It's A Low, Low, Low, Low Medium-Rate World
I would be remiss in my duties if I failed to point out that this recent run up in yields -- fundamental explanation here -- occurred a few short months after the cover of BusinessWeek declared: It's A Low, Low, Low, Low-Rate World
Back in November, I was walking by a magazine stand in Grand Central Station when that red cover caught my eye (a lesser hue might have gone unnoticed). Its a fair rule to assume I stop and look at pretty much any magazine cover that is either bright red or has Jessica Biel on the cover.
(As the nearby photo reveals, Jessica Biel in bright red is an automatic).
Since the aforementioned Biel was not on the cover of this particular magazine cover, it led to this post: Uh-Oh: It's A Low, Low, Low, Low-Rate World.
Other folks prefer more quantifiable basis for announcing their expectations of higher rates in public. Some rely on signs of a inflation, others choose to read the entrails of Fed meetings.
Chartist Michael Kahn, makes The Technical Case for Higher Rates in
In Barron's Online:
"The 30-year Treasury yield has moved above the 5% level to notch a 10-month high and technically, it has already confirmed the end of a 13-year trend of declining interest rates.
The benchmark 10-year yield is threatening a breakout of its own, too.
The major trend in interest rates has been down for the past three decades. This generational, or secular, move helped fuel the great bull market in stocks as corporations and equities typically do well when interest rates fall. But as the chart shows, the trendline that guided rates lower is now under attack."
Kahn suggests that itss too soon to "declare a generational rising trend in interest rates. Nonetheless, chartists still note that a major change in the 30-year yield has occurred."
graphic courtesy of Barron's
>
And this morning, Mike Santoli argues in The 5% Dilemma that "during this bull market of four-plus years, stock indexes have made essentially no upside progress in periods when the 10-year yield has been above 4.75% or so. Stock valuations and M&A deal premiums, in this context, will be crimped at lower rates than we became accustomed to in the prior decade."
However, do not assume that the 5%+ yields means the Bull just rolls over and dies.
"Moving beyond the history lessons, though, there are some encouraging aspects of the markets' action that suggest that this pullback in stocks (partially reversed with Friday's rally) is probably not the Big One, so to speak.
First is the fact that rising rates, which went unnoticed for weeks, have now become overexposed as a news story and a focal point of market commentary. From the headline-commanding comments of Pimco's Bill Gross (risk of 6.5% 10-years within five years) to the popular insistence that higher rates, at last, will bring the buyout boom to its Waterloo, this cacophony hints that stocks are in the process of discounting this story.
The other key sub-surface element to the bond selloff is that it wasn't accompanied by accelerating inflation expectations or carnage in the corporate-bond arena. Market-implied inflation forecasts have remained tame, and corporate-bond yields haven't risen nearly as fast as Treasuries. Corporate-bond spreads still seem too tight to the naked eye, but they have been a good indicator of general economic risk and liquidity for stocks."
Well said, and logical. But all I can say is: "Long Live the Magazine Cover Indicator!"
UPDATE: June 10, 2007 7:37am
Note that Barron's Randall Forsyth also noticed the coincidence of the mag cover and the recent interest rate spike:
Four months ago, Business Week's cover proclaimed "It's a Low, Low, Low, Low-Rate World," and that it would stay that way. Since then, the benchmark Treasury 10-year note edged down to around 4.50% -- near the low end of its trading range over the past year -- in March before jumping to nearly 5.25% by Friday, which marked the high end. Moreover, almost all of that rise has come in the past month or so.
John Roque, Natexis Bleichroder's technical analyst, says a close for the 10-year note above 5.25% would point to a target of 6.10%. "If yield were a stock, we'd be buying any pullback we could."
In other words, sell bonds.
>
Sources:
The Technical Case for Higher Rates
Michael Kahn
Barron's, June 6, 2007
GETTING TECHNICAL
http://online.barrons.com/article/SB118106760599125301.html
The 5% Dilemma
Mike Santoli
Barron's, June 11, 2007
Streetwise
http://online.barrons.com/article/SB118076694077022594.html
Global Rate Forecast: Up
RANDALL W. FORSYTH
BARRON'S, June 11, 2007
http://online.barrons.com/article/SB118076654624522539.html
Saturday, June 09, 2007 | 11:08 AM | Permalink
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A 10-year rate below the FFR is still pretty low. I think we're heading higher, but it's probably too early to declare the end of low rates.
Posted by: Steve | Jun 9, 2007 2:13:35 PM
Something seemingly overlooked in this recent bond selloff is the actions of the FCBs last week, and that also may explain why corporate bonds did not follow.
From The Federal Reserve H.41 release of June 7, 2007:
Memo (off-balance-sheet items):
Marketable securities held in custody for foreign
official and international
U.S. Treasury 1,229,911 - 1,499 + 109,624 1,224,824
Federal agency 725,543 - 2,359 + 219,914 725,209
As is shown, FCBs became net sellers of treasuries and paper last week to the tune of $3.8B, a 180 degree change from their usual action. Whether or not this is a one-week power play by China to let Paulson know who is really the boss or an actual change in FCBs metrics led by the oil producers will be critical forward going. It seems likely that Syria and Kuwait dropping the dollar peg would remove some demand. If the UAE follows suit, I would expect more upward yield pressure to follow suit.
Just goes to show, Mr. Paulson, you don't piss off Madam Wu.
Posted by: Winston Munn | Jun 9, 2007 2:30:40 PM
Steve:
Well said....! There was also talk about Putin inquiring as to how Mr. Bush was planning to pay for his proposed defence shield. Reality Sucks...!
Econolicious
Posted by: ECONOMISTA NON GRATA | Jun 9, 2007 3:03:48 PM
barry,
re bonds, pls see and quote from, randall forsyths excellent column in barrons (page m6) where a person who predicted this is calling for 1 6.1% 10 year soon.in other words, sell bonds!!
Posted by: jim | Jun 9, 2007 3:13:36 PM
Is it possible that a partial catalyst for the money coming out of debt markets last week was LBO funders raising cash to close?
The sheer size and number of deals suggest that the probability of multiple funders needing to raise cash at once must be increasing. Presumably, the opportunities for front running this must also be increasing.
Posted by: Estragon | Jun 9, 2007 3:32:07 PM
How many hundreds of billions of treasurys do the FCB's hold? They've experienced some pretty serious mark to market value destruction from the bond market selloff.
Pretty expensive revenge.
Posted by: S | Jun 9, 2007 4:06:26 PM
Maybe FCB's would (finally) rather lose money on their existing investments than throw good money after bad. Why do people lend money to US? We make top-notch planes, thanks to generous, decade-long Pentagon subsidies. But, what else? Suppose 30 years pass and all those US dollars are repaid: what can anyone buy with that from the US?
The manufacturers are leaving. So, what will our creditors buy from us when we finally pay them? Will they redeem their dollars for services? "We don't even mow our own lawns. We import laborers for that. Would you like to pay me dollars to have my laborer mow my lawn?"
The best thing this country can do is let the CIA loose on foreign governments. Instability elsewhere in the world lowers our relative cost of capital. Then, people won't continue investing in us out of choice but rather because we're the only safe haven in town.
Posted by: What Would Machiavelli Do | Jun 9, 2007 7:50:42 PM
Quote: "How many hundreds of billions of treasurys do the FCB's hold?"
FCB holdings estimated at 1.9 TRILLION.
In comparison, SOMA has $810 billion in their account.
So who is the Big Dog, the FCBs or the Fed?
Posted by: Winston Munn | Jun 9, 2007 8:01:06 PM
Per Mike Santoli:
"The other key sub-surface element to the bond selloff is that it wasn't accompanied by accelerating inflation expectations...."
end quoting.
--
I'm not sure I buy that, Mike. There's no way a 10-y-T can trade with a 6.5, e-v-e-r, without inflation expectations.
Here's much of what caused the yield blitzkreig:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aBZn.0Xtynb8&refer=home
And much of 'it' in turn was caused by a huge run-up in dairy prices in NZ. I addressed those issues in an earlier topic:
http://bigpicture.typepad.com/comments/2007/06/a_market_questi.html#comments
Now, let's speak about Gross' comments. I must say I don't know the time line involved with his mea-mea culpa, mea to the first culpa of his original May/June Pimco letter, after which he has now (within the last few days) raised the top yield range in 3- to 5-years from 5.5 to 6.5 on the 10-y-T, but I suspect his recent revision may have been induced by that NZ overnight hit.
We'd have to ask Mr. Gross, but moving from 5.5 to 6.5 just since the inception of his May/June Pimco epistle... had to be stimulated by some new dynamic causing that mid-stream equine re-mounting.
Too, in his interview on CNBC Friday, Gross mentions going to Brazil for "10% net" and there's no such thing as 10% gross or net, Mike, without i-n-f-l-a-t-i-o-n much higher than 2-3%.
The recent inflation expectation up-tick in the U.S. is a hat doffed to failed M-o-n-e-t-a-r-i-s-m, and not to core real economic strength, not in the industrialized West at least, where we're in a currency rate hoe-down. Call your partner:
http://www.easy.com.au/callers/HDmusic.htm
http://www.youtube.com/watch?v=NMKM7uC2Q40
Posted by: Eclectic | Jun 10, 2007 5:54:30 AM
"Note that Barron's Randall Forsyth also noticed the coincidence of the mag cover and the recent interest rate spike":
end quote.
---
Oh, you guys are scarin' me so bad. I accept and believe the mag cover thesis, but take a look at last year:
http://finance.yahoo.com/q/hp?s=%5ETNX&a=01&b=2&c=2006&d=06&e=10&f=2006&g=w
The Feb/Mar to Jun run last year was also head-faked to represent the death of under-5, and the run is up again because neither housing nor employment have taken a hit... not one that we can see clearly that is, not yet. And I don't know if those things will happen or not, but the economy is not healthy in more ways than it is healthy. There just hasn't been a trigger to trip Boomer sentiment in the other direction.
You can go and find "end of human civilization stories" back last year as well about the 10-y-T. I'm just too bored to look for them. I'm also bored and tired of demonstrating to you house ape curtain climbin' erroneo-historians that believing 5.25 on the Ten is historically low, ignores two realities; -1) History older than Barbarella, and -2) The thing that made them appear low historically was a Carter administration Keynesian Fed with its own special brand of irresponsible failed monetarism, the kind no self-respecting pure blood M-o-n-e-t-a-r-i-s-t like Dr. Anke could ever live with.
Anke'd rather get punctured with eagle claws and hung up like Richard Harris in "A Man Called Horse" than permit the kind of inflation that would push up the Ten to threaten rising through 6.5 to higher levels.
6.5 can NOT happen, s-o-o-n, unless the Fed permits its top range of inflation expectations to be exceeded. Those expectations that would permit so rapid a rise anytime soon would do more than "decimate" housing, as said by Billy Gross.
Yeah, China is hot, but so was the U.S. in the Roaring Twenties, and less than a decade later rates got as low as 4/10s of 1 percent.
Anybody here want to take me up on it?... Wanna do a realistic study of historical rates, or do you all just want to eat the baby food fed to you by CNBC?
If every time Santelli on CNBC had preached the death of Bondie over the last 4 or 5 years, rates had moved up and stuck... the 10-y-T would be at about a yield of 40%...annualized by now.
You witnessed the up-rate orgy when jobs were reported as 157K at the last BLS NFP, didn't you? Well, maybe they were 157K real jobs, or maybe BED will soon tell us another story such as the one that refuted last 3rd quarter's approximately 500K jobs.
Another problem is that derivative hedging of some gigantic secondary mortgage portfolios referred to by Dr. Benber N. Anke (which he contributed "contribute zippo" to their original chartered purpose) is a constant up-rate-ticking threat... but those folks are playing horseshoes with sticks of dynamite. Whaddya think this spikey run is doin' to those portfolios?... huh?
Posted by: Eclectic | Jun 10, 2007 11:36:28 AM
Quote Eclectic:
"You witnessed the up-rate orgy when jobs were reported as 157K at the last BLS NFP, didn't you? Well, maybe they were 157K real jobs, or maybe BED will soon tell us another story such as the one that refuted last 3rd quarter's approximately 500K jobs."
Quote International Forecaster:
"Morgan Stanley sees a 14% correction over the next six months, which would put the Dow at 11,700."
I'm looking for the start of this correction in August, when BED shows real contraction of the labor market instead of the fantasy gains BLS has been providing.
But the serious issue the Fed will have to decide is whether to protect the dollar or encourage the economy - when in fact there is no choice because without the dollar as reserve currency there is no American economy to save.
Posted by: Winston Munn | Jun 10, 2007 12:02:11 PM
Winston, per you:
"But the serious issue the Fed will have to decide is whether to protect the dollar or encourage the economy - when in fact there is no choice because without the dollar as reserve currency there is no American economy to save."
--
Winston, the USD is a long way from the skid row of recent mythology. It may surprise you to know that I actually think the Fed should raise rates now.
-It's just that I don't think they will...
-I just don't think they think they'll have to...
-I don't think they're as worried about inflation as this frenzied orgy of up-ticking in rates might indicate...
We will see, and I will admit if I'm wrong.
If the 10-y-T breaks 5.25, I'll doff my hat to Barringo, but only doff it for the moment.
If it breaks 5.50, I'll allow that he could've won $100 worth of goodies, but he was too chicken to step up to the plate.
If it's 5.25000 or higher at the close on last day 2007, I'll write him a self-deprecating poem of homage from Eclectic, to memorialize his intellectual acumen.
Posted by: Eclectic | Jun 10, 2007 1:25:19 PM
Quote Eclectic: "I don't think they're as worried about inflation as this frenzied orgy of up-ticking in rates might indicate..."
I am in 100% agreement, although possibly for different reasons. I am a believer that the Fed is nothing more than a follower and endorser of rates - it is the bond markets themselves that set rates. This Fed chair has expressly stated that he is opposed to "price stability", which is the chartered reason for the Fed in the first place, but he believes in "targeting inflation", which is another way of saying "allowing inflation." Ben would never, under any circumstances, on purpose contract the money supply a la Volcker. But isn't it odd that targeting money supply as Volcker did crushed inflation, yet this Fed keeps harping on the very inflation they create by expanding the supply of money.
I am of the opinion that it will be the markets who eventually contract the money supply - as the Fed is too politicized to do it - and therefore we will lose any hope of a regulatory mechanism that might shield the blow. Instead, greed will keep the engines on full throttle until the ship of state plows smack into the middle of the iceberg.
Nearer, my God, to Thee.
I agree that US dollar is not in eminent threat of collapse; however, with each failed war (our last four record of 1-2-1 won't make the playoffs) our "untouchable" image loses a bit more of its facade and countries who rely on our military might for the quid pro quo of a dollar reserve might see that our only real advantage is in nuclear might - and that can be copied.
Iran, anyone?
Posted by: Winston Munn | Jun 10, 2007 3:22:02 PM
per Winston with **my comments:
"I am a believer that the Fed is nothing more than a follower and endorser of rates."
**oh yeah?... so is that the reason the Fed chased rates so low they almost put the MM mutual funds out of business, or into receivership?... or into a MM mutual fund holiday?
"It is the bond markets themselves that set rates."
**only when the Fed accomplishes its *true* chartered mission, the one from its true ancestry, from Alexander Hamilton's vision of a unified stable currency. Too, Winston, you've completely ignored their 3 most powerful tools: 1)- open market actions of the Fed, 2)- setting reserve requirement levels, and 3)- setting margin requirements. Tool 1, along with the discount rate, allowed them to push short rates too aggressively low, and housing was the whipping boy. Of all their tools, moral suasion and the publication of the discount rate are their least effective tools. Often they are mere signals, and not followed up with the other operative tools. If you see them pull out tools 2 and 3, I can promise you they will then be serious about inflation. They don't buy those tools at HD or LOW.
"This Fed chair has expressly stated that he is opposed to "price stability....."
**you'll have to find that and show me in writing, Winston. And I'd pack a sack lunch if I were you.
"But isn't it odd that targeting money supply as Volcker did crushed inflation, yet this Fed keeps harping on the very inflation they create by expanding the supply of money."
**as I've said, Volcker was a tall, tall man, physically and figuratively. He understood that when market participants can't predict inflation, it ultimately freezes the capital markets because participants can not guage the net present value of future cash flows, and thus can not measure the marginal efficiency of capital. That's cap-ex, Winston. It was also an odd application of core Keynesian theory, if only by an otherwise wise and effective M-o-n-e-t-a-r-i-s-t by faith. It's probably the only thing about Volcker that made him like Milton Friedman, and Anke is Friedman's beloved protege.
"I am of the opinion that it will be the markets who eventually contract the money supply - as the Fed is too politicized to do it - and therefore we will lose any hope of a regulatory mechanism that might shield the blow."
**unfortunately, I have to agree with you about the late Greenspan era, but we haven't seen the measure of Dr. Benber N. Anke yet. However, go back and read my theories on perceived liquidity and perceived liquidity's substitution of nominal liquidity, and you'll see that it may be the psychological basis of money itself that could obviate the excess liquidity that market optimists remind us of day after day.
Posted by: Eclectic | Jun 10, 2007 5:15:11 PM
Quote Eclectic: ""This Fed chair has expressly stated that he is opposed to "price stability....."
**you'll have to find that and show me in writing, Winston. And I'd pack a sack lunch if I were you."
This is an extrapolation - "targeting inflation" means ignoring money supply, does it not?
This is what Bernanke said: "Targeting inflation can defend against deflation and inflation."
WTF???? So as long as the expanded money supply is creating unmeasured inflation, housing and equities, or exported to foreign countries, China and OPEC countries, then targeting iflation works...sort of. But what happens when the bubbles burst and foreigners get tired of imported inflation?
Peter Schiff agrees: "The mistake made by the Fed during the 1920's was expanding the supply of money and credit too rapidly. However, as increasing productivity prevented consumer prices from rising, the Fed was unconcerned about the inflation it was creating. Instead, the excess money and credit that spilled into financial and real estate markets caused asset prices to rise, which resulted in claims of a 'new era' (sound familiar?). The bust of 1929 led to the Great Depression of the 1930's not as a result of Fed tightening, as Bernanke claims, but due to the misguided economic policies of the Hoover and Roosevelt administrations."
You'll simply have to explain to me (use short, simple words, too) how allowing inflation also defends against inflation.
Posted by: Winston Munn | Jun 10, 2007 6:59:14 PM
Winston,
I'm afraid you've lost me. I've re-read our last exchanges and I don't understand your position well enough to respond.
Posted by: Eclectic | Jun 10, 2007 8:50:09 PM
Winston,
I'm afraid you've lost me. I've re-read our last exchanges and I don't understand your position well enough to respond.
Sorry. My fault. Combining ideas again without solid groundwork. Let me summarize for brevity sake?
This Fed chair takes great pride in being a scholar of the circumstances that surrounded the great depression; however, he has adopted the very same ideology (from Irving Fischer) that led up to and sustained the bubble that collapsed and created the depression.
My points are these: although you are right, I ignore the three weapons the Fed has to use as this Fed will never use those weapons - remember, they are targeting inflation and not money supply. Asset bubbles are non-inflationary, so what's the worry? The most you would ever see from this Fed is a rise in the target rate - remember, they don't consider money supple, i.e., credit supply, to be a problem, only inflation. In fact, Bernanke has said that credit availability is crucial.
As for setting rates, I am speaking of the worldwide bond market - simply too large of force for the Fed to control. Just in U.S. treasury holdings, the FCBs hold $1.9 trillion compared to $810 billion in SOMA. My point is who has more leverage as to rates - and remember, the FCBs are daily players, just as is the Fed. The Fed can target all they want, but unless the markets concur it means diddly squat. Especially as the Fed - with no monetary policy - will not intervene to contract the supply to protect a rate.
As for the comment about chasing the rates until putting MF's into receivership, we all have Easy Al to thank for that. The Fed could have kept the target at 2-3% and contracted the money supply to protect that rate.
On another note, I would like to read your ideas on economics but do not know where to find them. Could you point the way - slowly - to a few at a time?
Thanks.
Posted by: Winston Munn | Jun 10, 2007 9:36:12 PM
The Barrons chart shows the new trading range in bonds. Inflation spreads have not signaled problems. Bonds are a buy -- fade Gross/Pimco/Greenspain
Posted by: Frankie | Jun 10, 2007 10:38:26 PM
"In other words, sell bonds."
SOLD to me....at 5.24% overnight.
Posted by: Frankie | Jun 11, 2007 4:40:05 AM
Winston,
The great bulk of my condensed thoughts are in several of my comments here:
http://bigpicture.typepad.com/comments/2006/11/econojunk_fix.html
Posted by: Eclectic | Jun 11, 2007 7:51:18 AM
Winston and Eclectic:
You both have sharp minds (as does Barry)...yet sometimes the most simple elegant observations are "smarter". Last week we witnessed the "normalization" of the yield curve (except the FFR), which clearly suggest better growth ahead -- NOT INFLATION! In fact notice that the 90 day bill is now only 5 bps from being 10% below the FFR. Historically, every time it remains 10% the FFR, for a few weeks, the FED CUTS RATES. As well, notice that the action in the TIPS market screamed that the inflation many are arm waving about is not being respected by the final arbiter -- PRICE (aka the Market). Real rates are rising, but inflation spreads didn't move. Don't over think this.
Stochastics on the long bond also show a deeply oversold condition. This pull back (bothe markets) was a GIFT.
Posted by: Fred | Jun 11, 2007 12:32:37 PM
Quote Fred: "In fact notice that the 90 day bill is now only 5 bps from being 10% below the FFR. Historically, every time it remains 10% the FFR, for a few weeks, the FED CUTS RATES."
This is my position as well, Fred. The Fed does not "set" rates but only ratifies the market rate. Greenspan did not lower rates which caused bonds yields to fall - the Fed chased the 90-day as it fell.
Of course, at any point in time the Fed can say enough and use its might to restrict further credit growth, but neither Greenspan nor Bernanke are of this ilk - it didn't happen then and it ain't gonna happen now.
However, I'm going to have to disagree with your assessment that the normalization of the spread indicates normilzation of the economy - when the yield curve has inverted for this length of time, a recession has followed 100% of the time within a year. And with the timely finding by Business Week that we have been overstating GDP due to offshoring accounting errors, it may turn out that Nouriel Roubini was right and we have already entered a contraction in Q1.
The housing issues have not as yet been dealt with, as mark to market seems to have disappeared from the lexicon of the many who hold CDO toxic waste and derivatives based on that toxic waste - the upticks in the 10-year yield puts even more pressure on the ARM resets that will peak this year and next.
I think all we've seen is the tip of the iceberg - and that's why the Fed will eventually screw up again and lower rates.
Posted by: Winston Munn | Jun 11, 2007 8:02:09 PM
Fred:
You haven't read what I said, Fred.
Posted by: Eclectic | Jun 11, 2007 8:09:14 PM
Eclectic:
Have read what you suggested and am digesting. One thing immediately comes to mind (not about your hypothesis) and that is the reason behind the dollar's role as the world reserve currency.
It is my view that this is being done as a "protection racket" based on the military might of the U.S. Who have been historically the great suppliers of recycled dollars? OPEC and Japan. And what has been the U.S. role with these countries? To provide military protection to sustain the regimes, which in turn pay by keeping the dollar as "king currency".
However, a few bugs have flown into the mosquito netting and created a hole - China is becoming a big player in this game and the U.S. holds no "trump card" to force their hand.
The world currency domination game is tenuous - and without that game the U.S. has nothing but military might and hyperinflation left as weapons, both of which are poor resources in an economic war.
Posted by: Winston Munn | Jun 11, 2007 9:39:56 PM
Eclectic:
Could you explain to me how in your hypothesis "perceived liquidity" can rise yet real purchasing power can drop, such as occured in Wiemar Germany?
Also, as I believe you define "borrowing ability" as part of "perceived liquidity", what happens to perceived liquidity when lending standards tighten and interest rates rise?
Can you apply your hypothesis to the three great destructive economic events of our time: hyperinflation, stagflation, and depression?
Posted by: Winston Munn | Jun 11, 2007 10:06:44 PM
