By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Occasionally, we at Ryan ALM stumble over a fact or two that surprises us, and we like to bring it to the attention of our readers of this blog. Obviously, inflation and the impact of these inflationary pressures have been a dominant force within the US markets in 2022. Aggressive US Federal Reserve policy action (perhaps a bit late) has driven interest rates upward (FFR +4.25%) from historically low levels creating great uncertainty regarding the near-term implications for the US economic environment. Debate rages over the likely outcome with participants arguing about the potential for a hard or moderate recession or the Goldilocks soft landing.
Much debate has also focused on the primary source(s) of US inflation. Was it the stimulus provided to prop up our economy during the initial Covid-19 response or was it the disruptions to our ability to meet heightened demand as a result of global production disruptions, including the impact from both Covid-19 and the Russian invasion of Ukraine? There’s good reason to believe that both contributed to the four-decade-high inflation experienced in 2022, which makes the argument that inflation is transitory more difficult to accept.
Fact 1: In the nearly three-year period of 2020 to YTD 2022, the US has injected $6.8 trillion in net Treasury Bills, Notes, and Bonds into our economy. During the GFC (2008) and for 4 years subsequent, the US injected “only” $6.4 trillion in net Treasury debt to help the economy get back on solid ground from the most harmful recession that our nation had experienced since the Great Depression of the late ’20s to mid-’30s. That is a tremendous amount of stimulus that continues to work its way through the system. In addition, we have one of the strongest labor markets at this time with unemployment continuing to remain quite low at 3.7%, while annual wage growth hovers in excess of 6% as of November 2022. Yes, inflation has moderated during the last several months, but it continues to remain quite elevated relative to the Fed’s target level of 2%. Given the extraordinary stimulus and strong labor market, it is likely that a more aggressive stance by the Fed will be needed to finally eradicate inflation… not to mention the Fed’s intention to create real rates or an inflation premium which has averaged 3.04% since 1960.
One last observation (fact 2), in reviewing the history of Treasury issuance since 2000, it continues to surprise me that the US only issued $510 billion of gross Treasury Bonds during 2020 relative to the total gross issuance of nearly $21 trillion in Treasury debt (2.4% of total issuance) when the yield on the 30-year bond had fallen to 1.28% during the initial reaction to Covid-19. Why would you not extend maturity when rates were at historically low levels and not likely to fall any further? Instead, the US Treasury has had to refinance trillions in $s at ever-increasing interest rates? This scenario is likely to continue well into 2023 as the Fed appears committed. What a wasted opportunity.