Note: Technically everything discussed in this article happened on May 27th. It just so happens I didn't notice until I checked mortgage and bond yields the next morning on May 28th.

Today is May 28th, 2009. I'm going to call it "E-Day" (Economy-Day): The day market forces rebelled against artificial manipulation by the government and the Federal Reserve. And the media actually started reporting it.

I've been writing for months about the consequences of President Obama's stimulus package and bailouts combined with the Federal Reserve attempting to manipulate market forces with the goal of jump-starting the economy.

I wrote about the dangers and fallacies of Obama's deficit "stimulus" spending the first week in January.

I first wrote about pressure on mortgage rates back in January before the government had even begun borrowing any significant amount of money.

In February I predicted that the government was going to borrow all the money it could to finance the stimulus spending and then print the rest. This was confirmed a few days later when the U.S. basically went begging China to loan us money, and then announced we would be printing the shortfall a month later.

I warned of inflation in February and again in March.

Three weeks ago I suggested that mortgage rates might very well have bottomed-out and were ready to start their inevitable climb. And just yesterday I asked whether the recession was really almost over, pointing out a number of issues that would seem to question that conventional wisdom.

This is not to say that I'm in any way gifted with insight. This was all pretty simple economics. What's been strange is that these things have been hardly reported in the media; and when they've been reported they've largely been reported as caveats or some kind of fringe/minority view.

But today, May 28th, 2009, it seems that all of the sudden the mainstream media decided it was time to report these things. It was no longer possible to ignore these realities as mortgage rates jumped from 4.875% to 5.500% in a matter of 48 hours.

Also today the business reporting seems to have suddenly grown interested in the not-surprising possibility that, as I predicted back in February, there isn't enough money in the world for the U.S. to borrow and that it was going to have to print the rest. Today I'm seeing articles with quotes such as:

The government is going deeper into hock and that's starting to make people nervous... Simply put, it's growing increasingly difficult to imagine that there will be enough demand for all these Treasurys.

Analysts are increasingly concerned about the Treasury's ability to fund costly economic rescue measures that are expected to drive this year's budget deficit to $1.75 trillion.

"The market is looking at the over $1 trillion deficit and how we'll finance it and concluding it is too big to finance without Fed assistance. But Fed assistance is causing inflation worries.

Keep in mind that "Fed assistance" means "printing money."

Also remember that back in March I wrote "In order to continue funding the deficit spending, it's a pretty safe assumption that the Federal Reserve will end up printing some more money after that. $300 billion isn't enough to make up the shortfall for the proposed $1.7 trillion deficit. So in six months (or sooner, if the government ramps up spending faster) expect to see a similar announcement whereby the Federal Reserve will buy additional U.S. Government securities."

And, in the last few days, I've been seeing articles such as:

The Fed announced in March it planned to buy $300 billion in long-term Treasurys, but Mahoney believes the Fed needs to be more aggressive to prove that it's committed to keeping rates low - particularly to investors like China and Japan that own a lot of Treasurys.

'A $2,000bn deficit and $2,000bn in Treasury supply far outweighs the Fed's planned purchases of $300bn,' said Gerald Lucas, senior investment advisor at Deutsche Bank...

He said the bank did not rule out the Fed needing to buy more than $1,000bn in Treasuries in order to keep rates low. [NOTE: This boldface critical sentence was subsequently removed from the source article but was there originally on May 27th]

So just as I predicted back in March, more analysts are today finally predicting that, indeed, the Federal Reserve is going to have to print more money. In the above quoted article the number $1 trillion in printed money was floated--though that sentence was apparently subsequently removed from the article. I have also seen the number $2 trillion in printed money floated elsewhere.

I also said that "the decision to print money [to fund Obama's deficit spending] is potentially a death spiral." Today, an article in the Wall Street Journal said "But Fed assistance is causing inflation worries. We're caught in a vicious cycle."

It seems that in the last 48 hours the business press has finally started talking seriously about the U.S. Government not being able to borrow this much money, the obvious impact that the borrowing is finally starting to have on mortgage rates, and the probable eventual risk of inflation caused by the Federal Reserve printing all this money. They should've been talking about it seriously months ago, but better late than never.

The only thing that I predicted that hasn't happened yet is inflation... but it's coming. I'm actually surprised the increasing inability of the government to borrow money and the associated rise in interest rates happened this fast. It was inevitable but I thought it'd take longer to reach this point. President Obama probably thought it'd take longer, too. And at some point in the not-too-distant future the other shoe will drop in the form of inflation.

Update 5/29/2009: A financial expert has also agreed with what I said above--that the rise in interest rates was not expected, but came much harder and fast than anticipated.



... says Brian Bethune, director of financial economics at IHS Global Insight in Lexington. "We anticipated over time there would be some pressure on interest rates, but nothing like what we're seeing now."

A lot of things have happened (or been reported) quite suddenly in the last 48 hours and, unfortunately, it substantiates what I've been saying for months. I say "unfortunately" because the implications of this on the economy are not good. But they are inevitable given Obama's chosen course of action.

Ironically, on the day before E-Day--the day that market forces rebelled against Obama's and the Fed's manipulation--Obama declared:

"It's safe to say we have stepped back from the brink, that there is some calm that didn't exist before."

I find that comment ironic because it seems today that, more than at any time in the last four months, the outlook is decidedly more worrisome. And while there has been "some calm that didn't exist before," it remains to be seen whether that might yet be the calm before the storm.

What's sad is that if the storm is yet to come, the storm is being worsened by the policies of President Obama and the Federal Reserve.

Update 7:15pm: It would seem that if these rates persist--which would seem probable--that the Federal Reserve will have to take measures to drive Treasury and mortgage rates back down. The problem is that doing either of these requires printing more money and would only delay the inevitable increase in rates.

Trying to drive rates back down will require printing even more money than the Fed has already promised to print. This will eventually devalue the dollar, increase inflation, and drive interest rates higher. The higher inflation and interest rates could really cause damage to the economy, like back during the Carter years. Reliving Carter-era economic conditions when the country is trying to recover from the worst recession in decades would not be a good thing.

The alternative is for the Federal Reserve to do nothing and let market forces battle it out. That'd be the best long-term solution but it's unlikely the Fed will do that: Doing so would basically cause interest rates to go up significantly and quickly, it would cause any potential recovery to stall and maybe even relapse into a secondary recession, and it would make it impossible for Obama to spend all the money he wants to spend because there isn't enough money in the world for the government to borrow. The government can only spend this much money by printing it.

So the Federal Reserve is stuck between a rock and a hard place. Nothing they can do at this point is going to be pretty or without potentially severe consequences. The government (Obama and Federal Reserve) has been playing a game of chess with market forces, and market forces would seem to have put the government in check... possibly checkmate.

I definitely have to take issue with Obama's characterization last night of the economy having found some "calm." If anything it has been a false calm caused by manipulation by the Federal Reserve. The Federal Reserve has been stretching the market like a rubber band, and that rubber band snapped today. Hopefully it didn't outright break.

Update 5/29/2009: The Chicago Tribune explained it succinctly:



President Barack Obama and his financial gurus are getting schooled in the power of markets this week as bond traders bet against a key aspect of the government's plan to rescue the housing market by artificially pushing down mortgage rates...

But on Wednesday, bond traders struck back, worried that all the government spending is pushing the federal deficit to unsustainable levels and leaving the economy susceptible to inflation.

The result was a massive sell-off in U.S. Treasury securities, which drove up interest rates and caused an alarming spike in the average cost of a mortgage.

But the calm is likely temporary.

"The Fed is going to have to keep on defending [its position] until it achieves its goal or realizes it doesn't have enough money to do it," Giddis said...

Bond analyst Jim Bianco of Bianco Research said the standoff is setting up as a classic example of the limits of central bank power. Although the Fed has said it will spend up to $1.2 trillion to buy mortgage-backed securities, he contends the bond market is bigger and more powerful.

"You can manipulate markets only as far as they feel comfortable going," Bianco said. "But if you push them to where they don't want to be, it usually ends badly."



Indeed the Federal Reserve is manipulating and working against fundamental market forces. The market is looking at reality and judging that interest rates should be higher. The Federal Reserve is trying to artificially drive rates lower against the natural tendencies of the market.

This is akin to holding back the ocean with levees made of sand. It might work for awhile but ultimately the ocean is going to win. Likewise, natural market forces are going to overwhelm the Federal Reserve. The longer the Federal Reserve tries to push interest rates down, the more shocking and destructive the results will be when it finally loses the battle.

Update 5/29/2009: After two days of silence from the Federal Reserve regarding the jump in interest rates, we have the following from Fed Chairman Ben Bernanke.



The Fed has finally responded to the soaring mortgage rates, and the apparent failure of quantitative easing.

Their spin -- courtesy of CNBC's Steve Liesman (natch) -- is that the Fed was never trying to force down mortgage rates or "set" rates. Rather, by stepping in and purchasing bonds, the Fed is merely trying to "support" the credit markets.



As the linked article states, this assertion doesn't make much sense. "Supporting" the credit markets is about controlling the interest rates.

But I do believe the Chairman's assertion that the Fed was not trying to force down mortgage rates. As I wrote back in March, any effect on mortgage rates was only a beneficial side-effect of their real goal. The real goal has always been to print enough money to allow President Obama's spending to occur.

This is why the Federal Reserve is not coming out and saying they're worried about the interest rates. If they were, they'd come out and say so and promptly try to push rates down. But that's not their primary concern. Their primary concern is monetizing Obama's deficit so that he can spend all the money he wants to spend. But the Federal Reserve can't say that, either. I think that's why, for months, we've been getting vague messages from the Fed about "supporting credit markets."

Ever since the Federal Reserve announced its plan to print money, market analysts have seemed confused about why the Federal Reserve was doing that and why it was doing that so soon. They're confused because they've been subscribing to the belief that the Federal Reserve was doing this with an eye on controlling interest rates. In that context the Fed announcement back in March didn't make sense. But taken in the context of funding Obama's deficit spending it makes perfect sense.

I suspect the Federal Reserve's response to the current surge in interest rates will eventually cause more and more analysts to reach the same conclusion as I have. The primary goal was never about keeping rates low. The primary goal was printing money for Obama to spend.

Update 5/30/2009: In the two days following the initial shock to mortgage rates, the 10-year bond yield has dropped back down (although mortgage rates are still stuck above 5%). However, there wasn't another 10-year bond auction by the government in these two days. That means the drop has been largely due to market speculation as to what will happen whereas the shock to mortgage rates on Wednesday was due to the actual reality demanded as a result of the bond auction. So the real test will be to see how bond yields and mortgage rates react the next time the government sells 10-year bonds. Whether or not the next 10-year auction goes smoothly, shocks like this will almost definitely become more frequent with each auction-driven shock most likely driving rates up higher and higher.

Update 6/1/2009: In the first hour of the first trading day of June, Treasury yields are heading back up, and with them mortgage rates. It'll be interesting to see how these two rates move once the Treasury announces its planned auctions, and then how they move when the auctions actually take place. But with rates going up without any news on those topics, it does not bode well for rates.

Update 6/3/2009: And now Federal Reserve Chairman Bernanke is sounding the warning bells about the deficit. It's seeming more and more like May 27th and May 28th were the days that the world finally woke up to the realities of our current course of massive deficit spending.