The Fed Reserve balance sheet is 8 trillion with no plans to reduce this anytime soon, and the federal fiscal added $3 trillion in 2020 and the Biden administration adding an additional $1.9 trillion. The US economy is in uncharted waters with US federal government and the Federal Reserve deeply embedded into the economy to levels not experienced since World War II. In many ways, certianly in terms of monetary policy, the US economy is now a “command economy” that is centrally planned. Perhaps this is/was appropriate given Covid, but there is signifcant risk as the government now cannot error. And a commmand economy no longer has discreet pricing to inform as to when an error is being made as the USSR - now Russia - discovered.

The Fed is no longer “rules based” and as markets pricing action no longer provide symetrical feedback from pricing, the US could be on, or enter, a disastrous tangent, not be realized until well past the time for remedy.

The Relationship Between Long Duration US Treasurys and US GDP (current dollars - NGDP)

The long US Treasury yield is equivalent (over time) to US GDP annual growth.
The long duration US Treasury rate is anchored upon the expected Fed Funds over that tenor/time/maturity. Fisher defines Fed Funds as the instantaneous real GDP growth plus inflation (Fisher Effect).

Keynes states that long duration US Treasury rates synch with US GDP growth as the Keynes Liquidity Preference has long US duration rates are at the level that induce savers to leave the Zero duration of cash and extend out taking duration risk. Right now the savings rate is climbing and at a high level as US Treasury rates, though higher than recent century lows, are unusually low.

The long US Treasury yield is closely linked to the monetary policy of the Federal Reserve - anticipationg or pricing the Fed Funds rate set by the Federal Reserve over the comparable time period of the long US Treasury yield.


Most think the the Federal Reserve monetary actions has been successful in supporting GDP. If that were the case it should be expected that a change in the Fed balance sheet should result in a comparable change in GDP level. Was the large addition to the Fed balance sheet increased GDP? This has not been the case. The recent increase in Fed balance sheet has not been seen experienced, in terms of speed and size, since World War II. So far the economic impact has been negligiable.

The Federal Reserve is now “pushing on a string”, or has completed ‘Japanification’.

##               WALCL      GDP
## 2021-05-12 7830.663 24770.39
## 2021-05-19 7922.883 24915.17
## 2021-05-26 7903.541 25059.95
## 2021-06-02 7935.703 25204.72
## 2021-06-09 7952.327 25349.50
## 2021-06-16 8064.257 25494.27

There is an obvious relationship between the level of risk free interest rates, US Treasurys, which are determined for the most part by the setting of Fed Funds, and the NGDP annual change.

Given the very large snapback in US GDP from the nadir of 2020 - the Atlanta Fed now has 2021 2nd quarter GDP (real) at annualized 13.2% - the US Treasury 10 year should be well over 2 1/2% and starting a climb to “normal” rates of 3% plus.


The relationship between GDP and US Treasury yield is shown for recent daily levels. This is in accord with Fishers Fisher Effect but for the last several years.

The back eurodollars are responding while US Treasurys, even though rising from well under 1% to now over 1 1/2% percent, are still bound by the relentless Federal Reserve policy. The Eurodollar rate 7 years forward has backed from a low of last year 2020 to now trading at %. Usually the long dated eurodollars are in synch with the US Treasurys. Likely the US Treasurys, to reflect the US economy, is to rise to 3% plus. However, as the Bank of Japan has shown, the oppsite can occur and the long dated Eurodollar rate and the US NGDP will be reduced substantially to the Federal Reserve policy. This is called “Neo Fisherianianism”.

Risk Premium

The “risk premium”, the amount of yield required to compensate for extending one more year maturity is first derived. Most wrongly - including the Fed - see the risk premium as the yield increase per year in US Treasurys from 2 years to 10 years or longer. The 2 year maturity is too short as the Fed basically sets all rates under 5 year to 5 years. This report does not use the yield curve to calculate risk premium, but “deconvexes” the curve well past 5 years adjusted using multiple inputs.

Another plotting of the risk premium over a shorter time period.

The risk premium is now over 20 basis points, after reaching a low of 8 basis points in Q3 2019. Any forward growth in NGDP implied by steepening risk premium is more than offset by increased volatility and the Fed “dropping” forward rates.

The Term Structure of Fed Funds/NGDP out to 7 Years

The first 5 years of the yield curve is efficient and is based on the markets best assessment of Federal Reserve monetary policy setting of the Fed Funds rate. The risk premium derived, from structure and rates past 5 years, is used to build a Fed Funds yield curve out for 7 years. This is, according to Fisher, one and the same with NGDP.

The term structure of NGDP shows the progression of change from December 2018, when Powell announced that normalization ceased and that a steady ease would commence.


A close up of the Fed Funds term structure during the Trump administration with the rise in furture Fed Funds anticipated (normalization), from the election to March 2018 highs, was been undone so that until Q2 2020 the term structure of anticipated Fed Funds is lower than the election and the term structure negatively sloped. There has been an improvement of the term structure through Q3 2020 where the implied negative forward GDP rate does not occur until forward year 4.

The covid-19 emergency had the Fed drop the term structure to Q2 2020 lows to levels below the lows of the 2008 to 2015 “Great Recession”, reached in 2012. In Q2 2020 the forward GDP was trading at levels that are depression era and have only marginally improved to date.
The tumlutuous election now has the Biden administration starting and it is unlikley that any change in Fed policy will occur.

The term structure of US GDP at key dates:

The term structure of GDP currently and then for the last 8 months and then for November 2018 when Powell announced that the Fed would no longer normalize rates.

The term structure of GDP currently and then for the last 8 weeks.

With Term Structure of NGDP Growth, Expected GDP Level in 7 Years Derived

The term structure of GDP (NGDP) growth per year is used to derive a NGDP level in 7 years.

The GDP level in 7 years is derived by compounding out the term structure of NGDP growth.

The 7 years forward GDP level is then compared to current GDP. This is the 7 year “basis” of GDP.

The “Basis” of 7 Years Forward GDP to Current GDP

The 7 Years forward GDP is netted against current GDP and a basis is calculated. This is the level (in billions here) of expected growth in GDP over the next 7 years.

The basis has dropped from peak level of 4.7 trillion, only recently achieved in 2018 to the current basis now at 1.41 trillion, a change of 3.29 trillion from peak to now.

Using Current GDP to Qualify the R2000

The below uses a current GDP level on a daily level. This is from a smoothed spline and disaggregated reported quarterly GDP with last GDP level coming from Federal Reserve “NowCasting” of GDP. )

Using Current GDP to Qualify the SP500

The below uses a current GDP level on a daily level. This is from a smoothed spline and disaggregated reported quarterly GDP with last GDP level coming from Federal Reserve “NowCasting” of GDP. The SP500 is scatter plotted against and shows that SP500 is fair value, as most perceive it in relationship to the economy. HOwever the SP500 has a duration of approximately 7 years so to compare it to current GDP is apples to oranges and does not provide information. This has been overlooked for decades as SP500 had always an increasing forward value until 2012 and from 2018 to date.

The US Treasury Curve Flattens Jan 2019 to Q1 2020, But Then Steepened.

Most watch the yield curve from the 2 year. The curve from 2 years to 5 years is an administrated rate set by the Fed and does not reflect the US economy. The yield curve that does reflect the US economy is from the 5 years and this report uses the 20 years as there is a continuous time series - the 30 years stops in the 90s when the 30 years were no longer issued for a while. The yield curve of 5 years US Treasury to 20 years US Treasury is given,

The “Maturity” of R2000

The 7 Years Forward GDP Level Does Not Support Current R2000 Levels

A Significant Sell Off In R2000 Likely to Occur

The “Basis” of 7 Years Forward GDP to Current GDP

The 7 years forward GDP level difference to current GDP - the " GDP basis“. The R2000 level prices an implicit growth rate of the US economy. The R 2000 members cannot use offshore tax avoidance schemes such as the infamous”Irish Double-Dutch" structures or offshore tax havens. It makes sense to compare the GDP basis to current R2000 levels. Note the forward GDP is in the then current dollars, or is NGDP.

The Same Analysis Using 7 Year Forward GDP and the 7 Year GDP Basis to Qualify SP500

The above analysis is applied to the SP500. The ETF “SPY” is used for levels over time.

The SP500 level is rich versus the R2000 level. The R2000 is perceived as a domestic US stock index, with the members not able to arrange tax avoidance strategies. The leading weights of the SP500 all are intent in using international tax avoidance schemes as well as Chinese excess capacity to produce goods.

As forward GDP, the basic input throughout this report, was almost always a steady 2% to 6% per annum growth given the rather steady forwards in volatility and the instantaneous rates, there was little ongoing difference between comparing risky assets to current dollar GDP even though current dollar GDP has by definition “0” duration and and all risky assets have long duration.

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A Fisherian analysis has it that the US Treasury rate curve and US GDP and US risky assets like the R2000 or SP500 will, over time, be in synch.

The Federal Reserve has evoked a “Japanification”, or a “Lost Decade”, similar to what Japan experienced from the 1990 crisis well in the 2008 crisis. This will mean that the Fed stimulus in response to Covid-19, that was not a classic Bagehot “discount window” solvency action lending freely against “good collateral”, will cap if not offset the fiscal stimulus. Furtermore the fiscal stimmmulus is not public investments but transfer payments. These transfer paymnents have made savings surge given the general alarm. The fiscal stimulus is not, but has a less than 1 Keynesian multiple.

While the US Treasury rate and risk premium may adjust to levels that support the current equity levels, this is unlikely as a “catch all” that higher rates are negative for equities will likely drive equity down to recent lows. If Chinese excess capacity is no longer dumped into the US and with the massive fiscal and monetary intervention, then significant inflation will begin forcing the Federal Reserve to tighten at levels not seen since Volcker. But such ending of Chinese mercantalism is still not appearing and even more unlikely given a Biden administration.