Lacy Hunt on the Federal Reserve

The Hoisington Investment Management Company has been completely slammed in the past year because of their bullish projections on long-dated treasury bonds, but one of their principals, Lacy Hunt, makes for always educational reading. The fund’s Q3 commentary is well worth reading. Key takeaway:

The Fed’s mettle will be tested because highly over leveraged institutions will fail as they historically have done in such situations. Bad actors or their enablers should be directed to bring their collateral to the discount window or, if necessary, to the bankruptcy process rather than be given bailouts that have severely widened the income and wealth divides in the U.S. while causing the Fed to sacrifice price stability that’s so essential for broad-based economic gains.

This is the goal of using monetary policy in the current circumstances – there is no gain without pain. And the pain is coming.

We look at the trajectory of the 30-year US bond yield:

An investor that was long this since the beginning of the year (a rough proxy for a 25-year duration product is TLT) would be down about 32% on price. This is more than the S&P 500, which has seen “only” 25% depreciation to date.

Does the pain get worse? Probably. I’m wondering what institutions out there are unduly exposed to the 30-year yield rising to some “unthinkable” level, say, 500bps before they blow up. Just remember – in September 1981, the 30-year yield got to 15.2%!

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