The Trump bear market for bonds is fast arriving

Republican tax package will definitively put an end to 36-year upswing for Treasuries

John Plender

With Donald Trump set to sign off on the Republican tax package by Christmas, it seems almost certain that the president will be definitively putting an end to the 36-year bull market in US government bonds. With hindsight, we can identify the inflection point as July 5 last year when 10-year Treasuries closed at a rock-bottom yield of 1.37 per cent. The economist Paul Schmelzing, in a paper for the Bank of England that charts the risk-free rate back to the 13th century, points out that this is without historical precedent.

The immediate question is how much damage a bear market might inflict on investors. The most relevant pointer is the bond bear market of the second half of the 1960s. The parallels with today are striking. For a start, the US labour market was tight. Unemployment fell from 5.5 per cent at the end of 1963 to 3.6 per cent at the end of 1966. There was little or no slack in the economy and considerable complacency about inflation which was around 1.5 per cent in the middle of the decade.

There was fiscal activism: tax cuts under President John F. Kennedy in 1964 followed by increased public spending under his successor Lyndon Johnson for the Great Society programmes and the Vietnam war.

The US Federal Reserve started tightening under William McChesney Martin with a half per cent increase in the discount rate in late 1964 and the same again in late 1965 — notably similar timing to the Fed’s behaviour in the current cycle. Another interesting parallel is that no one was entirely sure how accommodative monetary policy was in the mid-1960s.

While Martin had famously remarked that the task of central bankers was to take away the punchbowl just as the party gets going, monetary policy was reactive rather than pre-emptive and conspicuously slow. Both Congress and the White House were strongly opposed to interest rate rises.

By the end of the decade, workers’ calls for increased pay were vociferous and inflation had taken off, surging to a peak of 6.4 per cent in February 1970. Mr Schmelzing estimates that bond investors lost 36 per cent in real terms between 1965 and 1970.

Happily for today’s investors, there have been significant changes in the way monetary policy and markets work. Much of the stock of government IOUs is now in the hands of price-insensitive investors, such as pension funds, that hold the paper to maturity to match pension liabilities. For them, mark-to-market losses are neither here nor there. Workers have lost much of their bargaining power as a result of globalisation and new technology. Despite resort to quantitative easing, central banks around the world are finding it difficult to raise inflation to targeted levels.

Fiscal policy is more transparent. The Johnson administration doubled spending on the war without informing Congress, which would be unthinkable today. Meantime, monetary policy now involves inflation targeting and explicitly aims to be pre-emptive. Since the so-called taper tantrum in 2013 when the then-Fed chairman Ben Bernanke rattled the markets by proposing to reduce the central bank’s asset purchases, the Fed has communicated with extreme care and looks less likely to puncture the bond market.

Future Fed chair Jay Powell in his comments to the senate joint economic committee last week indicated that he would continue along the path adopted under the outgoing Janet Yellen.

Whether Mr Trump will bully Mr Powell as ferociously as Johnson bullied Martin remains to be seen.

Above all, as Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, has recently emphasised, the disastrous inflationary experience of the 1970s has made it clear how costly it can be to lose control of inflation and allow inflation expectations to become unhinged.

Today, the problem is less one of complacency about inflation than the difficulty of understanding how the economy works in the post-crisis environment, securing a safe exit from unconventional central bank measures and handling the political fallout from rising inequality that has been exacerbated by central bank market rigging — all this against a background of bigger deficits and debt.

The new tax package, as well as being an unnecessary fiscal stimulus in an economy growing at an annualised rate of 3.3 per cent, will further increase inequality. The impending Trump bear market in bonds will not want for excitement.

The Madness of King Donald


President Donald Trump

WASHINGTON, DC – Much of America’s capital has entered a state of near-panic. In recent days, President Donald Trump has been acting more bizarrely than ever, and the question raised in the mind of politicians and civilians alike, though rarely spoken aloud, has been: What can be done with this man? Can the United States really afford to wait for Special Counsel Robert Mueller to wrap up his investigation (on the assumption that he’ll find the president guilty of something)? That could still take quite a while.

The question of timing has become increasingly urgent, given the heightened danger that the US will deliberately or accidentally end up in a war with North Korea. That risk, coupled with Trump’s increasingly peculiar behavior, has made Washington more tense than I’ve ever known it to be, and that includes the dark days of Watergate. To put it bluntly: the worry is that a mentally deranged president might lead the US into a nuclear war.

In just the past week, evidence of Trump’s instability has piled up. During an Oval Office ceremony to honor Native-American heroes of World War II, he offended them by issuing a racist comment. He picked an unprecedented and unnecessary fight with the prime minister of the United Kingdom, supposedly America’s closest ally, by retweeting a British neo-fascist group’s anti-Muslim posts. In an effort to win a Democratic senator’s vote for his pending tax-cut bill, he traveled to her state and told lies about her record (though the tax bill was so tilted to the richest 1% of Americans that no Democratic senator voted for it). And he continued to bait North Korean leader Kim Jong-un, who seems equally unstable.

At the same time, both the Washington Post and The New York Times ran articles containing disturbing stories about the president’s private behavior. Trump, it was reported, told people close to him that he considers the infamous “Access Hollywood”recording of him joking, off-camera, about grabbing women’s genitals to be a fraud, even though he admitted its authenticity and apologized after the Post released it in the final weeks of the presidential campaign.

Trump has also been revisiting his mendacious claim about Barack Obama having not been born in the US – the bogus allegation that launched his political career, which, under pressure from advisers, he’d renounced prior to the election. He said in a tweet that he had turned down Time magazine’s suggestion that it would name him “Person of the Year,” because it wasn’t definite. (Trump sets great store by such appearances on Time’s cover). But a Time official said that no such thing had occurred.

The fact that Trump appears to have some mental disorder, or disorders, has created a dilemma for psychiatrists, politicians, and journalists alike. The American Psychiatric Association has a rule that its members may not offer diagnoses of people they have not examined. But, given what some psychiatrists see as a national emergency, many have broken the rule and spoken or written publicly about their professional assessments of Trump’s mental state.

The most widely accepted view is that he suffers from a narcissistic personality disorder, which is far more serious than simply being a narcissist. According to the Mayo Clinic, such a disorder “is a mental condition in which people have an inflated sense of their own importance, a deep need for excessive attention and admiration, troubled relationships, and a lack of empathy for others.” Moreover, “behind this mask of extreme confidence lies a fragile self-esteem that’s vulnerable to the slightest criticism.”

This definition is all too reflective of traits that Trump regularly exhibits. Another view held by a number of medical professionals, based on how Trump spoke in interviews in the late 1980s and how he speaks now – with a far more limited vocabulary and much less fluency – is that the president is suffering from the onset of dementia. According to the highly respected medical reference UpToDate, a subscription-financed service used by professionals, the symptoms of dementia include agitation, aggression, delusions, hallucinations, apathy, and disinhibition.

Numerous Republican members of Congress are deeply worried about Trump’s capacity to handle the presidency – an incredibly demanding job. Secretary of State Rex Tillerson, rumored to be replaced soon, is said to have called Trump a “moron.”

Trump’s heightened erratic behavior in recent days has been attributed to his growing anxiety about Mueller’s investigation into his and his campaign’s possible collusion with Russia in the Kremlin’s effort to tilt the 2016 election in his direction – an investigation that could end in a charge of conspiracy. (Trump appears to be the only significant figure in Washington who won’t accept that Russia interfered.) And that increasingly bizarre behavior came even before the news broke, on December 1, that Trump’s first national security adviser and close campaign aide, retired General Michael Flynn, had agreed to plead guilty to one count of lying to the FBI in exchange for his cooperation with the investigation.

What made this highly significant was that Flynn is far and away the highest former official whom Mueller has “flipped.” Indeed, the generous plea deal makes it clear that Flynn is prepared to name figures higher than he was in the campaign and the White House.

That’s not very many people. It has already been speculated, with reason, that Flynn will point a finger at Trump’s son-in-law and senior adviser, Jared Kushner. But Trump’s several earlier efforts to steer prosecutors away from Flynn were strong signals that Flynn knows something that Trump desperately hopes that prosecutors won’t find out. We may learn what that is fairly soon.

Meanwhile, American and the world nervously await Trump’s reaction to this latest very bad turn of events for him.

Elizabeth Drew is a regular contributor to The New York Review of Books and the author, most recently, of Washington Journal: Reporting Watergate and Richard Nixon's Downfall.


Getting Real About Augmented Reality

By Jon Swartz

Getting Real About Augmented Reality
Getting Real About Augmented Reality Photo: Getty Images

It had all the makings of a long overdue coming-out party for augmented reality.

In June, Apple (AAPL) unfurled a new technology, called ARKit, for its army of developers to create AR apps for hundreds of millions of Apple’s mobile devices. “Simply put, we believe augmented reality is going to change the way we use technology forever,” Cook said during the company’s fourth quarter earnings call last month.

Alphabet (GOOGL), Facebook (FB), Microsoft (MSFT), IBM (IBM), and others have already placed their bets on what they consider one of tech’s Next Big Things. Last week, Amazon (AMZN) joined the fray with Sumerian, a new platform for developers to build AR, VR and 3-D apps.

Gaming isn’t the only industry poised to cash in. Job training, replacement of manuals (Mercedes-Benz), retail shopping (Zugara), parts assembly (Boeing) and other key industries are eyeing AR as a potential jackpot and means to boost their bottom lines. DHL estimates AR-aided order picking improved 25% for customer Ricoh. Coca-Cola, Siemens, and others have boasted significant improvements in productivity, worker efficiency and safety from AR-enhanced assembly, remote-expert assistance and customer service.

A new report on Tuesday suggests an emerging technology whose tentacles could have far-reaching implications for corporations and consumers. ARtillry, an immersive-technology research company, estimates that the enterprise AR market will skyrocket to $47.7 billion in 2021 from $829 million in 2016 and that consumer AR will reach $15.8 billion in 2021 from $975 million in 2016.

By early 2019, as many as 900 million smartphones and tablets could be capable of supporting AR apps fashioned from ARKit, Google’s ARCore and Facebook’s Camera Effects, according to Digi-Capital, an augmented and virtual reality adviser. By 2021, it could grow to 3 billion.

But first, a reality check.

Those breathless words at the Apple event in the spring had all but vanished by September, when the iPhone X was introduced. Nary a word was uttered about ARKit and some developers were openly grumbling about the onerous cost of creating apps.

So don’t start the revolution just yet.

The slow rise of AR is symptomatic of an industry that thrives on ever-changing ideas and concepts – often before its customers are ready. An alphabet soup of technology, from AR and VR to AI (artificial intelligence) and IoT (Internet of Things) is being ruthlessly pursued by companies large and small in a race for supremacy in the trillion-dollar high-tech industry.

“A lot of people got too excited, but you have to hold your breath before it becomes real in a few quarters,” says Shel Israel, co-author of The Fourth Transformation: How Augmented Reality & Artificial Intelligence Will Change Everything.

Breakthrough technology takes time, money and – most important – customers to take hold.

AR, for now, fits neatly in the coda of underwhelming technology like artificial intelligence.

When new, immersive technologies emerge, the experiences of consumers often wildly diverge from what app developers originally expected. Such has been the case with AR-like products for decades. In 1968, Ivan Sutherland, the father of computer graphics, came up with a “head mounted three-dimensional display” that overlaid a 3-D image onto the real world.

A variation of Sutherland’s invention was used by Defense Advanced Research Projects Agency (DARPA) to help fighter pilots navigate jets. But the use had limited commercial appeal because it demanded so much computing power. Boeing eventually deployed AR at its 777 assembly plant near Seattle to track aircraft components.

Fast forward to the 2010s and Google Glass, a bulky AR play left consumers cold, prompting Google to return to the drawing board.

The potential for AR is undoubtable because companies and vendors keep trying despite technological hurdles. “We’re not quite there – hardware, software, not one standard operating system,” says John Cutter, product manager of IBM Watson, AR/VR Labs.

Widespread adoption of AR has lagged because high-definition content is hard to create. The leap from simple 2-D smartphone overlays from Pokemon Go to 3-D high-definition and photorealistic AR graphics is a “huge undertaking,” says Josh McHugh, CEO of Attention Span Media, a digital and social media agency.

It’s also expensive. An AR/VR content developer from a major publishing company told McHugh it costs about $250,000 to create a good AR app or experience, and AR head gear can put developers back $1,000 to $1,500. Great AR hardware simply isn’t available to the public.

Magic Leap is illustrative of the AR echo chamber: Despite years of anticipation and nearly $2 billion in investments, the much-ballyhooed start-up has yet to release a product. When The Information got hold of one of it prototype devices in 2016, it registered its disappointment, prompting a tweetstorm from Magic Leap CEO Rony Abovitz.

Culturally altering technologies takes time to catch on with a mainstream audience. The popularity of the modern cell phone is credited to iPhone, which made its debut in 2007.

The first iPhone was many things: a touchscreen mobile phone with camera and Web-browsing capabilities. It was also slow, lacked storage and sported a small screen. As smartphone chips, hardware design and data networks evolved, so did its popularity.

Like iPhone and other technologies, AR is dependent on advances in chips -- a speedy new Qualcomm cellular chip should help matters -- and advances in hardware design. Microsoft’s HoloLens may be too big, slow and goofy looking, but it will evolve to the satisfaction of a wider audience. Meta AR’s head set has earned raves, but yet to reach a wide audience. Snap’s Spectacles have the right form factor but not the ideal user experience.

Still, there are encouraging signs. Google is developing an API that would let advertisers incorporate AR and VR into their content. Perhaps iPhone X, with its distinct face-recognition feature, could accelerate acceptance of AR if that feature can be used to project images, McHugh and others say.

AR “is not mainstream yet [with consumers] but mainstream among developers,” says Ori Inbar, founder of Super Ventures, a fund for AR start-ups. “Any Fortune 500 company that has some respect has deployed it.”

Apple reportedly is working on an AR headset, and ARKit and ARCore will help drive down the cost of creating AR content for a new generation of developers. And Google is developing an API that would let advertisers incorporate AR and VR.

Only Apple has shown the technical and marketing chops to make augmented reality a reality via ARKit, iOS 11 and the 500 million devices that support both, says Jon Cheney, CEO of start-up Seek, a content platform for AR.

The question is, when?

We’re still waiting for AR’s coming-out party.

How Tax Cuts Will Trigger Recession

By Patrick Watson

According to the more cynical pundits, government programs usually achieve the opposite of their intended goal. And sometimes they do.

For example, Richard Nixon’s “War on Drugs” is still in progress, but the drugs are definitely winning.

Some government programs, however, are more effective. Firefighters are doing a pretty good job extinguishing fires. The US Coast Guard saves lives every day. Public school teachers educate students who would rather be elsewhere.

And then there’s our increasingly dysfunctional Congress. Where to begin?

I’ve written recently how Congress’s new tax plan misses a chance to boost economic growth. Now I think it may be even worse. Instead of merely failing to stimulate growth, the tax changes could actually launch a recession. I’ll tell you why in a moment.

Image: Renegade98 via Flickr

Long and Weak Expansion

I explained two weeks ago why tax cuts won’t stimulate the economy as much as Republican lawmakers think. Most CEOs say they will use any tax savings for stock buybacks or dividends, not new hiring or expansion.

Since then, the Joint Committee on Taxation, Congress’s nonpartisan scorekeeper, found the Senate tax bill would spur only 0.8% of economic growth, split over 10 years, and add a net $1 trillion to the national debt.

But let’s set aside debt for now. What if, instead of little or no growth, this tax bill sets off an outright contraction?

The current economic expansion is now the third-longest since World War II. It’s also the weakest.

Here’s a chart I showed last summer.

Source: BCA Research

The yellow line is the current recovery that began in 2009. Only the 1960s and 1990s growth periods went on longer—and both had much higher growth.

So, just by length of time, we’re already due or overdue for recession. Yes, the economy could improve further from here… but probably not for long.

Potential Achieved

Last week, the Commerce Department revised its third-quarter inflation-adjusted GDP estimate to a 3.3% annualized pace. While that was good news, it also marked something ominous.

In addition to actual gross domestic product, economists track “Potential GDP.” That’s how fast the economy is capable of growing, considering the number of available workers, productivity, and other factors.

If subsequent data confirms last quarter’s 3.3% growth, it will mark the first time since 2007 the US economy achieved “maximum sustainable output.”

Image: Washington Post

The gap between the gray line (potential GDP) and the red line (actual GDP) represents unused capacity. You can see we had a lot of it at the recession’s 2009 depth. The gap slowly shrank since then. Now it’s closed.

Great news, right? Yes, it is—but don’t celebrate just yet.

The End Is Near

Actual GDP can’t stay above potential GDP for long before bad things start happening. This chart proves it:

Image: Washington Post

We see here how GDP moved above and below its potential since the 1970s. Notice that each time the green line went above zero, a recession (the gray bars) began soon after.

“Soon” can vary, of course. GDP ran above potential for extended periods in the late 1990s and 2006–2007, but in both cases, intense downturns followed. Plus, the Fed wasn’t tightening as it is now—which suggests the current expansion is at least approaching its endpoint.

The Trump administration and congressional Republicans disagree, saying their tax changes will stimulate years of economic growth and more than pay for themselves.

President Trump himself said last month he thought growth could reach 4% and even “quite a bit higher.”

I agree we may get a quarter or two of 4% real annualized growth. But will it continue for years? Probably not, unless potential GDP takes a big leap.

Here is the potential GDP chart above, extrapolating the future as it would look with 3–4% growth over the next decade.

Image: Washington Post

I’m sorry this chart is so tall, but that red triangle is necessary to project as much growth as the president anticipates and that Congress says will pay for the tax cuts. The smaller yellow fan below it is the less thrilling estimate of nonpartisan economists.

In either case, to do what the Republicans predict, GDP must grow above potential for years, unless potential GDP rises in a similarly spectacular fashion.

That’s not impossible: a major technology breakthrough might do it, say, a cure for cancer that frees up more workers, or wearable supercomputers to make workers more productive.

But just as likely, a recession, natural disaster, war, or other shock could sharply reduce GDP.

The projections above don’t account for that possibility.

Booms Going “Boom”

Actual GDP can outpace potential GDP at the end of a cycle, but by definition, such growth is unsustainable. The inputs to higher production—available workers, productivity—can’t grow fast enough, so those booms end up going “boom.”

Now consider what else is happening.

The Federal Reserve is in tightening mode, both raising short-term interest rates and reducing its massive balance sheet assets. Fed officials think the economy is close to full employment, and they want to control inflation pressure before it gets out of hand.

If this tax cut finally passes—and I’m still dubious that it will—I don’t think it will create anything like 3–4% GDP growth. I think it will do the opposite, as the US Treasury borrows hundreds of billions more dollars to cover deficit spending. That will drive rates higher; not good for real estate or consumer spending.

Much like the War on Drugs gave us more drugs, the “War on Slow Growth” might give us even slower growth.

Image: Danlele Pesaresi via Flickr

Recession Triggers

Here’s where we are:

• The current expansion is long in the tooth, suggesting a recession could start anytime

• GDP growth is running above potential, which also points to recession in the near future

• The Fed is tightening, soon to be joined by other central Banks

• Treasury borrowing will likely increase in the next few years as deficits rise

• Bitcoin and other cryptocurrencies look increasingly bubble-like

All that is happening even if we get no surprises. War with North Korea, a NAFTA breakup, Chinese banking crisis, a hard Brexit—any of those could extinguish global growth.
My main fear as we entered 2017 was that the Fed would tighten too much and too fast, pushing the economy into a deflationary recession. I still think that’s the most likely scenario.

If this tax bill passes in its current form, the recession may happen sooner and go deeper. The combined fiscal and monetary tightening could be the triggers.

However, first we might get a sugar-high inflationary rally, which could last a while. GDP ran above potential for four years in the late 1990s, and for over a year in the housing craze.

Those were fun times while they lasted. Then the fun stopped.

One thing I’m positive won’t happen is another 10 years of uninterrupted 3% or 4% real GDP growth, as politicians so glibly promise. That’s pure fantasy.

Gravity still applies, no matter how many people wish it didn’t. We may get a demonstration soon.

See you at the top,