A response to an email; Why we all should care about rising bond yields

For amateurs like us at the bakery, can you explain in simple terms, and with practical examples, how our everyday lives will be any different with rising interest rates. I see gas going up, but how’s that connected with higher interest rates? I see food prices creeping up…

…I understand the “cost of capital” will affect mortgage rates, but please explain–again, for normies like us out here in real world land–why this will be so catastrophic. Give us examples please. Otherwise, it’s all Greek to us. Make it concrete and specific to our lives.

Rebecca

The Magic 8 Ball 

I get asked from time to time; what does it matter if bond yields move higher? They will ask, what does that matter to me?

The answer is straightforward here. It’s not the bond markets that are causing the problems. Rather, it’s the problems that are causing the bond markets. This is why I often refer to bond prices as the “Magic 8 Ball” of the financial system.

Putting the cart in front of the horse

So, what does an 8% 30-year treasury yield mean? It’s not the treasury yield that will cause the problems. It’s the problems that cause the treasury yield.

Imagine the catalysts that are causing and will continue to cause an increase in treasury yields as well as all sovereign debt yields across the globe.

For people running businesses this may not mean a lot if they can pass along their costs to their customers. This is usually the case with the biggest and brightest companies in each sector. Extended periods of supply bottlenecks and extended inflation usually result in industry consolidation and a washout of the weaker and smaller businesses.

Failure to adjust

To wit, companies like bakeries will find it tougher and tougher to pay the bills. An owner of a bakery may not have to worry about an 8% treasury yield, per se, but will have to concern him or herself with the factors that led to it.

And if these small niche companies can’t adjust accordingly, the large institutional bakers will remove the vacuum.

Unfortunately, the same will be true for just about every other business providing products. The more capital intensive a smaller business is, the more vulnerable it becomes over time.

If I were a smaller bakery owner and I were planning on increasing my capacity to reach higher economies of scale, an 8% Treasury yield would be very important to me. Many small businesses go under, because they fail to account for increasing costs of capital when planning capital budgeting.

Let the largest companies market to the poorest

My advice to the small business owners and to the owners of bakeries is simple. In order for these small businesses to survive, they must adjust and differentiate themselves to target a customer base that is less vulnerable to the problems caused by the catalysts that are driving up bond yields in the first place (e.g. top 20% of balance sheet and income wealth; the asset owners).

If I were to own a bakery and wanted to survive over the long term, so I could fatten my profit margins, I’d exclusively target the asset owners as my customers and I wouldn’t waste my time trying to advertise to the bottom 80% in balance sheet wealth. The poorest people tend to be the worst customers anyway.

Marketing in a dystopian future

We are the asset owners and we are much more likely to sympathize with the small business owner and the efforts they put in to succeed.

A small business owner should develop an economically resilient business and concentrate advertising campaigns on marketing to people like me and my wife, my retired next door neighbor who golfs everyday, or my friends. We’re white European Caucasians and we have money to burn. Moreover, we live off of passive income and everything else we make is just gravy. We are the asset owners and we are much more likely to sympathize with the small business owner and the efforts they put in to succeed.

My best friend and her husband just sent their only child off to Chapman University in Orange County this fall. Their family is worth at least $20 million. They just flew out there for Chapman University’s homecoming today. When I asked my friend how she pays for all her airfare, she tells me it’s all accumulated points from the money she spends running her business. Chapman costs upward of $100,000 a year with all fees, room and board included. A couple months ago, they paid a $7,000 special assessment for their beach condo and didn’t think twice about it.

These are the customers a niche bakery should be directing its marketing dollars toward. If these small business owners are unable to adjust, they might as well just close shop and drive for Doordash, because under distressed economic conditions, it’s much more likely that an unexpected event or set of circumstances will upend any future plans and destroy everything you had worked to create.

The extra income of those in the top 10% to 20% of wealth tends to be spent on the frivolities on life. The amount of extra income a wealthier person spends on impulse items can be greater than the same spending of 10 people at the 40-50th percentile. For some of my friends, it’s spent on vacations and furnishing their properties. For me, it’s spent on bullets shooting guns and health supplements and foods. For my wife, it’s spent on everything organic, beauty appointments, and high-end bakery items she gives out to her friends.

The winners and losers of an 8% yield

So, a world with an 8% 30-year Treasury yield can provide properly leveraged asset owners with a desirable outcome. I include the sensible small business owners in this group. For they own an asset as well, which is a money making business.

For a few others, higher bond yields may just be a minor inconvenience.

Unfortunately, for the majority, it will be brutal.

It will be brutal for many naive small business owners who will not only be contending with ever greater across-the-board expenses, but concomitantly dealing with ballooning borrowing costs as well. Thus, any poorly planned business expansions or capital intensive improvements could result in the undoing of everything that business owner previously worked for.

The catalysts driving higher bond yields will also be devastating to the wage earners who will no longer be able to afford your products or services.

If I were a small business owner, I would definitely care about the world in which the US 30-year Treasury yield rises to 8% and beyond.