Yield Ahead: Rates Hold the Key to 2025

January 17, 2025 – The fate of the bull market rests on interest rates. That's the claim of Chris Puplava, Chief Investment Officer at Financial Sense Wealth Management, who joins us for an insightful discussion on the critical themes shaping the economic outlook for 2025. In this episode, Chris Puplava and Financial Sense host Cris Sheridan explore the pivotal role of the bond market, where rising interest rates could spell trouble for both equity investors and government finances. Chris shares his expertise on why the bond market might compel the Federal Reserve to step in, potentially reversing its balance sheet reduction strategy to curb yields and manage inflation. Want to know how this year is going to play out? Listen in as we discuss why rates, inflation, and the bond market are going to be a key area to watch.

For related charts and material, see Buckle Up: Bond Vigilantes Are Back

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Transcript

Cris Sheridan:
Buckle up. The bond vigilantes are back. That's a piece that we just posted on Financial Sense. And we're going to discuss the key themes for 2025, some of the things that we're looking at when it comes to the forecast and how we're investing here at Financial Sense Wealth Management with our Chief Investment Officer, Chris Puplava. So, Chris, last year was obviously an amazing year for the stock market, and we're going to be seeing a major change of guard, politically speaking, here in coming days. What are some of the key themes that you're going to be watching as we head through a new year?

Chris Puplava:
My overarching opinion, Chris, is that everything is going to be dependent on the bond market. If interest rates on the US 10 and 30-year long-term rates move north of 5%, I think that's definitely going to cause the market to wobble. As long as rates can stay anchored and below that, then I think the market has a pretty good chance of having a good year. Now, if we do breach that 5% level, it will likely lead to a market correction. And if yields really kind of gain steam on the upside, then I think at some point the Fed is going to be forced to basically come in as the buyer of last resort. Right now, the Fed is shrinking its balance sheet. My bet is probably by midyear the Fed will be done shrinking its balance sheet and could be in the second half of this year contemplating even having to step in to cap interest rates and do some form of yield curve control to keep rates down as well as the financing cost of US Government debt and start expanding its balance sheet by buying Treasuries. And you know, one of the quotes that I think is really apropos is the one from James Carville, the Democratic strategist. He famously said, "I used to think that if there was reincarnation, I'd want to come back as the president or the Pope or as a .400 baseball hitter. But now I'd like to come back as the bond market. You can intimidate everybody." And that was true. It kind of derailed a lot of what Bill Clinton wanted to do in the '90s, and he kind of shifted his focus to balancing the budget later in that decade. And when you look at where we were, I mean, just look at what happened in '22 and '22 interest rates. The dollar came unanchored. They surged higher, as did inflation. And it was pretty much everything down but dollar up. Market oil was also up because of the invasion by Russia of Ukraine, but it was a really lethal cocktail for investors, for equity investors, of a strong dollar and strong or higher interest rates. And that's what we've been seeing over really since I would say, September, we started to see interest rates move up as well as the dollar. They're kind of joined at the hip. And that's one of the number one things I'm watching, is the path of interest rates as we carry out this year.

Cris Sheridan:
Yeah. The reason that's so important because, as we often discuss here on our show, interest rates are the other way of looking at that is borrowing costs. Right. So as interest rates go up, that means it's more costly to borrow, not just for consumers but also for businesses and also for the US Government.

Chris Puplava:
That's correct. And you look at the interest expense on our debt, it's quickly on the current trajectory going to exceed Social Security. We're already spending more on our interest expense than we are on our defense budget. And one of the reasons why I'm primarily concerned about bond yields this year is the amount of rollover of debt. I took a look at the G10 countries, and collectively they have about $14 trillion of debt rolling over. Now, every one of those countries is running a budget deficit. The U.S. with a 7% budget deficit. Italy is running a 7% budget deficit. France is at a 6% deficit. And then you've got Belgium at a negative 4. And then you have some other countries at negative 2 and negative 3. So not only are they going to have to roll over their maturing debt, but they're going to have to issue debt on top of that to finance their budgets. And so we are looking, you know, probably on the order of closer to 15 to 18 trillion dollars of total debt that's going to be issued this year. And that amount of supply has the risk of pressuring yields higher as the market is just not big enough to absorb that, where we might need central banks to step in.

Cris Sheridan:
And so again, that's where you're forecasting that that could be something that we see around midyear, where the Fed finally stops quantitative tightening. That is, it's no longer letting US Treasuries and mortgage-backed securities roll off its balance sheet and potentially move back towards quantitative easing. So there's going to be a little bit of a delay between the time that they end quantitative tightening, which they're doing now, and quantitative easing. But you think we're getting closer to looking at that type of situation given the level of debt that has to be rolled over?

Chris Puplava:
We do. And I think it's essentially the Fed's going to be forced into this. When you look at what the central bank is doing, the market has started to become concerned about rising inflation or at least stabilizing rising interest rates, where central bank easing typically leads to a drop in interest rates across the yield curve at all maturities. Not this time. One of the things I took a look at was the Bloomberg US Long-Term Treasury Index looking at it after the Fed had cut interest rates for the first time. And currently, the Bloomberg treasury index is down 12% since September when the Fed had its initial rate cut. And this is the worst performance of Treasuries since that point since 1974. So clearly, there's something different where the market is not welcoming further easing by the Fed because that essentially could lead to too much stimulus, too much growth, which drives inflation and interest rates higher.

Cris Sheridan:
So again, as you said, we're likely looking at a situation where the Fed is going to need to step in, perhaps this year, maybe next year, with quantitative easing. A lot is going to depend on what we see with treasury volatility. But tell us about some of the analysis that you are providing when it comes to the level of the current fragility of the US treasury market as you see it.

Chris Puplava:
Well, part of the problem that we have is, you know, who's buying our debt, who's showing up at the auctions. And it used to be where we had a large portion of our debt purchased by foreigners, and ever since 2010, they have dramatically decreased. I believe something around 35% of debt was owned by foreign governments and countries. And then I think we're closer to around 10% now. So that is a dramatic reduction in the ownership of US Treasuries by foreigners. And what we've seen, you know, sometimes the Fed has had to do QE, and the Fed has stepped in, in and out. But of late, what we've seen is that one of the primary buyers of US Debt has been the hedge fund community. And the hedge fund community, they operate on leverage. So it really increases the fragility of the US treasury market given one of the primary borrowers or buyers of our debt are hedge funds. And that's something that's concerning the treasury, you know, what happens if hedge funds go to cash dramatically and dump a bunch of Treasuries onto the market. You know, that could dramatically increase things. So we definitely are in a much more precarious, fragile position in the treasury market given the lack of buyers. And we're now depending on hedge funds for buying, and this is probably one of the reasons why, I think, if interest rates do move over 5% materially, we may even see the Fed step in, not only stopping to shrink its balance sheet, but starting to expand it.

Cris Sheridan:
So, Chris, every quarter we track what the treasury is producing in terms of the updates on their borrowing needs. From your recent readings, is there any sense from the Treasury's point of view that we're getting closer and closer to the point where they're going to have to launch quantitative easing and step back in?

Chris Puplava:
Actually, Chris, they are projecting they will have to step in, which is kind of an eye-opener. One of the things that was missed leading into the elections was the Treasury Borrowing Advisory Committee, or TBAC, their release on October 29, which was the latest update. And in it, they had a couple of supplemental reports. One was on crypto, but another one was from the Interagency Working Group, which is headed up by several agencies, such as the SEC, the Federal Reserve Bank of New York, the Comptroller of the Currency, the US Treasury. It's really a lot of the monetary authorities and agencies within the US, and they were basically discussing how fragile the US treasury market is becoming, some of the steps they've done to increase liquidity and stability in that market. But one thing that I found fascinating was they had a slide talking about Fed intervention. And in their slide, they were showing the Fed's balance sheet continuing to be reduced up until mid-2025, and thereafter expanding at 5% per year, indefinitely. So that's their forecast, but they're basically kind of putting on that they think the Fed will have to step in. I believe their estimate is early next year, 2026, as buyer of last resort to support the treasury market. You know, my guess is whatever timetable the government has, usually it's, you know, way off. And I have a feeling that the Fed will be monetizing debt later this year.

Cris Sheridan:
And again, the reason the Fed would have to step in as a buyer of last resort is because there's just not enough buyers out there to absorb the massive number of US treasury bonds that are going to be hitting the market. That's basically the idea there, right?

Chris Puplava:
Correct. The yield is really where the equilibrium of supply and demand comes in. If we have a huge influx of supply and there's not enough demand, well, that's going to drive yields higher. So essentially, you need to bring demand in to overwhelm supply and bring yields lower. And I think the Fed will be forced into that position. And part of the reason why I'm also believing that interest rates are going to move up this year is the link or long-term relationship between interest rates and inflation. They do tend to move up and down with each other over time. And when we look at some leading indicators for inflation, they do argue that we are likely going to see inflation bottom here and begin to pick up in the coming months. One of them was from the US San Francisco Fed. They essentially broke out measures of inflation for acyclical and cyclical, where the cyclical ones are those tied to the business economy, much more sensitive to what the Fed is doing in monetary policy. The acyclical are things that have long-term trends that aren't really as influenced by the economy. So it kind of gives you an underlying sense of where inflation is that's primarily dominated by health care and living expenses. And what's a concern, though, is when you look at the acyclical or the part not impacted by the Fed or the business cycle, that has begun to turn up, and what we see is it tends to lead to overall inflation levels anywhere from three to six months. So with that turning up, it does argue that the market's favorable reaction to lower inflation could be short-lived.

Cris Sheridan:
Chris, when we last spoke with you, it was in late December. You had mentioned that we here at Financial Sense Wealth Management had trimmed back on our positions, moving from an aggressive posture on the stock market to a neutral posture. If you wouldn't mind, boil some of these things down for us. When you're talking about the risk from rising interest rates, the acyclical parts of inflation starting to pick back up, and some of the other things that you discussed with us, how does that relate to what we're doing here at Financial Sense Wealth Management, the outlook that we have for stocks and bonds?

Chris Puplava:
Well, we have definitely a cautious stance right now in the bond market. I think the risk is for higher yields, not lower. So when we look at the maturity of our bond side, we're very short in terms of the maturity for bonds for our clients. And that's going to continue to be the case for a while. When we look at the equity side, one thing that we're really curious about, and we'll know this in short order, is next week when Donald Trump takes office. How dramatic are the tariffs? I've seen some estimates that the market's already priced in roughly 10% of tariffs. If it comes in higher than that, that's obviously going to be a shock. It will likely lead to a higher dollar, higher interest rates to support the higher inflation expectations. And with that, the market could definitely wobble. So I think, you know, it makes sense to have a fair amount of cash. Obviously, there's going to be a lot of good things Donald Trump wants to do in terms of reducing regulation and improving market efficiency and supporting the market. But we'll have to see. It's going to be a wild year, I think. You know, betting on higher volatility is probably the easiest bet to make in '25, but we'll just have to see what Trump ends up passing next week, and that could set the tone for at least the next several months.

Cris Sheridan:
So it sounds like heading into this year, the outlook is for the potential for a bit higher volatility than what we saw in 2024. Obviously, 2024 was a very good year for the market. We were aggressively positioned for a good portion of that this year. Higher volatility, you want to be a little bit more flexible and nimble. Of course, we are active managers at our firm. So if any of our listeners would like to come on board or find out more about how we can help them, either with money management or comprehensive financial planning services, what would be the best way to do so?

Chris Puplava:
They can reach me at 888-486-3939, or they can shoot me an email at chris[dot]puplava[at]financialsense[dot]com.

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