Latest / Stagflation Conversations with Fexingo: High Inflation, Slow Growth, and 1970s Echoes / Why the Bond Market Is Hearing 1970s Echoes
Transcript
- Lucas: So the 10-year breakeven inflation rate just ticked up to 2.34 percent — that's the highest it's been in months, and it's happening while the S&P 500 is down nearly a percent on the week. That's the bond market telling us something the stock market doesn't want to hear. Luna: And gold's up almost six percent in five days, trading near $4,700. That's a lot of money moving into the classic stagflation hedge. Lucas: Exactly. And when you put those pieces together — higher inflation expectations, a sliding equity market, and gold ripping higher — you get the classic stagflation signal. Today we're going to drill into what's happening in the Treasury market and why it's the one place that seems to be pricing in the worst case. Luna: And it's not just the breakeven rate. The headlines about Treasury Secretary Bessent have been pretty dramatic this week, too. Lucas: Right — Bessent's been trying to calm the bond market, but so far it hasn't worked. He's been talking up a Treasury buyback operation that could be more than $4 billion, and he said there's a 'very good chance' the deficit has peaked. But the market isn't buying it. Luna: What exactly is a Treasury buyback, and why would it calm the market? Because to me, it sounds like the government just buying its own debt. Lucas: It is exactly that. The Treasury buys back older, less liquid bonds and issues new ones in their place. The idea is to improve liquidity and smooth out the maturity wall. But the market sees it as a bit of a gimmick when the real problem is the size of the deficit. Luna: So $4 billion is… not nothing, but it's a drop in the bucket when we're talking about a $40 trillion debt mountain. Lucas: Right. $4 billion is less than one one-hundredth of a percent of the total debt. It's symbolic. And the market is saying, 'We don't care about the mechanics; we care about the trajectory.' The breakeven rate climbing to 2.34 percent is the market's way of saying inflation is going to average above the Fed's 2 percent target for the next decade. Luna: And that's notable because the CPI number that just came out for July was basically flat — 332.8, up from 332.57. That's a tiny increase. Lucas: Yeah, headline CPI is nearly flat, but the bond market isn't looking at the headline. It's looking at the trend in services inflation, wage growth, and the fact that job openings are still high even though they've come down. JOLTS was 7.36 million in June, down from 7.54 million — but that's still a tight labor market by historical standards. Luna: So the market is looking past the month to month noise and seeing a structural problem. Lucas: Precisely. And when you think about it, the bond market has been in this weird spot for a while. On one hand, you have the Fed fighting inflation with high rates. On the other, you have fiscal deficits that keep pumping demand into the economy. It's a tug of war, and the bond market is starting to think the fiscal side is winning. Luna: This is starting to sound a lot like the 1970s — the decade we keep hearing about whenever stagflation comes up. Lucas: There are echoes, for sure. In the 1970s, you had oil shocks, wage-price spirals, and a Fed that was slow to react. Today, we have supply chain disruptions, a tight labor market, and a Fed that tightened aggressively and is now stuck. But there's a key difference: the Fed's credibility on inflation is much stronger today. The 2 percent target is baked into the cake. Luna: But if the bond market is pricing in 2.34 percent breakeven, that suggests credibility is eroding, even if it's not collapsing. Lucas: That's the nuance. It's not a 1970s-style breakdown where inflation expectations become unanchored. But it's a slow drift above target, and that's enough to make long-term investors nervous. And when you add the $40 trillion debt and the government's interest burden, it creates this vicious cycle: higher yields mean more debt service, which means more issuance, which pushes yields higher. Luna: So what can the Treasury actually do here? Bessent's buyback isn't working. What else is on the table? Lucas: The most obvious lever is fiscal discipline — actually reducing the deficit. But that's politically unpopular. Bessent says the deficit has peaked, and maybe it has if the economy doesn't fall off a cliff. But the market is skeptical because the structural drivers — entitlements, interest payments — are growing faster than the economy. Luna: And the Fed is stuck between a rock and a hard place. They can't cut rates because inflation is sticky, but they can't hike because growth is slowing. Lucas: Exactly. The Fed is in wait and see mode, but the bond market is ahead of them. It's already pricing in a higher inflation path. And look at gold — up nearly 6 percent in five days. That's not a coincidence. Gold is the ultimate anti-stagflation asset because it's not tied to any central bank's promise. Luna: Speaking of which — we've been having these conversations for a while now, and I know we've both been learning a lot from the research. If you're a regular listener and you've found these episodes useful, a couple of dollars a month genuinely makes a difference. It keeps the show ad-free and lets us keep digging into these topics. Lucas: Yeah, we're not backed by a big network, so listener support is what keeps us going. If you've gotten value out of these episodes, consider grabbing a coffee for us at buy me a coffee dot com slash fexingo. Luna: Even a small amount helps us keep the lights on and the tape rolling. Lucas: Right. So back to the Treasury market — the other interesting thing is that the 10-year Treasury yield has been creeping up even as the economy slows. That's not what you'd normally expect. Typically, in a slowdown, yields fall because the Fed is expected to cut. But here, yields are rising because inflation expectations are rising. Luna: So the bond market is basically saying, 'We don't believe the Fed will cut enough to offset the inflation risk.' Lucas: Exactly. And that's the stagflationary mindset. The market is pricing in a scenario where nominal GDP stays okay but real growth is weak and inflation stays above target. That's the worst of both worlds. Luna: And for the average person, that means higher borrowing costs, higher prices, and wages that don't keep up. Lucas: Yeah, and that's why the breakeven rate matters. It's a direct measure of what the market expects inflation to be over the next ten years. When it goes up, it means your cost of living is expected to rise faster. And 2.34 percent might not sound like a lot, but it's above the Fed's target and it's been creeping up for months. Luna: Is there any good news in all of this? Any reason to think the market is overreacting? Lucas: There's always a chance the market is overreacting. The PCE price index, which the Fed prefers, actually dipped in June — it's at 131.4, down from 131.53. And wage growth has been moderating. So the fundamental data isn't universally bad. But the bond market is supposed to be forward-looking, and it's seeing a lot of red flags. Luna: Like what? Lucas: Like the government's debt trajectory. We just crossed $40 trillion in debt — that's double what it was a decade ago. The interest payments alone are now a huge chunk of the budget. And when you're issuing that much debt, you need buyers. If the market starts demanding a higher premium for holding that debt, it becomes self-reinforcing. Luna: So the bond market is like a canary in the coal mine. And right now, the canary is looking a little woozy. Lucas: That's a good way to put it. But I want to be careful not to overstate the 1970s comparison. The Fed is much more independent and credible today. Inflation expectations, while drifting up, are still anchored relative to the 1970s. And the labor market is tighter, which is bad for inflation, but the productivity picture is better. So it's more like 1960s stagflation lite, if that's a thing. Luna: What should our listeners watch for to see if this is turning into something more serious? Lucas: I'd watch the breakeven rate, first of all. If it breaks above 2.5 percent, that's a warning sign. Also watch the yield curve — if it starts to steepen in a big way, that means the market is pricing in a lot more inflation risk. And keep an eye on gold. Gold at $4,700 is already telling you something. If it goes to $5,000, that's a major red flag. Luna: And the Bond market's also signaling that the Fed might have to keep rates higher for longer, which is bad for housing and any interest-sensitive sector. Lucas: Right. And that's the stagflationary trap. The Fed has two mandates: price stability and maximum employment. When inflation is above target and growth is slowing, they can't address both. They have to make a choice. And the bond market is betting they'll choose inflation — or at least that they'll be forced to. Luna: So, bottom line: the Treasury market is a bright red flag, but not yet a full alarm. Lucas: Exactly. It's a signal worth watching, and it's a reminder that the economy is entering a fragile phase. The next few months will be crucial. Will the Fed find a way to thread the needle? Or will we stumble into a real stagflationary episode? The bond market is placing its bets.