The U.S. Treasury Bond Can Bring Obama Down II

So far, there's been very little analysis or speculation over why the June job's report was so bad. That makes some sense for several reasons. First, one month's numbers almost always doesn't give anyone enough data to make any fair determination. Second, it's almost impossible to know exactly what caused the economy to move anyway.

Still, I don't think that it's mere coincidence that the month of June was also a month in which interest rates shot up. Starting the last week in May, the U.S. Treasury bonds, mortgage bonds, along with most other interest rates shot up over a two week period. They stuck there for a week and then began coming back down toward the end of the month of June. Mortgage rates shot up a full percentage point, from 4.875% to 5.875% on the 30 year fixed, before pulling back toward 5.5%. (where they are currently) The sudden rise in rates was caused by fears of future inflation due to massive new government borrowing. It started when speculation occurred that the U.S. Treasury bond would be downgraded. Credit rating agencies shot down this rumor but frankly not in a way that satisfied the market. As such, massive government borrowing will continue to create significant upward pressure on treasury bond rates for the indefinite future.

Here's the first thing that higher interest rates did.

So what's a half a percentage point or even three quarters of a point, when mortgage interest rates are still historically low? Well, apparently a lot.

I'm told that a lot of loan applications, and refis in particular, that are currently in the pipeline were submitted without a rate lock. Mark Hanson, of the Field Check Group says, "millions of refi applications presently in the pipeline, on which lenders already spent a considerable amount of time and money processing, will never fund."

The sudden rise in mortgage rates meant that a plethora of mortgage applications in the "pipeline" (as we say in the industry) were lost because they were dependent, and expecting, much lower rates. It hasn't been reported just exactly how much business was lost but there's no doubt it was significant.

Beyond that, it made borrowing that much more difficult. This means that real estate values had more downward pressure, refinancing slowed down, and real estate was that much more difficult to sell. Of course, higher treasury rates mean that interest are higher everywhere. It meant that small business loans were that much more difficult. Higher treasury rates were the springboard to higher borrowing costs all across the board. All of this started at the end of May.

So, is it any wonder that June was a month in which our unemployment picture got worse? In January, I analyzed the potential pitfalls of the Obama administration's borrowing, and its effect on the U.S. Treasury. Here's what I said then.

The ramifications of this will be severe. Just as quickly as refinancing boom will be created so to will it end. Rates will shoot up and cause downward pressure again on real estate values. Furthermore, it will make future borrowing by the Federal government that much more difficult. After all, it is significantly more difficult to pay back a $2 trillion loan if you rate is 5.5% than if it is 2.5%. Since the ten year is a pre cursor to all other long term rates, it will make most long term borrowing much more difficult. As such, it will have a devastating effect on an already weak economy. You will likely see so called experts pointing out that the Obama administration was careless in their borrowing methods. The Republicans will likely cling to this and point out that Obama doesn't have the economic sophistication to manage the economy. People will point out that the stimulus effect of all that borrowing will be
counteracted by the buying power lost of higher interest rates.

President Obama has been entirely unconcerned by the fate of the U.S. Treasury bond. Instead, he has ceded to Chairman Bernanke who has used quantitative easing to manipulate treasury rates lower. (by creating money and then using said money to buy these bonds) This policy has only been marginally effective. From March through May, rates were very low, and probably not coincidentally, the jobs picture also improved. Then, at the end of May, rates shot up and they've only pulled back slightly since.

At the beginning of June, I predicted that the U.S. Treasury bond can bring Obama down. Then, I predicted the 10 year U.S. Treasury would reach 5% (currently 3.45%) and the 30 year fixed would reach 7% by the end of the summer unless the Obama administration turned course on some of its spending plans. I predicted that this move would bring the administration down because the higher borrowing rates would stunt and reverse whatever growth all this government spending is creating.

In fact, I may have been Conservative in my predictions. The U.S. Treasury may have already brought him down, and it will continue doing it (worse for everyone is that it will choke off economic growth) The U.S. Treasury bond is in a constant tension with itself. Either it will be driven by the realization of the weak economy, or it will be driven by the fear of inflation caused by massive government borrowing. When it's the former, the rates get better. When it's the latter, rates go up. It's also true that Bernanke will continue to aggressively buy treasury bonds in order to manipulate rates down. Bernanke has been doing that aggressively for about four months and he's about run out of money. If he is to continue doing this, he will have to announce a massive new injection.

Now, given the dynamic, you can see how the U.S. Treasury bond will continue to bring Obama down. That's because as we see signs of an economic recovery the treasury's narrative will focus on massive deficits. This will drive up interest rates and choke off the recovery. That will likely lead to rates dropping which will usher in another mini recovery, and so on and so forth. Yet, you can see that a recovery will never fully materialize because the strengthening economy will lead to higher interest rates which will then choke off the recovery.

This is in fact what many of Obama's fiscal policy detractors have been arguing all along in the abstract.

The United States has to borrow a net $3 trillion to $4 trillion over the next two years — far more than the $1 trillion a year average of the last three years. Obama may well face a tough choice: Print more money (monetizing the debt), triggering a run on the dollar — or let interest rates skyrocket, killing off the recovery.

Alternately, he could raise taxes to try to fund his programs (particularly his health-care proposals). But even tax hikes confined to the upper brackets will undermine his popularity — and slow the economy.

Then, folks like Paul Krugman, who favors aggressive government spending to stimulate economies during recessions, calls such hypotheses nonsense. We don't need to deal in the abstract. Reality will suffice. From March through May, interest rates were very low. Borrowing picked up and the economy showed some signs of recovery. Then, at the end of May, with more signs of recovery, the market began fearing inflation as a result of massive borrowing and interest rates went up. It just so happens that the economy then slowed down in June. I believe that June was the first of many such months. A constantly sputtering economy will mean then bring down Obama's entire domestic agenda. We aren't about to pass health care reform and cap and trade when we're hemorrhaging jobs. In the summer, and even more the fall, the president will need to expand plenty of political capital to get his agenda passed. It will be exactly this time when the economy sputters. We'll see signs of recovery and then weakness. The president will have trouble keeping the confidence of the voters with such an economic environment. Without the confidence of the people, he'll have little political capital.

President Obama has shown an utter lack of any sophistication about what his fiscal policies will do to treasury rates, and what that will do to the economy. That, ultimately, will bring him down.