Economic Newsletter 39 2021

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Treasury Yield Update

Last week we reported on the yield rumble going on at the short end of the U.S. Treasury maturity spectrum. We explained that the yields are currently not structured as they would be if the market had a free rein, suggesting that the Federal Reserve’s June increase in its rate on reversed repos from zero to 0.05 percent went against market preferences. Judging from the ongoing yield mess, the central bank and the market are still not in agreement. The yield on 1-6 month Treasury securities have been bouncing around the 0.05-percent mark like high-school guys fighting over a date with the prom queen.

In other words, demand for Treasurys with 1-6 month maturity is higher than what is consistent with a 0.05-yield level. Yet, the Fed insists on going against the mainstream, and the only rational explanation is that the Fed is trying to return the sovereign-debt market to higher interest rates.

For a number of reasons, it is easier for the central bank to push interest rates upward by hiking yields on short-term securities, than trying to pull rates upward from the longer end of the maturity spectrum. A major reason is that higher interest rates are political dynamite. A rise in longer-maturity yield inevitably includes the ten-year Treasury, which is considered a benchmark and therefore has high media visibility. In a political climate where higher interest rates are controversial, a push upward from the bottom attracts less attention and therefore comes with a lower risk for political backlash against Fed chairman Powell.

Unfortunately, the politics of Powell’s reappointment refuses to die down. On Tuesday, Senator Elizabeth Warren explained that she opposes his helmsmanship at the central bank. She even went so far as to call him

a “dangerous man” because of the financial regulations that have been loosened during his tenure. “Your record gives me grave concern,” the Massachusetts Democrat told Powell while he was testifying before the Senate Banking Committee. “Over and over, you have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed. And it’s why I will oppose your renomination.”

On September 22, the Wall Street Journal aimed to defend Chairman Powell, though the Journal also suggested that under his chairmanship the central bank’s “biggest … mistake by far has been underestimating how much its policies would lead to inflation”. This argument misses the point that the Federal Reserve really had no choice but to monetize the enormous deficits of 2020 and – so far – 2021. There is little doubt that leading policy makers at the Fed understand the inflation threat; their problem is how to walk back its harmfully expansionary monetary policy.

Plainly, the central bank is caught between the fiscal-policy devil’s unending appetite for more spending and the deep blue sea of growing sovereign-debt market mistrust in long-term U.S. debt. When the Fed pushed up short-term yields back in June, the hope was apparently to move investors into longer-term Treasurys. Higher demand for those would have pushed down their yield rates, but after falling initially after the June rate hike, the average yield on the 10-30 year Treasurys has stabilized just above 1.6 percent.

This tells us that investors aren’t as eager as the Fed might need them to be, to buy longer-term U.S. debt. More than three months after the June increase, the Fed is still battling it out with the market over the short-term structure. Behold the absurdities on September 29, 29 and 30:

  • The one-month security paid 0.07, 0.05 and 0.07 percent, respectively;
  • The two-month security paid 0.04, 0.04 and 0.05 percent;
  • The three-month security paid 0.04 percent all three days; and
  • The six-month security paid 0.06, 0.05 and 0.05 percent.

In other words, two of these three days buyers of the one-month bill got more than buyers of the six-month bill. On average, over the past seven trading days the one-month bill has paid more than the two, three and six month bills, with the biggest margin being over the three-month bill: 0.057 vs. 0.036 percent.

Markets do not allow such arbitrage-like opportunities to exist more than momentarily, but since June this absurd yield pattern has been the norm rather than the exception. As Figure 1 reports, the average yield for 1-3 month Treasurys has actually become more volatile recently than it was earlier in the summer.

Figure 1

Source of raw data: U.S. Treasury

Figure 1 also illustrates a spike in the long-term maturity average. In two weeks, from Sept. 16 to Sept. 30,

  • The 10-year security has risen from 1.34 percent to 1.52;
  • The 20-year has increased from 1.83 percent to 2.02; and
  • The 30-year is up from 1.88 percent to 2.08.

Most of these increases have taken place in the past week.

These are not unprecedented increases per se, and would be logical if the Treasury market finally had come to a point where it learned to love longer U.S. debt. However, the sharpness of the rise suggest a different explanation, as does the fact that it coincides with prevailing, possibly even rising, uneasiness about the yields on the shortest Treasury bills. Therefore, a more likely explanation is that the rise in long-term yields is driven by politics. It cannot be ruled out that this increase in yield is the result of a deliberate attempt to create highly visible interest-rate turmoil around the debt-ceiling debate.

On Sept. 28 Jamie Dimon, CEO of JP Morgan Chase, made a highly publicized comment where he called a ceiling-driven default on U.S. debt “catastrophic”. This is unusual for the U.S. public debate, though not unheard of from earlier debt-ceiling battles. If there is a political intent behind Dimon’s comment, it will likely be followed by similar statements from others with comparable positions, whereupon interest rates will rise further and – as the ultimate goal – this be used as pressure on Republicans in Congress to vote in favor of raising the debt ceiling.

America’s Entitlement Dependency

There are three major sources of personal income: workforce participation, investments or equity, and entitlements. The composition of income from these sources is essential to the long-term resiliency of an economy: the more of the income that comes from, primarily, workforce participation and, secondarily, equity, the more resilient the economy will be through any phase of the business cycle.

By contrast, rising dependency on entitlements makes an economy increasingly vulnerable to adverse macroeconomic episodes. It is also a recipe for increasingly violent fiscal episodes, eventually resulting in a full-scale meltdown of the Greek kind. Therefore, it is troubling to see that entitlements have grown their presence in personal income in all 50 states. Using data from the second quarter of 2021 we can get an idea of where the economy is – and where the states are – in the recovery from last year’s artificial economic shutdown; unlike the first quarter, the second quarter is largely free of discretionary stimulus checks affecting personal income.

To get an idea of how our economy has changed we compare the Q2 2021 numbers to the same numbers from Q2 2019. That year was, of course, the peak year of the Trump economy. Nationally, in the second quarter of 2019 entitlements paid for on average 18.4 percent of personal income. In Q2 2021 that share had risen to 22.3 percent.

Put differently,

  • In Q2 2019 entitlements accounted for more than 20 percent of personal income in 13 states;
  • In Q2 2021 another 20 states had been added to that list.

Figure 1 illustrates the rise in dependency on entitlements:

Figure 1

Source of raw data: Bureau of Economic Analysis

It is worth repeating that Q2 in 2021 was not a “stimulus check” quarter. Except for minor spillover, those funds went out in Q1; to illustrate the effects of those checks on the personal-income data for that quarter, entitlements accounted for more than 20 percent of personal income in all the 50 states, exceeded 25 percent in 39 states, passed 30 percent in 23 states and topped 40 percent in West Virginia.

Again, by Q2 the extreme entitlement dependency had returned to what can be considered a “normal” level. In other words, Q2 data are more representative than Q1 data of how the economy is structured post-2020. For this reason, it is troubling to see that the increase in entitlement dependency from 2019 to 2021 is mirrored by a reduction in the role of workforce participation and equity as sources of personal income.* The equity-based share of personal income has fallen, with the national average declining from 20.1 percent to 18 percent. As for the states:

  • In Q2 2019, equity provided more than 20 percent of personal income in 19 states, with Florida topping the list at 28.7 percent and Wyoming coming in a hair behind at 28.6 percent;
  • In Q2 2021 only seven states edged above the 20-percent threshold, with Wyoming at 26.6 percent and Florida at 25.7 percent.

The relative decline in equity as a source of personal income is reflected in a small decline in actual equity-based income, from $914.2 billion in Q2 2019 to $912 billion in Q2 2021. By contrast, entitlements went from $782.4 billion to almost $1.1 trillion. This is driven in part by higher unemployment numbers and the unemployment-bonus program; states began phasing out the bonus program in Q2, but as we have reported in previous issues of this Newsletter, the main effect of the phase-out was not visible until July, i.e., the first month of Q3.

Figure 2 reports the share of unemployment benefits in personal income as a comparison between 2019 and 2021:

Figure 2

Source of raw data: Bureau of Economic Analysis

The rise in unemployment benefits as a contributor to personal income is reflected in the amount paid out per unemployed person. As shown in Table 1, this amount varies significantly across the country; states marked in green are opt-out states, though it deserves to be pointed out again that the unemployment bonus opt-out did not take full effect until Q3.

The numbers reported in Figure 1 are not actual payout amounts; they are, instead, an illustration of state spending on benefits if divided up as weekly benefits, among the individuals reported as unemployed. A very high number, as in Massachusetts or New York, is likely to some degree reflective of fraudulent unemployment-benefits filings (a point we made in our first report on the effect of state opt-outs) more than exorbitant per-unemployed benefits. That said, fraud does not account for anywhere near the bulk of state-to-state differences:

Table 1

Sources of raw data: Bureau of Labor Statistics (unemployed); Bureau of Economic Analysis (benefits)

In addition to unemployment benefits, the “other” category of entitlements accounts for a larger share of personal income now than it did in 2019. As mentioned, the stimulus checks were part of the “other” category, pushing first-quarter “other” entitlement payouts nationally to $2,586 billion. However, they do not have more than a marginal (lingering) role to play in the $960.4 billion paid out under this category in the second quarter. This number is to be compared to $495.4 billion in Q2 2019.

In total, the “other” entitlement category and unemployment benefits account for a significant share of personal income. Figure 3 illustrates a disturbing rise in dependency on entitlements:

Figure 3

Source of raw data: Bureau of Economic Analysis

Let us keep in mind that these dependency rates do not include Social Security, Medicare or Medicaid. In other words, America’s households are at a historic high in terms of government dependency. More than ever, the American family needs government handouts to make ends meet.

This does not bode well for a future fiscal crisis.


*) The definition of “equity income” is limited to dividends, interest and rent. It could be construed to include proprietors’ income, but this category is less obviously a distinction between workforce-based and investment-based income. Furthermore, the narrower definition of equity applied here is more easily tied to macroeconomic fluctuations than one which included proprietors’ income. However, for a more comprehensive analysis of the long-term effects of economic policy – especially fiscal policy – it is advisable to also include proprietors’ income under equity.