Bond Markets and Macroeconomics

Alexandra Scaggs is a senior writer at Barron’s covering financial markets with a special emphasis on bond markets, and she previously wrote news and commentary for the Financial Times and for Bloomberg. Alexandra joins the show today to talk about the current state of bond markets and what it means for the economy. David and Alexandra also discuss corporate debt, the inversion of the Treasury yield curve, and the lasting impact of the modern monetary theory debate.

David Beckworth: Our guest today is Alexandra Scaggs. Alex is a senior writer at Barron's covering financial markets with a special emphasis on bond markets. She previously wrote news and commentary for the Financial Times, and for Bloomberg

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

David Beckworth: Alex joins us today to talk about the current state of bond markets, and what it means for the economy. Alex, welcome to the show. 

Alexandra Scaggs: Thanks for having me. 

David Beckworth: Glad to have you on. I've followed your work. You write at Barron's now, you used to be at the Financial TimesFT Alphaville, we’ve interacted on Twitter. So it's great to chat with you in person, and to tap into your knowledge of the bond market. 

David Beckworth: Now with most guests, I ask them how did they get into this particular career path. In your case, financial journalism. So how did you become a journalist covering bond markets? 

Alexandra Scaggs: So when I first went into school, I thought I wanted to do finance. I figured I'd do something useful. Try to make sure I was employed after college. 

David Beckworth: Sure. 

Alexandra Scaggs: It turns out that I don't necessarily have the attention span for spreadsheets upon spreadsheets. But I do like covering it. It turned out ... I went to Washington and Lee University in Virginia, and they actually have a business concentration in the journalism school. 

David Beckworth: Okay. 

Alexandra Scaggs: So I ended up going into that. I figured okay, this will be useful because I can specialize. And I declared that major in I think 2007, 2008. Not to date myself. 

David Beckworth: Wow, good timing. 

Alexandra Scaggs: Yeah. It was funny of course, because I thought I'd do that because people didn't find finance or business all that interesting. 2009 rolls around and it's really the only game in town. 

David Beckworth: Was it easy to find a job at that time in journalism? 

Alexandra Scaggs: Well, it was easier I guess. 

David Beckworth: Okay, yeah. 

Alexandra Scaggs: I'm not sure it was easy for much of anyone to find a job back in '09. It was funny, my parents always said, "Oh you can do whatever you'd like after college, you just can't come back." But then youth unemployment rose above 15 percent. It was something absurd. And they were like, "Actually if you need to, you can come back." 

David Beckworth: Very nice. 

Alexandra Scaggs: Which was I think the sign that things were really rough. 

David Beckworth: So you worked for Bloomberg, and then you worked for Financial Times, now you're at Barron's. So what is it like to work there? You mentioned before the show that you were just in a newsroom meeting. So what goes on, the day in the life of a journalist? 

Alexandra Scaggs: Well at this latest meeting, we were basically pitching story ideas. Talking about things we find most interesting in markets. My day starts pretty early. I end up sort of catching up on the headlines from overnight. Reading my inbox, a lot of research. Because I find it's sometimes difficult to talk about bond type stuff really off hand. So I have to do a lot of reading before I call anyone. 

Alexandra Scaggs: So I do that, and then the mid-morning stuff is basically reporting, writing, waiting for edits, the sort of standard. I do try to get out of the office as much as I can. Just because it's nice to put faces to names and see people in person. 

David Beckworth: So you go meet actual practitioners on Wall Street and ask them for their views on the latest developments in bond markets? 

Alexandra Scaggs: Definitely. Because those are the people that are doing it. Talking to folks in the market is one of the best ways to figure out what's going on. 

David Beckworth: It sounds like it's an always interesting job. There's always something happening in bond markets. Bond markets are always responding to the latest political and economic news. So it sounds like you never are bored. You're always doing something interesting. 

David Beckworth: One of the things that has kept your interest, and all of our interest recently has been the flattening, and for at least a while, inversion of the Treasury yield curve. My understanding is it's actually not inverted right now. It's gone back to more of a flat position. But for at least last week, week before it had inverted. 

David Beckworth: So the Treasury yield curve shows us the relationship between a different maturities of Treasurys and interest rates. So one month Treasury bill versus a 10-year Treasury bond. What you're saying is typically the 10-year Treasury interest rate is higher than the real short term interest rate on a Treasury bill. That's because if you're going to lend the government for longer, there's a great chance of default, or interest rates change. Or some kind of risk, and you've got to be compensated for that. 

Alexandra Scaggs: Inflation. 

David Beckworth: Inflation, that's kind of the standard story for the reason it's higher, is that right? 

Alexandra Scaggs: Yes. Because inflation ends up eroding the underlying value of the money you get back. So the higher you expect inflation to be, the higher interest rate you should ask for, to tie up your money for that long. 

David Beckworth: Okay so we've got this yield curve. It's typically what we'd say upward sloping because you're looking at interest rates again from short maturities to long maturities as you said. It's typically upwards sloping, and that's a good sign, that's normal. Inverting is when that upward sloping line that draws this relationship begins to flatten. Then eventually it inverts. Which would mean the short term interest rates go above the long term interest rates. 

David Beckworth: Again, we briefly experienced this here. We're not in the first week of April and late March we experience this. Why is that such a warning sign? Why do people get concerned when they see that happening? 

Alexandra Scaggs: If you think about it, it really doesn't make a ton of sense. In what conditions would you want to tie up your money for 10 years, rather than three months. That would be times when you expect inflation to fall over the long term. Or you expect interest rates to fall over the longer term. Usually that means recession, if interest rates and inflation are falling. 

Alexandra Scaggs: Historically actually a lot of strategist and economist types have looked at this. The difference between the three month, and the 10-year Treasury yields are a pretty good indicator of recession. 

David Beckworth: Okay. So if the long term interest rate, the 10-year goes below say the three month, it's an indicator that a recession is coming, generally that's been the case. And it's not a good sign, because if the 10-year's falling, it's indication that the market thinks that in the future short term rates are going to drop. Because inflation is going down and the economy is going down. We had that. 

David Beckworth: Now my question is that I've read some of your work, some of your colleagues’. You've all been expressing some caution in how we interpret it. That maybe it could be pointing to a weakening through a recession. But maybe it could also be pointing towards something unique or different. Is that right? 

Alexandra Scaggs: Yeah. It's tough because of course every time yield curve inverts, everyone wants to say this time is different. But there are some interesting things about this. 

Alexandra Scaggs: First of all, the yield curve didn't stay inverted for very long. That's a really good sign. Because I was looking at one strategist’s sort of historical analysis of this. He said it usually takes about 10 days of inversion to be a really strong recession signal. 

Alexandra Scaggs: It only stayed that way for about half that time. 

David Beckworth: Okay. 

Alexandra Scaggs: So that's probably the most important footnote there. Secondly, the Fed is actually playing a much larger role in the Treasury market right now, than it has historically. 

Alexandra Scaggs: So people have been saying the 10-year yield is lower than it should be. Because the Fed still owns a bunch of 10-year notes. Which it can be tough to make that argument. But I do think that there are some distortions. Because the two year yield actually did not go above the 10-years yields. Which was surprising. 

David Beckworth: So the inversion wasn't a complete inversion. It wasn't a symmetric inversion, only some of the short term rates went above the long term 10-year yields. I came across that in your writing. That is interesting. And you're saying the Federal Reserve’s balance sheet policies may have some bearing in what we're seeing with long term Treasurys. They've decided to keep its balance sheet large, and that means they're going to be holding some long term Treasurys. In fact some of those mortgage backed securities are holding ... will eventually convert into Treasurys. 

David Beckworth: So there's this elevated demand for Treasurys. The argument is at least that that's going to lower the interest rate on the remaining outstanding Treasurys. Is that right? 

Alexandra Scaggs: Yep, that is the general logic behind the argument. Though I do think people have been talking about the potential maturity of what the Fed ends up owning. And it could end up owning shorter term securities. 

Alexandra Scaggs: So I'm not sure if they're going to go all the way into bills, but around the two year mark, maybe shorter maturities there. 

David Beckworth: Okay. So it's an open question what the composition of the Fed’s balance sheet will be. It will be larger, but we're not sure what. If they hold short term securities, like a treasury bill, or treasury notes, what you're saying then is that this argument may not be as convincing. But it's at least one explanation given for why, again, it might be different this time. Why the inversion that we did see, may not be so consequential. Maybe we shouldn't be so worked up. 

David Beckworth: Kind of the message I'm getting is maybe it is different this time. I hope it is. I guess one of the concerns I had though, coming in out of last year. The Fed seemed really eager to raise short term interest rates. Without any concern ... they've changed their tune since then but if you recall John Williams saying, "Hey if the yield curve inverts, so be it. If that's what it takes to get to normal, so be it." 

David Beckworth: There's a number of officials saying it's okay to keep pushing rates up. Then we had that December rate hike. And many are calling that maybe an accident, or a mistake. So there was this sense, at least last year, that the Fed was really gung-ho, and ready to tighten no matter what. That might have contributed to the normal understanding of why yield curve has flattened or inverted. But there's these other stores going on is what I hear you saying that could kind of be offsetting that interpretation. 

Alexandra Scaggs: It's funny to see how quickly the Fed changed direction too. Because they clearly freaked markets out a lot in the fourth quarter. The amount of volatility that we saw was really, really substantial. I think the Fed noticed, clearly. 

Alexandra Scaggs: Even the Fed continuing to raise rates, I mean, a lot of times it's possible that what the yield curve could be signaling when it inverts historically is just that the Fed has raised rates too high. 

David Beckworth: Yeah. 

Alexandra Scaggs: They're maybe raising rates so high that it causes a recession. Though I don't want to say that for sure, because I think it's difficult to pinpoint what exactly causes a recession. But there's definitely a body of academic work that says that sort of thing. 

David Beckworth: Okay. Well we're going to be hopeful that the yield curve flattening, and then temporarily inverting is not an ominous sign. We thank you for your- 

Alexandra Scaggs: Fingers crossed. 

David Beckworth: Yeah keep your fingers crossed, and thank you Alex for that positive spin. But again, that's just one potential interpretation is what you're telling me. There's others more pessimistic. But it’s an interesting story none the less, and we'll have to follow and keep up with it. Maybe get back to you later in the year and see what actually happened. 

David Beckworth: Now related to this discussion of the Treasury yield curve is the fact that there is this underlying government debt. This talk of US government debt. Some have concerns about the size of the debt. You often hear this number $22 trillion thrown around, but in terms of truly marketable US government debt it’s closer to $15.7 trillion, last I checked. There's a good portion of that $22 trillion, or the difference between a $22 trillion, and $15.7 trillion is debt held by the government. So it's not really a liability. 

David Beckworth: So we have this $15.7 trillion outstanding, that's about 75 percent or so of GDP, and more deficits are projected. So as a percentage GDP it is higher than before 2008. More deficits are projected. Yet we see really low interest rates on the 10-year Treasury. At least by historical standards. 

David Beckworth: So last I checked it was around 2.5 percent for a 10-year Treasury yield, I'm not sure what the 30 is. But that's pretty remarkable. If you assume there's going to be average inflation of two percent, that's not much of a real return on a 10-year Treasury. In fact in March, it fell down to 2.37. So it's gotten really low despite the run up in deficits. Despite the growing stalk of debt. What does this tell us about the debt capacity of the US government? 

Alexandra Scaggs: Well what's really interesting right ... I don't know if you know that James Carville quote from the 90s, he said something like when he dies he wants to come back as the bonds market, because they can scare anybody. 

David Beckworth: Nice. 

Alexandra Scaggs: You know the whole idea of bond vigilantes pushing up yields to punish governments that spend too much. In a world with QE, with quantitative easing from global central banks, it's really tough to make that case. I think we're seeing that the United States debt capacity is a lot higher than people thought. Because the interest rates tell the story. 

David Beckworth: It's clear to me, if you believe in markets, and markets do tell us a story, prices tell us a story. It does suggest that the US is not a credit risk yet. It sounds like you attribute some of that to QE, the Fed buying up assets. Are there other stories one could tell too? How about the safe asset shortage story? So even in the absence of central bank intervention, would rates be low anyway? Because of demographics, because of the demand for safe stores of value from Asia? 

David Beckworth: How much weight do you put on central bank intervention versus this natural other developments occurring in the global economy? 

Alexandra Scaggs: I think it's really all part of the same story. 

David Beckworth: Okay. 

Alexandra Scaggs: I think that even if QE weren't ... even if the Fed’s balance sheet wasn't as large as it is today, I think that US interest rates would still be low. I do think that part of that is the ageing of the global population, like you said. A lot of it is that people just want to save. If you're going to save money, you're going to want to put your money into something. 

Alexandra Scaggs: Right now the only real place you can put that money is into some sort of US dollar denominated security. Because I think that the United States has some of the best property rights laws. You know if you put your money into a dollar denominated security in the US, the government isn't going to just take it, and be like, "Oh, that's mine now." You know? 

David Beckworth: Right. 

Alexandra Scaggs: Which that's not actually guaranteed other places in the world. So because there's this demand for safe assets, like you said, it just keeps a persistent buyer base for the United States debt or Treasurys, or you know, whatever you call them. 

David Beckworth: Yeah, it's kind of a counterintuitive understanding. I get it, you get it. Sometimes you try to explain this to someone who hasn't thought about it before. Many people are going to freak out when they hear this number. Often people whip out the $22 trillion to really scare people. 

David Beckworth: But even $15.7 trillion is not small, but it's still striking with that large of outstanding debt, the US government is paying record low interest rates. If you or I racked up a bunch of debt proportional to our income, we would be a credit risk. Our interest rates, and our credit cards, and our mortgages, they would all go much higher. 

David Beckworth: So it is a remarkable development to see this. Again, it speaks to the fact that the world does come to us. They do want our debt. They see us as a safe place to park funds. Which, again, it's an interesting idea and a kind of a mind blowing idea to think about. 

Alexandra Scaggs: Yeah, you and I also don't have printing presses that print the world’s favorite currency. So- 

David Beckworth: True, very true. 

Alexandra Scaggs: ... if we did, maybe it would be a little different. Maybe we'd be able to take on a little more debt. But that's not exactly how it works unfortunately. 

David Beckworth: Well you know, speaking of that, there's been a debate recently that's come in with the new congress. With the democrats taking over the house, and the push for the Green New Deal. There's been an interest in this idea, Modern Monetary Theory, a debate. This idea has been around for a while, it kind of makes that point that you just said that a government that can print its own currency will never outright default. The US government, even in the worst case, can always print money. Which would imply inflation in the extreme limit. 

David Beckworth: So it might implicitly default through higher inflation. But the US government will never default on its debt. You'll never have to have someone worrying about Uncle Sam paying its bills. They will pay its bills, it's just a question of whether that payment will be worth as much as they expected when they invested. 

David Beckworth: So what are your thoughts on this MMT debate? Has it been productive? Has it made the world a better place do you think? Are we better off in our understanding of how public finance works because of this conversation? 

Alexandra Scaggs: So I actually think that this has really done a lot of good. The reason I think that is because if you think about what happened during the Obama administration, the government shut down for a long time, and almost did default on its debt because it would have been an error by congress. Because you had a lot of voters, and a lot of elected representatives that were thinking about the United States, and its fiscal status as if it were a household. 

Alexandra Scaggs: They were sitting there like, "Oh my God, trillions of dollars, that's a lot of money." Yes, of course it is, because the United States is an enormous country. So sort of watching that kind of close call ... I do think that it's very important for the United States to make its interest payments. Because the entire system of global finance is based on the US always making its interest payments. It's known as the global risk free rate. 

David Beckworth: Right. 

Alexandra Scaggs: When you start using I guess the credit worthiness of your own country as a bargaining chip, it starts to become the sort of thing where you need ... I guess it changes the conversation enough that a lot of the sort of useful illusions that policy makers used to prop up, need to be sort of stripped away. 

David Beckworth: I like that. 

Alexandra Scaggs: I do think that it was useful at some point to think that, "Okay, the government should try to be efficient with the way it spends money." I think pretty much everyone agrees with that. I don't think that US voters are so crazy, or crazy ... I'm trying to think of the right word, spendthrift I guess? That they're going to go wild if they find out, "Oh, it's actually not like a household. We can sort of support this debt load for a while." 

David Beckworth: Yeah. 

Alexandra Scaggs: So that sort of says ... yeah, that's generally the thought. 

David Beckworth: So you see it as an overall productive conversation. I wonder though how wide reaching has the impact been? So you're aware of this conversation, I'm aware of it, maybe our listeners are aware of it. But MMT has gotten some pushback too, right? There's been some prominent Fed officials who've kind of pushed back against it. It seems to me many more mainstream economists are pushing back against it now. 

David Beckworth: Do you see this conversation as a flash in the pan? Something more persistent? How big of a lasting impact do you think this really has? 

Alexandra Scaggs: So it's interesting, because I think that there are really two things that people are talking about when they say MMT. One is just the sort of accurate description of the amount of debt that the US can carry, and why. We have a printing press, our interest rates are low. Then the other thing ... and I think this is what all of these Fed officials and prominent academics are reacting to, is this sort of political agenda that MMT is sort of linked to, very loosely right? It's not only just for the political agenda, but the people who are pushing the theory most also really support the Green New Deal. They just want to get rid of the question of how can we pay for it? 

David Beckworth: Yeah. So one characteristic of MMT is most of its proponents are left of center. Most of its proponents tend to be more progressive. I don't think I've ever met an MMT proponent who is free market, conservative, anything along those lines, right? Maybe I'm mistaken. 

Alexandra Scaggs: The funny thing is, wasn't it Dick Cheney that said that Reagan proved that deficits don't matter? 

David Beckworth: He did, he did, he did, but I- 

Alexandra Scaggs: And maybe he's not a free market Republican, I don't know. 

David Beckworth: My question to you is you've met people in the bond market who probably tend to be more fiscally conservative, or at least moderate. They don't want to go crazy. I wonder what their reception has been to MMT? 

Alexandra Scaggs: Yeah, it's been really interesting. I think because it sort of has that left leaning sway to it, like Americans like to really think of themselves as fiscally conservative. Because like I said, I think everyone would agree, "Yeah, the government should spend its money efficiently." 

Alexandra Scaggs: So I do sometimes wonder if because of the association with the political side of it, people associate it with, "Oh, we can spend as much as we want no matter what. Who cares about inflation." I don't think anyone who's actually a proponent of MMT has ever said [that]. But people tend to hear it that way because they see this sort of left leaning folks who are supporting it. 

Alexandra Scaggs: I think it's not terribly fair, necessarily. But the association is so strong that then of course people denounce the idea that the US can spend indefinitely when MMT'rs have never actually said that. 

David Beckworth: That's fair. I think MMT'rs are very clear that they would spend until they see inflation taking off. I guess what makes people nervous, including myself, about MMT is that the Green New Deal does seem to be a very ambitious, in terms of the actual dollar size, right? So you look at the actual size of the programs that they want. Then how they're going to fund it. That's what makes me nervous. Well, are they actually going to get expenditures only up to the point of inflation? Or will they push beyond that? 

David Beckworth: My concern is you're opening the door to maybe going beyond that point. I think the other concern is just who ultimately will control the money creation process. So correct me if I'm wrong here, and I may be wrong. My understanding is MMT would effectively delegate what the Fed does to Congress, or to some kind of fiscal body. So you would have politicians determining how much money creation there would be. Is that a fair assessment, or am I making it wrong? 

Alexandra Scaggs: I do think that that is generally the idea. They want permanent interest rates at zero, and they do think that it's up to representative democracy to decide where to spend the society’s resources. Which I can also see why some people would have reservations. Because it sounds nice, but we see what Congress did during the last administration when faced with the debt ceiling. So I can also understand that. 

David Beckworth: Yeah, it can go either way. It can cause crazy behavior in either direction. So to me this kind of boils down to why do we have an independent central bank, or at least a quasi-independent? We know there's not truly independence creation of Congress. Congress can change it. But we have this set up that gives at least a veneer of some independence, right? I think one of the reasons we give it independence is to avoid these temptations. Delegating it completely back to Congress might not just set up the current congressional representative to spin in a reckless way, but maybe future ones. 

David Beckworth: None the less, let's step back on this. We're getting deep into the MMT weeds here. I think the bigger point though, I think if there's one contribution they've made, despite my reservations with it. An important contribution MMT has made is it's helped us to think about the fiscal capacity of the US government. 

David Beckworth: Now I think others have been making this point too. I don't think they're the first ones. There's large literature on the safe asset. The world, again, is literally coming to Uncle Sam, this image of Uncle Sam sitting in the Treasury Department, and there's this long line of foreigners and even domestic investors, and they're knocking at the door. Knock, knock, knock. We want a vehicle to put our savings in to. And Uncle Sam is the best provider of that. 

David Beckworth: It's an interesting way of thinking. There's definitely many people who need to save more. I won't argue with that. But for every saver, there has to be a debtor out there somewhere, right? 

Alexandra Scaggs: Exactly. 

David Beckworth: That's the bond market, that's Uncle Sam. That's probably the best person to put your savings into, because you know they'll be the last one standing if it ever becomes a large credit crisis again. 

Alexandra Scaggs: Exactly. It's interesting, there are actually some professors who said that when there's not enough safe assets out there, the private sector tries to create them. But that turns into things like securitized mortgages, which ended up causing the financial crisis. 

Alexandra Scaggs: Having a synthetic safe asset can sometimes be riskier than having just government issued, plain vanilla, Treasury bonds. 

David Beckworth: Yeah, that's a great point with all kinds of interesting implications that we could spend time exploring. Everything from ... President Trump, maybe one of his unintended consequences is to help solve part of the safe asset shortage problem. By running up these deficits, he's creating more debt that is helping satisfy this demand. 

David Beckworth: It's an interesting discussion, and again, it's just really hard to wrap our minds around it, that the world is really knocking at the door of the US government asking for more debt. With interest rates so low, that's basically the signal. We want more, despite the fact that it appears really large, enormous, and maybe troubling for many observers. 

David Beckworth: Let's move this conversation on and talk about maybe who is buying up the debt. So one of the, again, common perceptions is that China, foreigners, they own a bunch of our debts. They hold a gun to our head because of that. Is that a fair interpretation, or is that more scare mongering? 

Alexandra Scaggs: Oh man, that one drives me nuts, I got to say. It's funny because the US does, like I was saying before, have some of the strongest property rights, and most consistent enforcement of property rights in the world. When you have securities in US dollars, you can enforce your claims using the US system. 

Alexandra Scaggs: So the demand is just super, super high for US securities because it is sort of consistently enforced. We have a predictable set of laws that people feel comfortable with. It's the world risk free asset. 

David Beckworth: Going back again to the image I've painted. People are at the Treasury, knocking on the door, and Uncle Sam's inside. He's working as hard as he can, as fast as he can to get those debt securities out the door. 

David Beckworth: I mentioned this before on the show, just to reiterate the point. One of our comparative advantages, one of the things we do well is export debt for all the reasons you just listed. 

Alexandra Scaggs: For sure. 

David Beckworth: For better or for worse, that's what we have. It's called the exorbitant privilege, and it creates some distortions, but it also has some benefits. Now going back again to China, Japan, some of these large holders. So I'm looking at a chart that tabulates the different holders of Treasury securities. It comes from SIFMA, they have statistics on this, and there's other places as well you can get it. It shows foreign holders holding at around 45 percent. Now that's come down, but at the peak around 40, close to 45 percent. It's actually been declining a little bit. Since the past two or three years, the share of outstanding Treasury debt held by foreigners has been coming down. 

David Beckworth: Any concerns about that? Now I'm going to be clear, it's come down, according to this graph just under 40 percent, so it's not a huge decline. Foreigners are still the largest outside holder of US debt. But it has come down. Any thoughts on that, or no worries? 

Alexandra Scaggs: You know, I really struggle to worry about that. This is a headline I see all the time. It's like, Russia threatens to sell Treasurys because we made them mad. Or Saudi Arabia threatens to sell Treasurys because we made them mad. 

Alexandra Scaggs: First of all, they're not really big holders. Secondly, what's the worst case scenario? Let's say a bunch of foreign holders sold Treasurys over the next two months. Yields rise and domestic investors can now earn a half decent yield on Treasurys, which are risk free. So they buy that. Let's say that they buy that instead of I don't know, investing in a VC fund, sure. But thinking about the types of companies that have had money thrown at them in the past five years. Like Juicero, I'm not sure if I'm losing that much sleep over the next Juicero not having funding. 

David Beckworth: Yeah, so the decline has been relatively small. They still hold a large share. Your point is there would be offsetting effects. Something else that I think about is because they are such a relatively large holder of Treasury securities, they're the ones that might actually lose the most. If it became known that China was liquidating all of its Treasurys, like you said, prices would adjust almost instantly. Yields would go up. Bond prices would go down. China would end up losing a lot of wealth. All that savings it's put into Treasurys would be lost. 

David Beckworth: So they probably have more to lose than we do in a farfetched scenario like that. So it's unlikely it would happen. It would be more gradual process. I agree through probably nothing to worry about. That the foreign share has declined a little bit. 

David Beckworth: What's interesting I guess, and I don't know how to make sense of it, maybe you do. Is that there's been a slight uptick in domestic holding of Treasury securities. Any thoughts on that why? Due to regulations, or people want to hold more Treasurys? Any thoughts on what's going on? 

Alexandra Scaggs: You know what I think that is? I think that's the fact that in 2018 the Fed raised rates four times. All of a sudden, there was a real yield, isn't super high. But pension funds, investment funds can now say, "Oh, I'm getting a 2.4 percent return on this two year treasury note, why not just hold that? 

Alexandra Scaggs: So when yields rise, you do have institutional investors who all of a sudden think money market funds are starting to look decent now as an investment option. So I think that's really driving that data. 

David Beckworth: Okay. So these are all small movements. The grand scheme of things. We still have a large demand overall. There's maybe a little less in Asia, maybe a little more at home. Still, the evidence is in the fact that the yields are still really low, 2.5 percent as we talk. 

David Beckworth: Now if I take a look around the world, and I did right before the show started. I look at other interest rates on government bonds and other advanced economies with similar good institutions, good rule law, minimal corruption. I see even more stark scenarios. I turned to Germany, its 10-year yield, last I checked was like .01 percent. That's a nominal, that's not a real but a nominal interest rate to .01 percent. So basically zero percent. Switzerland, it's minus .3 percent. That's the 10-year yield. Japan's like minus .05 percent and then it starts to go up. In the United Kingdom today it was 1.1 percent, Australia 1.84 percent, then you come back to the US, 2.5 percent. So we're the highest. 

David Beckworth: But all around the world, there's this amazing amount of debt that has really, really low interest rates. In some cases, negative. Again, it's very hard to understand. Maybe if you reason from a household perspective, but it's there. I want to read to a quote from a Bloomberg article and it speaks to this. In fact, it speaks to the fact that a good portion of debt in the world has negative yields, or negative interest rates on them. This comes from I think a few weeks ago, it's a Bloomberg article. And the title of the article is “Negative Yielding Bonds Top $9 Trillion as Growth Worries Return.” But here's the quote I want to read to you. It says, "Last October, the world stock of negative-yielding debt, or negative interest rate debt had tumbled by more than half from its records highs as investors adjusted to the end of super loose monetary policy. Now it's souring again after the dovish pivots around the world. The Bloomberg Barclay's Global Aggregate Negative-Yielding Debt Index has increased its value by well over $3 trillion since its slow five months back to $9.3 trillion on Wednesday." 

David Beckworth: So there's $9.3 trillion as of a few weeks ago, of government debt out there where the interest rate is negative on it. So people are actually paying money to the government so these countries keep their principal safe, and they're willing to pay a fee for it. Again, that's pretty remarkable, is it not? 

Alexandra Scaggs: Yeah, I always think that's amazing that institutional investors are actually willing to pay money to keep their own money safe. I think the change is striking like you mentioned. I think that's really a factor of the Fed almost. Because the change in policy from October when Jay Powell was saying, "Oh, we're a long way from neutral." Which meant we had a lot more interest rates to come to January. Where they're saying, "Okay, we're going to go on hold for the whole year." 

Alexandra Scaggs: I think that's really part of the driver of that. Of course, Jay Powell is responding to things in the economy. Like Europe has slowed down a decent amount. People are concerned about China's growth. But just the speed of the change like you said is really stunning. 

David Beckworth: It is stunning. But let me ask a different question. So there has been this change, when there's been a sudden turn around, which is tied to recent developments. The expectations of slow down, the Fed’s pivot. But even if we step back before, there's still been this large stalk of outstanding debt that has negative interest rates on it. 

David Beckworth: I guess the explanation for it is the same one we've been talking about. There's just this shortage of safe assets out there. People are clamoring to get it. Whether it's from Germany, Switzerland, the US, Japan. Is that the right interpretation for why there's so much debt with negative interest rates on it? 

Alexandra Scaggs: Yeah, I think so. 

David Beckworth: Okay. 

Alexandra Scaggs: Also it's investors’ expectations for what central banks are going to do. 

David Beckworth: Okay. 

Alexandra Scaggs: Because if you can buy a bond with a negative yield, and you think, "Hey, maybe the ECB will start easing again soon." Then you can sort of expect a decent return because maybe you'll end up selling that bond to the ECB. 

David Beckworth: That's a good point. 

Alexandra Scaggs: And the same thing in the US. Our yields aren't negative, but I think that's also a reflection of the fact that people are now thinking that maybe a recession isn't so far away. 

David Beckworth: Good point. Alex, let's move on to corporate debt. So we've been talking about government debt, let's move to corporate debt. Any news there we should be aware of? Anything happening over the past year, or past six months? Anything interesting going on? 

Alexandra Scaggs: Oh gosh, has there ever. So around October, around the time that Jerome Powell, Chairman of the Fed, said that we were a long way from neutral, the corporate debt market basically freaked out. There was a huge selloff in a lot of riskier bonds, high yields, the lower grades of investment grade debt. Because basically thought, "Wow, the parties over, borrowing costs are going to go up a lot." 

Alexandra Scaggs: So that sort of sparked this ... I don't want to call it a panic, but it was close. You had hedge fund managers saying that they thought there was a bubble in the corporate debt market. You had GE, I guess its debt sold off really fast, for outside reasons, but it's still ... it happened very quickly and I think it was in part precipitated by some of the broader fears about the market. You had a bunch of other examples of sort of risky companies. All the sudden people rushing to sell their bonds all at once. This was all end of last year when we had a lot of stock market volatility. The high yields market also experienced a ton of volatility. 

Alexandra Scaggs: Then since the Fed has sort of stepped back, people are now thinking, "Okay, so borrowing costs are not going to rise that much from here. Everything's okay." So we've had basically a rally back to where we were before this big selloff last year. Borrowing costs are still slightly incrementally higher, and if there is a recession coming up, I'm not sure how comfortable people will feel owning junk bonds. Because maybe I'll talk a little bit about what's happened over maybe the past decade. 

David Beckworth: Yeah, please do. 

Alexandra Scaggs: Because the amount of corporate debt outstanding has grown a lot since the financial crisis. 

David Beckworth: Okay. 

Alexandra Scaggs: The financial crisis was basically precipitated by the consumer, by individual people and their mortgages. So after that, banks really tightened down on individual lending. But they didn't necessarily tighten down on corporate lending. 

Alexandra Scaggs: So companies had a decent amount of debt, but they were able to make their interest payments, everything worked out. But after that, they just kept borrowing because interest rates were so low. So the amount of total corporate debt outstanding is pretty sizable. Since that point, it's just ballooned a lot. A lot of the growth has been in the lower quality tiers of the market. They call them the triple Bs, because they're one level above junk. 

David Beckworth: Okay. 

Alexandra Scaggs: So this has all been happening over the past decade or so, and last year people started thinking, "Oh wow, this is the beginning of the end of that." So I think it really sort of freaked people out. 

David Beckworth: So if there is a next recession, would part of it be tied to this market? Particularly you mentioned there's these junk bonds, these high yield bonds in the corporate sector. Would that be a part of the story if we do have a recession at some point in the future? 

Alexandra Scaggs: You know, of course it depends on what starts the recession. 

David Beckworth: Okay. 

Alexandra Scaggs: But in terms of where the pressures would be, there's been a lot of they say froth. Like basically sort of exuberant behavior in the high yields section of the market. But interestingly enough, it hasn't been in high yields bonds, it's been in high yields loans. 

David Beckworth: Okay. 

Alexandra Scaggs: This is a different asset class because they have floating rates. They're still to only junk rated, pretty risky companies. But these loans are supposed to come first. If a company files for bankruptcy. So if you're Toys "R" Us for example. Toys "R" Us as lenders should be able to collect whatever cash they have left over before a lot of other investors, like bond investors- 

David Beckworth: Okay. 

Alexandra Scaggs: ... subordinated bond investors who have come after them. But the problem is that a lot of companies are issuing loans to borrow money, and then never issuing bonds. 

David Beckworth: I see. 

Alexandra Scaggs: So it's like you have a line in a bankruptcy, but everyone's at the front of the line. They're all pushing for part of the same, I don't know, part of the same product. 

David Beckworth: So the loans might be a big part of the next recession. The loan portion versus the corporate debt bonds. 

Alexandra Scaggs: That's been one of the places where investors in the market, analysts in the market have been saying they've been seeing some excessive behavior. 

David Beckworth: Okay. 

Alexandra Scaggs: Part of this is because there's this big securitization machine, which actually people have compared to the mortgage securitizations before the crisis. They basically just buy loans, and then pay out the interest payments for the loans in order of quality. 

David Beckworth: Very interesting. So like the housing boom where mortgages and home loans were securitized, what you're telling me is in the corporate sector, something similar is going on. Those corporations that have opted for loans over bonds are having their loans securitized and that's where the risk could lie. 

Alexandra Scaggs: Yes, for sure. It's just the demand for these securitized loans that has allowed companies to borrow with basically no requirements for their behavior. 

David Beckworth: I see. 

Alexandra Scaggs: It used to be that a company would borrow, or would issue a loan, and it would come with a requirement. Like you can't have debt that's more than like two times your earnings. Like at all, ever. 

David Beckworth: Okay. 

Alexandra Scaggs: Then if it rose above that level, the company would default. But now those requirements just aren't there. Because everyone wants loans, and the companies can issue them without those requirements. 

David Beckworth: Okay. Well this is fascinating because as you mentioned earlier, it speaks to the importance of the Fed. You mentioned the Fed tightening, creating expectations of more rate hikes this year. At least by the end of last year there was this expectation. The Fed was affecting this corporate bond market and creating stress. Normally when I think about the Fed’s role, its reach beyond monetary policy, I often think about its international reach. It affects emerging markets, causes problems for governments like Brazil, and Argentina, trying to get financing. What the Fed does, it affects them globally. 

David Beckworth: But what you're telling me is that also affects the corporate bond market pretty heavily as well. 

Alexandra Scaggs: Yep, sure does. It's interesting because there was a similar emerging market selloff in June of last year, I'm sure you remember. 

David Beckworth: Yep. 

Alexandra Scaggs: So everyone in emerging markets freaked out, and then everyone in corporate debt markets freaked out. They were kind of similar in the speed and the sort of mood, I guess of the selloff. 

David Beckworth: Yeah, this is what makes the Fed’s jobs so challenging. It has a domestic mandate, but has this international reach. Public sector, private sector, and ultimately has to be mindful. Especially if those developments come back and affect the domestic economy. 

David Beckworth: In the time we have left here, I want to ask you about the Fed’s discussions this year about its target, its communication, its tools, its student reviews, you know? You wrote about this. One of the proposals is to move to something called average inflation targeting. I wonder what effect, if any, would that have on bond markets? Would it be destabilizing for bond markets? Or would it be indifference on their part if the Fed moved to it? 

Alexandra Scaggs: So I don't think it would necessarily be destabilizing. I do think it matters though. It matters a lot because it means that the Fed is going to keep rates lower for longer, basically. In the context of today. Because if you go a long time with inflation that's low, like we've done, then you need to spend a decent amount of time with inflation above target, to sort of even it out. 

Alexandra Scaggs: So that means that the Fed is not going to be raising as aggressively as it would have otherwise, which means that companies can probably afford their interest payments more easily. Emerging markets probably won't be under as much pressure. 

Alexandra Scaggs: I talked to a couple of investors who were really optimistic about markets because of this. 

David Beckworth: Okay. So it has the potential to make financing costs easier. I guess one potential downside, it might also fuel more instability, buildup of asset prices, borrowing. So it could cut both ways, I guess. 

Alexandra Scaggs: Mm-hmm. The materials of the selloffs, like we saw last year, those are sort of creating in these times of credit expansion. But after the October thing, I think that funds managers are just happy to have a little bit more time. 

David Beckworth: Sure. 

Alexandra Scaggs: The party is going to continue for, I don't know, another year maybe. 

David Beckworth: Right, right. Yeah, well very interesting. Well our time has come to an end. Our guest today has been Alexandra Scaggs. Alex, thank you so much for coming on the show. 

Alexandra Scaggs: Thanks for having me. 

David Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app. While you're there, please consider rating us, and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening. 

Photo credit: Ken Lund/Flickr

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Apr 29, 2019
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A Macro Musings Transcript