All right? You got to borrow cheap yen. You got to borrow a depreciated Japanese currency. So you borrow in Japanese yen at 0% from the government. You convert your yen over into generally the US Dollar into another currency. As long as those currencies kind of stay stable, you're good. This works. All right? Then you take that borrowed money that you borrowed at zero and you invest it in things like U.S. treasury bonds, very safe, safest investment in the world. Or you buy corporate stocks, emerging markets, whatever that offer higher returns. You keep the spread. Basically, you keep the difference. You profit from the spread. The difference between the interest rates that you're borrowing from Japan at 0. And you profit the difference.
Here's the key, here's the caveat, here's the catch: As long as the currencies remain stable. If the yen weakens, you can get into big trouble real quickly because you're having to buy back those securities to pay back your loan to the bank of Japan in a very depreciated currency problem. Okay? Now here's where this unwinds. We saw a little bit of this back in August last year, okay? So if the Japanese yen suddenly strengthens against other currencies, the cost to buy back in and repay the loan spikes. When the bank of Japan raises interest rates to protect their currency though that, again, that dot, that yen, their currency appreciates and you've got sudden losses, margin calls, whatever. So to exit that trade, to unwind that yen, carry trade, you've got to repay your debt quickly because you're losing money on currency. You gotta unwind this very quickly. So it's kind of like a forced sell off, what you and I, Garrett, would call a margin call. You've gotta sell off foreign assets, stocks, U.S. government bonds. Buy back the yen, which can trigger sharp drops and high volatility in global markets. So, you know, excuse me, you saw Scott Besant, the Treasury Secretary, who's doing a good job, by the way. Besant, you saw him act earlier this year to support the Japanese yen. Why does the Treasury Secretary, the US Treasury Secretary, care about the Japanese yen and their currency? This right here, this. That's what you're seeing. So you're seeing more and more of that as things get intertwined. And so this bears watching. This bears watching. If there's a catalyst for some bad things happening, this could be it.
Okay, last. And we'll kind of close with this. Okay, There's a terminology that we use called the equity risk premium. Equity risk premium. So mentally, we should understand that stocks are more risky than bonds. By and large, that's a true factual statement. Okay. Stocks are riskier than mine. So if I'm gonna invest my money in stocks, I need to have a reward for the extra risk that I'm taking. Makes sense, right?
Garrett: Yep.
Lance: So I should be rewarded for taking more risk. Well, great. Okay. And normally when there's a very high risk premium, you're being rewarded for buying stocks instead of safe or risk free investments like bonds like U.S. treasuries. Well, you see this spike up, spike down as we sit here today, Garrett, that's almost in parity. So let's, let's kind of run the math here. So 10 year treasury is about 5.2, 5.3%. I'm seeing if they'll put it up on the TV and that hasn't popped up yet. So if I can Invest my money, 5.25 10 year treasury, if I can invest my money in the safest, most risk free investment on earth at five and a quarter percent, why should I take risk and buy stocks? There needs to be a carrot on the end of that stick. And so as dividend yields have gone down in the market cause the market's appreciated, the concern there is the market's going to have to generate a lot of forward earnings momentum, a lot of profits. Those corporate earnings, another one of our big four, you have to generate a lot more profits and a lot more return to overcompensate for a risk free at five and a quarter. And during the big equity run up, run up post economic crisis 0809 interest rates went to zero. And we had a term in the industry. We called it Tina T I N A there is no alternative. You can't make any money in anything else. You can't buy CDs, bonds, savings accounts, whatever. You got to buy stocks. And you saw these huge flows into the equity market in stocks and you saw the market rally because of that. Well, there's an alternative now and it's going to be interesting to see if the market, the stock market can overcome that and if these companies in the S and P and whatnot, these public companies are going to be able to generate enough income in return to compensate for that added risk. This really bears watching here. Okay. All of a sudden the stock market has competition
Garrett: and for this equity risk premium, is it using the inverse of the price to earnings multiple to determine what the essentially
Lance: what your return is and dividend yield. Okay.
Garrett: [00:28:18]
Lance: Yep, gotcha. Yeah. So
Garrett: you're,
Lance: you're not getting paid a lot right now for it.
Garrett: Right, Gotcha.
Lance: So you're not getting paid a lot for it. And then if you watched our last episode on Politics, you'll see that the average return during a midterm election year, second year presidential cycles, about 4.6%. So might see a little bit of regression to the mean here. We'll see. We'll see.
Garrett: Gotcha. Well, we've made it to this point. Hopefully if you're still here and you're still listening, then you have made it over the hump. It'll all be, it'll all be more entertaining from here on Lanceopedia.
Lance: we'll do our best.
Garrett: Yeah, absolutely. Well you did a pretty good job of keeping me engaged on that one. Hopefully everybody else is still still
Lance: with us. Still
Garrett: awake and still awake. Yeah, absolutely. I had a hard time sleeping for a couple of weeks last week. I could just turn on the Bond Vigilante podcast and but now I joke with you but this
Lance: good stuff.
Garrett: Really really interesting stuff. Especially piggybacking off our last episode with the election coming up. Obviously this is a lot of policy driven. The two go hand in hand in in a lot of different ways. So I'll be interesting to see how things shake out. So for folks who have made it 30 or so minutes listening to us talk about bonds and global interest rates and currencies, how can they reach Lance Browning and and learn a little bit more about how you can help them.
Lance: So office line is 903-787-8909. Online, you can check out our website where all These podcasts are www.lancebrowning.com or come see us at troop. Com. Troop command center here, 3200 Troop highway in the beautiful city of Tyler, Texas.
Garrett: Awesome, my friend. Well, thank you for for your time as always. Have a great weekend and look forward to chatting with you again soon.
Lance: Appreciate brother. Thanks. [00:30:10]
Garrett: Bye.
Garrett: Lanceopedia is for entertainment and educational purposes only. The views and opinions expressed in the show are that of Lance Browning and are not guaranteed to come to fruition. If you have questions about your investments or your financial plans, you should seek a financial professional or give Lance a call at 903-787-8916. We thank you again for watching or listening to the podcast and we'll see you next time.
