Latest / Money Grows on Trees / #363 - Last Time Bonds Did This, A Recession Followed

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#363 - Last Time Bonds Did This, A Recession Followed · Money Grows on Trees

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The US 10-year bond yield just broke above 5% for the
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first time since 2007. And most people have no idea
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what a bond yield is, let alone what matters to them. The
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reality is the bond market sets the price of money. And
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when the price of money changes, mortgages, property values, share valuations,
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businesses, inflation, the whole economy will move with
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it. And what's happening right now is that one of the most important signals is
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occurring in global finance, and almost nobody watching
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their bank account understands what it means. I'm Lloyd J. Ross, seven-figure investor
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and entrepreneur, and I've helped thousands of everyday Aussies, Americans, New
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Zealanders, Canadians, and those from the UK get out of debt and build real
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wealth. And in this video, I'm going to explain exactly what bond yields
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are, why 5% is a number worth paying attention to, whether
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this is actually pointing to economic collapse, and
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what it actually means for your money right now. Okay,
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to kick things off before I talk to you about why high
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bond yields is bad and what can happen, I want to talk to you
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about what a bond actually is. So let's go back to the very beginning of what a bond actually
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is. At its simplest form, a bond is an IOU. It's
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a lending instrument. It's what people call a lending contract, a
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lending arrangement. You can buy and sell bonds just
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like you can buy and sell shares. There's different types of bonds. There's
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a corporate bond where you're lending money to a company. It's called a corporate bond. There's
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a municipal bond where you're lending money to the municipality. There's
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a treasury bond, which is the main one we're going to talk about today, which is
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where you're lending money to the government. That's why they call them treasury bonds. You're
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lending money to the treasury. and they owe you money. And
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so there's three different types of treasury bonds. And we're talking about
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United States treasury bonds, but they call them T-bills, which has got
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a maturity of one year. So it's an IOU for one year. So if I
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buy a T-bill, it means I'm lending money to the US government for
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12 months. And I will be paid what's called a coupon, which
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is the same as an interest rate payment, they
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call it a coupon, based on the bond yield. for
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what the current lending rate is for me
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to lend money to the government for a year. Now, the shorter the maturity to
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be, the lower the interest rate, and the longer the maturity, usually
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the higher the interest rate, because you've got to pay for duration of the
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propensity for that loan to be repaid. So you're going to get compensated
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for the length of time or the maturity time of the
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money you're lending. The second type of treasury bond is a note. And
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that's where the bond is a 10-year term. And then finally, they call
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the 30-year terms bonds. So there's T-bills, notes, and
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bonds. And the 30-year bond is the most predominant. But
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it effectively is where a treasury bond is where the
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government needs money. And so it raises money by
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institutions and people lending money to them. and then they'll issue
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you a bond. So the bond says, the US government owes
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you money, and until it repays it, it pays back
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the original principal at the maturity date, it will pay you
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an interest payment for borrowing your money. It's
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pretty simple stuff. It gets a bit complex because of the jargon. So
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what happens is, generally speaking, so you pay a price for
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a bond. Let's say it's a treasury bond and it's $100 for
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a treasury bond. and it's gonna pay you an
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interest rate of say 5%, okay? Whatever it might be. So the
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yield is the coupon rate or the interest rate, sorry,
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the amount of interest, I should say, the coupon divided by
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the price of the bond. Simple. So if you're gonna get
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a $5 coupon payment for the year on $100 bond,
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as an example, it's 5%. $5 divided by
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100 is 5% bond yield, okay? So if
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an existing bond becomes less attractive, Investors sell the
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bonds, prices of bonds fall and yields rise. So
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right now if you're seeing bond yields rising, which means the
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interest rate to lend money to the government is rising, it's because
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people are selling those bonds more than buying them. And
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if you look at the treasury market, the treasury bond market's massive. It's
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basically the global monetary system. So when people
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say things like, oh, the US dollar is going to collapse and Man,
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good luck trying to dislodge treasuries and bonds from
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the global money story, because it ain't happening. The
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whole world ebbs and flows on US treasury bonds.
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Japan is actually the biggest holder, I believe. I haven't done the numbers, but I'm pretty
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sure it's got I don't know, one point something trillion in U.S.
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Treasury bonds. It's the biggest holder. Then you've got China. I know they're offloading
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some. I think they had 400 billion. And then you've got other countries and institutions
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like U.S. Treasury bonds are the monetary system
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of the U.S. dollar. And they're the risk-free rate. You can
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lend money to the U.S. government risk-free because if they need to pay back,
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there's pretty much money. So that's why it's risk-free. at 5% right
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now, over 5%. So you can get a risk-free return of 5%, which
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is amazing, right? So anyway, just so you know, when bond prices fall,
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yields have gone up, okay? So there's this inverse correlation.
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If interest rates go up, effectively the price of bonds are falling. There's
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an inverse correlation with yields and bond prices. You
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don't need to worry about it too much, but I just needed to explain that to you. What's happening
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when bond yields go up is that the risk-free asset,
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US Treasury bond, if you're going to pay me over 5% for that,
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it means that there's a bit more risk in owning or lending money
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to the US government. And that risk comes from, 40 trillion
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in debt, it's at war, there's some inflation challenges there.
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Yeah, we want a little bit more money. If we're gonna lend money to you, US
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government, we want a little bit more interest back for that, for the risk that we're taking lending
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to you, okay? And that's why they've gone up, because there's
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a little bit more risk in it. But still, the American economy is very
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robust. It's growing at a crazy, I think it's five or
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6% GDP, because some mental number for the size of it. People
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don't realize this, but it's strategically positioned in the world in a very fortuitous spot. It
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surrounds Canada, especially now with the Greenland deal. It
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produces its own oil and exports. It's the biggest oil exporter in the world, just
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so you know. It's got fertile soil all throughout. It's not
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desert-like in Australia. It's fertile soil. It's got strategically located.
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You can't force project into it. All those things, and it's got a free democracy, and
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it tracks people with the H1B visa, and it's got all these underlying
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elements of success built into it. It's quite
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amazing, the American story, without going into much detail. So do I think
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it's in trouble? No, I don't. I'm not worried that the US is going to default or
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anything like that, even with 40 trillion debt. They can still get out of that, it's fine. They make a
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lot of money. I think it's fine, but it's interesting
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now what's happening because bond yields are going up. It's more expensive
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for the government to raise money now than it was. What
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does a 5% yield mean? It's one of the most important financial
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benchmarks in the world because it's the risk-free rate. It's the rate at which the
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US is effectively raising money. It influences
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all other borrowing costs. So a high treasury yield
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in the US can flow through to, and it will, it'll dictate bank
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mortgage rates. So for example, a bank can borrow at
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usually the, it can usually borrow at the overnight rate, which
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is very close to the risk-free rate. It can borrow at that rate. So let's say it's 5.2%. Banks
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can borrow at 5.2%. but they'll then lend out at
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the retail rate, say it's 6.5%, and the bank will take what's
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called a net interest margin. So they'll borrow wholesale, and they'll lend
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retail. And that's how banks make money, by and large. They'll
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borrow from you at an even lower rate, they'll pay you less
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than the bond, and they'll lend at a higher rate. So depositors get
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paid much less, or a little bit less. So you'll see it in your mortgage rates.
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So if bond yields are going up, it will dictate that the RBA or
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the Federal Reserve or whoever the reserve bank is, they'll increase. If
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they increase the reserve rate because of the bond yields, then
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you're going to see a knock-on effect at banks. Banks do
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not want to get a net interest margin amount. So that will increase
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retail rates to offset that and that's why you'll see 7% rates soon.
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In Australia, if the RBA raises again twice, you're
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probably going to see 7% interest rates. In America, it's already 7%, just so
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you know. So you've already seen the knock-on effect of your mortgage rates. Now, how
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that affects you is all of a sudden, honey, our mortgage repayment
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went from $4,000 last month up to $4,500. What? Why
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did that happen? Oh, because we had a 10% increase
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in our retail rate. So that's how it affects you.
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All of a sudden, you've got to then find $500 of extra after-tax dollars each
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month. So where are you finding it? You see what I'm saying here? This is the
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knock-on effect of the treasury yield to people's own household
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income. Commercial property loans change, your car loan might
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go up, will go up. Governments, like
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the US government, it's got 40 trillion in debt. It's own
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repayments on that borrowing is going up. That's why
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they're trying to, Scott Besson in America right now, he's trying to keep bond yields low.
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They're like, fuck, let's keep it low, because they don't want to pay more money on
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their flipping 40 trillion debt. Who would, right? That
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also affects you, the taxpayer, because if the government needs to raise more money
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to pay that, they'll tax you for it. So it's crowdfunding. So there's
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going to be more tax. That's how it impacts things. And of course, asset
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valuations, which I've spoken about on the show lots of times before. As
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bonds go up, rates will follow to curb the
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inflation and as a result of that, asset values
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fall. Let me just summarize this for you. Right
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now, to save the yen, Japan is
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selling U.S. Treasury bonds, a lot of them. China is
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selling U.S. Treasury bonds. People are selling U.S. Treasury bonds. So
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as they're selling the bonds, the yield on the 10-year note in America has gone
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up. So that means America is going to pay more in interest on
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its 40 trillion in debt. Now, it won't want to do that. It won't want
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to default either, so it'll print more money. So that helps inflation. Now, it
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won't want to let inflation get away, so it'll start to increase the
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Federal Reserve rate to curb spending. So, I
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think all roads lead to rate rises here. Now, when that happens and
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you have rate rises, it means that there's less propensity for people
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to borrow money to buy property and shares and other assets, which means
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if there's less demand for those things, to borrow money to buy those things, you're going
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to see the prices fall. Plus, if you discount those future cash flows
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back from an asset using a higher discount rate or higher interest rate
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from the bond yields being higher, you're going to actually find that the
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asset value today, the net present value is much lower. That's a mathematical formula. So
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the values of assets fall when the bond yields
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are up. So that's why we're seeing in America, housing's falling.
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Australia, housing's falling. Stocks and growth stocks have been,
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they should be falling more, they are presently now, but they should
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be falling more because of the discount rate, the bond yields are
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going up. But the AI story is so
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exciting. So the productivity growth is so high that they're just bucking
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the trend. They're going for it. So I don't know what's going to happen there, but usually
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if the bond yields are going up, the value of the current share price
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of those companies usually falls. So I hope this is making sense to
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you. I'm just trying to impart here these basics. But
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if you want some real more practical like money
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moves to make that's not about bond yields, then I'd encourage you to go grab
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the Money Buys Happiness book. You just go to moneybuyshappinessbook.com, get the book,
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it'll give you the framework to follow to turn your finances around in the next 90 days, okay?
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That's for someone who's watching this going, Lloyd, tell me about how I get my finances on track. Just
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go get the book, at the end of the show notes, grab the link, start there. So
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why does this matter to you, the bond yield thing? Explain how it's going to pass
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on the costs, okay? Asset full fall, rates
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will go up, mortgages will get harder, inflation
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might increase, rates will go up to curb that. It's a precursor to
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a recession. if that makes sense because there's a
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thing called the yield curve and if long-term bonds have a high yield,
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it means that I'm lending my money for 10 years and
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I generally want to get more return than if I'm lending
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it for 3 months, right? So the yield
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on the maturity rates goes up, okay? But occasionally, it flips where
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then short-term rates become higher than
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long-term rates. So let me explain this
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thing called the yield curve, because you'll see the yield curve being spoken
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about on financial news, etc. So in a normal scenario, you're
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going to see, if I were to draw a curve like this, a
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normal yield curve, that short-term rates are
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lower than long-term rates, but over time, the rates should be higher. That's
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called a regular yield curve. But then what happens
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is the yield curve inverts and it goes the other way, like that, concave this
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way, because short-term rates are higher than long-term
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rates. That's called an inverted yield curve. And
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that historically has shown to be the precursor to a
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significant recession. It's a pre-recession indicator. When
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the yield curve inverts, I think the New York Fed
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did a research paper on this and they found that when the yield curve inversion happens, it
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has preceded six US recessions. So
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it's in the data. But here's the twist. The US yield
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curve isn't inverted right now. It's not. If you look at the
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three month, it's 4.14 or something, two years, four,
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10 years, five, and 30 years, 5.34. So the
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yield curve is steady. It's not inverted. So it's like, is there a
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precursor to a recession? So if someone says bond
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yields prove that an economic collapse is imminent, it's a little bit too
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simplistic because the classic recession indicator that it is not there. It's
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not flashing the usual way. So why are the
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long-term bond yields rising? Why is that happening? Mainly
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the reason for it is because of inflation. So investors don't want to lend money
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at 3% for 10 years if inflation could run near that level. So
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they demand compensation for it. So inflation is currently still elevated. So
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the Fed raised rates lifting the target from
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3.75% to 4%. Saying inflation remains elevated,
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so there's an issue with this inflation. That's why increasing rates, okay now
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I know Donald Trump wants them to fall, but it looks like they're going to continue to rise to
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curb this inflation So interest rates may stay higher, so
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if investors believe that the central bank will keep raising rates It means the long-term yield
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can rise so that's why you're seeing this normal yield curve happen right
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and so the Fed projects that the rates will They'll
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stay elevated for probably a couple of years a year or two certainly
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by the end of 2027 so 18 months And this is where it gets
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really interesting. The governments are currently
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issuing enormous quantities of debt. And
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the reason for that is because they're funding wars and they're funding flipping,
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oh my God, I think they just borrowed five trillion. There's a huge amount of debt
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being borrowed too, because Donald Trump said we can borrow and spend our way
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out of this $40 trillion of debt, okay? So
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there's more supply of bonds happening, which means investors
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need to absorb more debt. And so the investors will
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demand a high yield for it, like I said before, with what's happening with who's releasing and
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selling these treasury bonds. And then you add on top of that the uncertainty in
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oil, war, inflation, fiscal policy, all the debt, the central
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bank uncertainty, what's going to happen. And so people are just demanding a high yield,
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and that's why. The yield curve doesn't
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automatically just mean recession, it means if you want my money
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for the next 30 years, you're going to pay me more because of the uncertainty. Does
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that make sense? I might be repeating myself, but the challenge with it is
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that this accumulation of debt is so big in the United States that
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if that continues to happen, the federal debt could
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run beyond 100% of GDP. Michael
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Burry said that it could eventually evolve into a Ponzi scheme where they're not making
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enough money to even pay the interest. And then we got some problems. Then you could see
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a huge catastrophe. I wouldn't even, I can't even imagine what
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would happen if the United States couldn't pay their
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debts. But for now, it's okay. The energy cost, I think, is
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a trillion. and they can service it, but as long as
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it doesn't get out of control. So I think if
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the government can get control of its spending, which is easier said than done, we
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would start to see bond yields fall. But Jamie
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Dimon has come out and said the bond market is going to crack, whatever that means, and
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I believe at that point America will just have to print, which kind of lends
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itself to this inflation story. So I actually think that
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we would see inflation rise. Now, if that happens, there's some interesting things.
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It's probably the precursor to this massive commodities boom.
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Because if you're long commodities, then you've got physical assets and
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you're going to see them rise in relation to the currency. So,
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that's why I think how this affects you and your investing is, I think we're about
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to see a huge economic, a commodity super cycle, oil, copper,
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metals, blah, blah, blah. We're probably going to see a huge uptick in that, other commodities,
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food. And so, I think we're going to have elevated bond
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yields for the foreseeable future. And that's
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why, and you're going to see then if they print money, there's an inflation, there's rates
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go up, then you're going to see higher term deposit
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rates at your bank and a higher risk-free rate, which
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is fascinating. And if you look at what Warren Buffett's doing based on this information, he's
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currently got $400 billion in cash and T-bills. So he's
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saying to himself, Hey, I'm going to get 5% risk-free. Why
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would I even bother deploying this into stocks and other things? I can risk-free, done. I
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can deploy 400 billion. So I understand these things enough to position
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half of our portfolio in commodities. And I've positioned, I don't
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mean pure commodities, businesses that mine oil and
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copper and a railroad stock. So then on the other side of
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that, I've got half the money in turn deposit because I'm getting a 5.13% return
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on that risk-free. So I'm positioned basically
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to see this inflation high bond
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yield story through the next few years. And I'll
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make a risk-adjusted return on the investments of a really nice amount,
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producing cashflow. It all makes sense to me. And
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it's why I'm not long property. It's why I'm not long growth stocks. Because
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I'm seeing that the fact of the matter is that it
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appears that the United States doesn't have this under control. And they
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don't have inflation under control. We don't have inflation under control in Australia. We're going to see
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rates rise here. This thing isn't finished yet. Oil
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is the last commodity to actually show up in
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a super cycle in terms of inflation adjusted pricing. And
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it should show $200. So I'm like sitting here waiting and
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waiting. So I'm sitting pretty, I'm just, I'm waiting to see this story out.
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The tricky part about that is how does it finish? How does it transition?
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What does it look like at the end? And I don't think it's going to be
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slow. I think we're seeing precision inflation, high oil prices, higher
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central bank rates, government deficits will rise. I think this will continue. And
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so I'm positioning accordingly, but KB,
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if you do own growth stocks, good quality, high quality companies, it doesn't mean run
18:29
out and sell them. It just means what else can you diversify into
18:32
to protect yourself in this inflationary environment in case the
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AI thing bends a little bit? what else are you buying or
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how you position your capital accordingly. That's what I want you to consider
18:43
from this episode. So at least now, you know what a bond is,
18:46
why it's important, how it affects the global economy, how it affects your own personal pocket,
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right? You don't ask whether the 5% bond yield means the economy is going
18:53
to collapse, but you'd want to ask yourself the question, like, why are they rising? Inflation,
18:56
growth, government debt, loss of confidence. And what's the yield curve
19:00
doing? Is it inverted or is it steepening? And it seems to be steepening. So
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can you handle, and can governments handle, can businesses handle higher
19:08
rates for longer? And if the answer is no, how can you position yourself to
19:11
do that? And that's what I'll impart to you in this episode. So hopefully you feel
19:14
now more equipped to have a conversation with an investment banker about bond
19:18
yields at the next cocktail party you might be invited to. Do they still do those? And
19:22
again, this is just to educate you. So if you've enjoyed this episode, hit
19:26
us a subscribe. If you wanna learn how to invest in shares and so
19:29
forth, go back and check out our masterclass that we did. Great
19:33
piece of content, go check that out. And of course, share this with a friend and
19:36
go to the show notes and check out the other resources we have. And I'll see you in the next episode.