The Economy and Bond Market Highlights (week ending 2/15/2010)

Monday, February 15th, 2010

The Economy and Bond Market

Treasury yields moved higher this week on the back of large Treasury auctions that met somewhat tepid demand. Domestic economic news was relatively uneventful; it seemed the poor weather conditions in many parts of the country were a bigger story. Internationally it was a different story. Chinese bank lending jumped in January to one of the highest totals on record and Chinese M1 money supply grew 39 percent on a year-over-year basis, see chart below. The Chinese government has enacted numerous tightening measures in recent weeks and another was announced on Friday, raising bank reserve requirements by another 50 basis points. Growth indicators are very strong but the government tightening has begun and in the short term the economy has a lot of momentum but the government needs to be careful and not make adjustments too rapidly as it would have a global impact.

Strengths

• January retail sales rose 0.5 percent and beat market expectations.
• The National Federation of Independent Business (NFIB) small business index hit a 16 month high.
• Weekly initial jobless claims fell to 440,000 breaking the recent trend higher.

Weaknesses

• China is tightening policy on an almost weekly basis and that raises the risk of doing too much too soon.
• February’s University of Michigan Confidence Index fell to 73.7, below expectations.
• The trade balance unexpectedly widened in December on higher oil imports.

Opportunities

• The economic recovery is still intact but looks more fragile now than just a couple of months ago, which likely keeps the Fed on hold for some time.

Threats

• If one of the Euro countries were to seriously threaten default, the whole Euro currency system comes into question and threatens global financial stability

Tags: Bond Market, China, Chinese Bank, Confidence Index, Currency System, Emerging Markets, Euro Countries, Federation Of Independent Business, Global Financial Stability, Global Impact, Growth Indicators, Initial Jobless Claims, Market Expectations, Money Supply, National Federation Of Independent Business, Nfib, Oil Imports, Poor Weather Conditions, S University, Treasury Auctions, Treasury Yields, University Of Michigan Confidence
Posted in Markets | No Comments »

The Economy and Bond Market Highlights (week ending 02/07/10)

Sunday, February 7th, 2010

The Economy and Bond Market
Treasury yields were mixed this week as the middle part of the curve rallied while the long end rose slightly. Concerns over the potential of a debt default in Greece early in the week quickly spread to wider problems in the euro zone which include similar concerns surrounding Spain and Portugal. The U.S. dollar rallied strongly on these concerns, which helped support the Treasury market.

Two important pieces of economic data were released this week: the ISM Manufacturing Index and the amount of change in nonfarm payrolls in the unemployment report. These two series are graphed below and represent the past 20 years of data and shows how these two series tend to move in tandem. This week the ISM index hit the highest level in more than five years, which bodes well for job growth in the near future if history is any guide.

Strengths

• The ISM Manufacturing Index hit 58.4, well above the economic breakeven level of 50, the highest level in over five years. The jobs index component also rose the highest levels since 2006.
• Retail sales in January broadly beat expectations, reinforcing the idea that the economy is improving and consumers are becoming more confident.
• The ISM Nonmanufacturing Index also rose in January, hitting 50.5 with strength seen in the amount of new orders.

Weaknesses

• Concerns over the potential of a debt default in Greece early in the week quickly spread to wider problems in the euro zone which include similar concerns surrounding Spain and Portugal. These concerns caused risky assets to fall across the board and are a threat to global economic recovery.
• January’s employment report was somewhat disappointing as nonfarm payrolls failed to break into positive territory as the economy lost 20,000 jobs last month.
• Construction spending fell 1.2 percent in December and a record 12.4 percent for the full year.

Opportunities

• The economic recovery is still intact but looks more fragile now than it did just a couple of months ago. This will likely keep the Fed on hold for some time.

Threats

• If one of the euro zone countries were to seriously threaten default, the entire euro currency system could come into question, threatening global financial stability.

Tags: Bond Market, Consumers, Curve, Debt Default, Economic Data, Economic Recovery, Economy, Employment Report, Euro Zone, Greece, Ism Index, Ism Manufacturing Index, Market Economy, More Than Five Years, Nonfarm Payrolls, Retail Sales, Risky Assets, Tandem, Treasury Market, Treasury Yields, Unemployment Report
Posted in Markets | No Comments »

Economy and Bond Market Highlights

Sunday, January 24th, 2010

The Economy and Bond Market
Treasury yields rallied again this week as concerns over Chinese attempts to slow their economy may threaten the global economic recovery. It was reported that China’s government ordered banks to slow down their lending to prevent overheating the economy. The Chinese government has enacted several measures in recent weeks aimed at slowing their economy which expanded 10.7 percent on a year over year basis in the fourth quarter.

Economic data was mixed this week and other macro issues were more significant in driving the market. The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December. The chart below plots the LEI index and GDP on a year over year basis since 1980. If economic activity follows historical patterns, GDP is due for a significant recovery as we move through 2010.

Strengths

• The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December.
• China’s GDP rose a very robust 10.7 percent in the fourth quarter.
• 30 year mortgage rates dropped below 5 percent for the first time in four weeks.

Weaknesses

• The Chinese government has enacted several measures in recent weeks aimed at slowing their economy.
• Housing in general appears to be bouncing along a bottom but unable to make sustained improvement.
• The producer price index rose 0.2 percent in December and on a year over year basis has jumped 4.4 percent driven largely by rising energy prices.

Opportunity

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4 to 5 percent. The global economic recovery appears to be taking hold.

Threat

• Coordinated global removal of fiscal and monetary stimulus is the biggest threat to the financial markets.

The Economy and Bond Market

Treasury yields rallied again this week as concerns over Chinese attempts to slow their economy may threaten the global economic recovery. It was reported that China’s government ordered banks to slow down their lending to prevent overheating the economy. The Chinese government has enacted several measures in recent weeks aimed at slowing their economy which expanded 10.7 percent on a year over year basis in the fourth quarter.

Economic data was mixed this week and other macro issues were more significant in driving the market. The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December. The chart below plots the LEI index and GDP on a year over year basis since 1980. If economic activity follows historical patterns, GDP is due for a significant recovery as we move through 2010.

Strengths

• The Index of Leading Indicators (LEI) rose more than expected, rising 1.1 percent in December.
• China’s GDP rose a very robust 10.7 percent in the fourth quarter.
• 30 year mortgage rates dropped below 5 percent for the first time in four weeks.

Weaknesses

• The Chinese government has enacted several measures in recent weeks aimed at slowing their economy.
• Housing in general appears to be bouncing along a bottom but unable to make sustained improvement.
• The producer price index rose 0.2 percent in December and on a year over year basis has jumped 4.4 percent driven largely by rising energy prices.

Opportunity

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4 to 5 percent. The global economic recovery appears to be taking hold.

Threat

• Coordinated global removal of fiscal and monetary stimulus is the biggest threat to the financial markets.

Tags: 30 Year Mortgage Rates, Banks, Bond Market, China, Chinese Attempts, Chinese Government, Economic Activity, Economic Data, Economic Recovery, Economy, Emerging Markets, Energy Prices, Financial Markets, GDP, Index Of Leading Indicators, Macro Issues, Market Economy, Measures, Producer Price Index, Rising Energy, Stimulus, Treasury Yields, Year Mortgage
Posted in Markets | No Comments »

Roundup: The Economy and Bond Market

Sunday, January 17th, 2010

The Economy and Bond Market Treasury yields rallied as this week’s 10 and 30-year auctions received a good response and concerns of global stimulus removal have highlighted risks in the global recovery story. Economic data was mixed this week as December retail sales were surprisingly weak and seemed to contradict earlier data. On the other hand, industrial production rose for the sixth straight month and is giving a classic sign of economic recovery. The chart below graphs industrial production on a year-over-year basis and makes clear the change in direction of activity. Strengths

• Industrial production rose 0.6 percent in December and has now risen for six months in a row.
• Chinese imports and exports moved sharply higher in December, which implies continued improvement in not only China’s economy but the global economy.
• Consumer prices in December remained muted, rising only 0.1 percent and giving the Fed plenty of room for monetary policy flexibility.

Weaknesses

• Retail sales for December disappointed and appeared to contradict earlier data. One positive caveat was November data was revised higher making the numbers a little more palatable.
• The Obama administration is proposing a tax on big banks as a way to recoup the government’s support. The concern is that this appears somewhat punitive and more taxes and/or regulation are not an effective way to stimulate the economy.
• The Fed’s beige book reported only a modest improvement in the economy around year end, and cited weakness in real estate and labor markets.

Opportunities

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4-5 percent. The global economic recovery appears to be taking hold.

Threats

• The U.S. is facing a long-term risk as Fitch cited the budget deficit as a threat to the U.S. AAA debt rating.

Tags: Beige Book, Bond Market, Budget Deficit, Caveat, Change In Direction, China, China Economy, China S Economy, Chinese Imports, Economic Data, Economic Recovery, Emerging Markets, Global Economy, Global Recovery, Imports And Exports, Labor Markets, Monetary Policy, Plenty Of Room, Retail Sales, Stimulus, Treasury Yields, Year End
Posted in Bonds, Gold, Markets | No Comments »

Chart of the Day: Lending Still Shrinking

Tuesday, January 5th, 2010

As shown in the graph below, courtesy of Clusterstock - Business Insider, the latest figures from the St. Louis Fed show that commercial and industrial lending is still declining.

The dilemma is that US banks can borrow for almost nothing and lend money to the government by buying 10-year Treasury Notes and 30-year Treasury Bonds with yields of 3.8% and 4.6% respectively. “Thus, the banks are thriving on the ‘yield curve’ while the poor slob on the street gets nothing for his savings (assuming he has any savings at all). And when you think about it, why should the banks make risky loans to the poor goof on Main Street when they can play the yield curve with almost zero risk?, remarked Richard Russell, author of the Dow Theory Letters.

It goes without saying that lending needs to expand before a decent economic recovery can get under way.

Source: Clusterstock - Business Insider, January 4, 2009.

Tags: 10 Year Treasury Notes, 30 Year Treasury Bonds, Advertisement, Banks, Business Insider, Dilemma, Dow Theory Letters, Economic Recovery, Goof, Graph, January 4, Money, Poor Slob, Richard Russell, risk, Risky Loans, Treasury Yields, Yield Curve
Posted in Markets | No Comments »

Economic Threats and Investment Opportunities

Monday, December 14th, 2009

In an article, published today at GlobeAdvisor.com, Pierre Daillie, Managing Editor, AdvisorAnalyst.com discusses how economic threats translate into different investment opportunities.

Confused about what’s in store for the economy? The long-in-the-teeth rally in equities, falling U.S. treasury bond yields, and record gold prices reflect both the uncertainty, and the conflicting wagers on inflation and deflation. It appears we’re at an inflection point, the outcome of which will depend on how economic policy makers act. The debate as to what happens next rages on.

To read the story, please visit http://www.globeadvisor.com/advisoranalyst/aa200912132.html

Tags: Act, Advertisement, Amp, Avw, Cb, Ck, Economic Policy Makers, Economic Threats, Economy, Gold, Gold Prices, Img Src, inflation, Inflection Point, Investment Opportunities, Lt, Managing Editor, Openx, Policy Debate, Rages, Rally, Random Number, Teeth, Translate, Treasury Bond Yields, Treasury Yields, U S Treasury, Uncertainty, Wagers
Posted in Markets | No Comments »

Convergence of Corporate and Treasury Yields Not What You Think

Friday, June 12th, 2009

Many economy watchers are of the mind, simply so, that the market’s appetite for risk is increasing, and others would like nothing more than to believe that this is yet another ‘green shoot.’

Earlier this week we provided a note from Northern Trust’s Paul Kasriel discussing the convergence of treasury yields versus corporate yields.

This combination of a rise in the Treasury bond yield, declines in yields on privately-issued bonds and rising stock prices is consistent with an asset allocation shift away from an asset with no credit risk to assets with credit risk. How can this lessen the chances of an economic recovery? If the current and increased supply of Treasury debt coming to market were “crowding out” private debt issuance, then the yields on privately-issued debt would be holding steady or rising in tandem with the rise in the Treasury bond yield. But again, yields on privately-issued debt are falling. In sum, investor risk appetite is returning, which is a good thing for the prospects of an economic recovery, not a bad thing.

Joe Wiesenthal, at ClusterStock believes that the convergence between government and corporate yields in absolute terms is due to the recognition that the bonds of large financial companies effectively carry the same government guarantees, only they’ve been far more attractively priced until recently.

Ordinarily, a shift of assets away from Treasury bonds toward privately-issued bonds signals a growing appetite for risk and yield, which might indicate either inflation fears or hopes or economic recovery. But the huge shift we’re seeing now (see the chart (above), and Northern Trust economist Paul Kasriel’s analysis this morning) might signal something else entirely: that the market is pricing in the implicit government guarantee of the debt of financial companies. So instead of a shift away from risk-free assets, we may be seeing a shift between different classes of risk free assets.

This isn’t just a theoretic possibility. It’s something that is actually on the minds of asset managers. As early as January, asset manager Eric Roseman was advocating purchasing the corporate bonds of financial companies on this very basis.

In fact, Bill Gross, the bond king, openly pointed this out earlier this year. In his May Outlook, Gross had the following to say vis-a-vis the future of investing:

Shaking hands with the new government is still the prescribed strategy, although it should be done at a senior level of the balance sheet.

But, even more relevant is that in an interview with Bloomberg’ Kathleen Hays, February 10, 2009, Gross pointed out very specifically, and presciently, that their investment strategy was to ‘shake hands with Uncle Sam.’

KH: All your themes lately have been, ‘go with the government,’ If the Fed’s buying treasuries, you’re not going to buy them too?

BG: Well, we wouldn’t buy treasuries, but we would buy bonds that are correlated and related to treasuries with a higher yield.

KH: If even if the Fed starts this program of buying treasuries, which you said, hey, good idea, do it, you wouldn’t
buy treasuries, but you’d buy bonds correlated to them with higher yields. Let’s talk about corporate bond issuance which has really exploded recently. Why is that, and I know you have been recommending certain kinds of corporate bonds, holding them. Where do stand on that now?

BG: Sure, we’re recommending the higher tranche, the higher echelon of investment grade bonds, not necessarily Baa bonds, but single A, AA, and, in fact the bonds of the banks. Our motto is to shake hands with Uncle Sam. To the extent that the banks are supported, bank debt’s supported, those yields are in the 6-7-8% category, relative to 2-3% treasuries.

KH: I think you make a very good point. Right now, buy the corporate bonds, they’re safe, you get the yield, stay away from the equity, right? When does this stuff start working though? Wouldn’t that be a point when an investor could say, at some point when stocks bottom, you usually do get a bounce, a pretty good bounce that can carry you up high. How do you gauge that, I know you’re a bond fund, but nevertheless, then do you wish at times that you had a few equities? Will there be a point like that, when they’ll outperform?

Tags: Absolute Terms, Asset Allocation, Convergence, Credit Risk, Debt Issuance, Divergence, Economic Recovery, Government Guarantee, Government Guarantees, Inflation Fears, Investor Risk, Northern Trust, Paul Kasriel, Private Debt, Risk Appetite, S Paul, Stock Prices, Treasury Bond Yield, Treasury Bonds, Treasury Yields, Wiesenthal
Posted in Markets | No Comments »

Why are other yields falling as Treasury yields rise?

Wednesday, June 10th, 2009

This post is a guest contribution by Paul Kasriel* of The Northern Trust Company.

There is a lot in the press these days about how the recent rise in Treasury bond yields has the potential to abort a nascent economic recovery. To this I say, nonsense! Chart 1 shows that as the Treasury bond yield has risen in recent weeks, the yields on privately-issued debt have declined in absolute levels. Chart 2 shows that the stock market has been trending higher since March as the Treasury bond yield has risen.

This combination of a rise in the Treasury bond yield, declines in yields on privately-issued bonds and rising stock prices is consistent with an asset allocation shift away from an asset with no credit risk to assets with credit risk. How can this lessen the chances of an economic recovery? If the current and increased supply of Treasury debt coming to market were “crowding out” private debt issuance, then the yields on privately-issued debt would be holding steady or rising in tandem with the rise in the Treasury bond yield. But again, yields on privately-issued debt are falling. In sum, investor risk appetite is returning, which is a good thing for the prospects of an economic recovery, not a bad thing.

Source: Paul Kasriel, Northern Trust - Daily Global Commentary, June 9, 2009.

*Paul Kasriel is Senior Vice President and Director of Economic Research at The Northern Trust Company. The accuracy of the Economic Research Department’s forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul’s 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst.

Tags: Absolute Levels, Credit Risk, Debt Issuance, Economic Forecast, Economic Research Department, Global Commentary, Investor Risk, Journal Survey, Lawrence R Klein, Northern Trust Company, Paul Kasriel, Private Debt, Risk Appetite, Senior Vice President, Survey Panel, Survey Participants, Treasury Bond Yield, Treasury Bond Yields, Treasury Yields, Wall Street Journal
Posted in Markets | No Comments »

Between a Rock and Hard Place

Friday, May 29th, 2009

Money managers, investment advisors and investors alike face a daunting emotional and financial challenge in these markets as a result of all the conflicting signals the markets and the economy are giving. In addition, when what you hear, see and feel do not match up, seasickness or motion sickness may set in.

Economists are reporting that the rate of economic worsening is slowing down, treasury yields are rising again at the long end, and there are so-called green shoots. Government is signalling a turn in the economic outlook.

The stock market has enjoyed what some are calling (hoping) a new bull market and others, a massive bear-market rally, and corporate earnings beat severely beat-down earnings forecasts in the latest reporting season. Questions remain as to what is stable, and what is not?

In a recent post, Barry Ritholtz referred to Randall Forstyh’s “Green Shoots = Ganga” article in Barron’s:

Randall Forsyth elicits chuckles via his clever phrase-turning. He turns his poison pen on the ubiquitous nonsense known as “green shoots”  that has been so in vogue amongst the perma-wrong crowd:

“So, why the attraction of green shoots? One can only speculate that they must be in some ways intoxicating. Perhaps not the shoots exactly, or the stems or seeds, but the leaves of a certain plant. Those might be smoked or otherwise ingested to bring about a euphoric effect. From what I’ve read, the current crop is far more potent than the commodity available in years past. How else to explain the mind-bending notion that an economy that is declining less quickly is somehow improving?”

Like all great inventions, it obvious in hindsight.

Once someone else has invented it, everyone says (or at least thinks to themselves) “How on earth did I not come up with that myself . . . ?”

Dan Dorfman discusses an interview with an asset manager who repeatedly referred to himself as an idiot, to make the point about “the unrelenting pressures facing Wall Street’s performance-oriented big guns, many of them leery, and offers a credible reason why the beleaguered stock market could get another significant shot in the arm provided it doesn’t cave in first.”

When I told him of my interest in writing a piece on his latest market thinking, he chuckled and shot back: “Why would you solicit the views of an idiot?”

Why such a disparaging reference?, I asked. “Because my gut and the facts tell me the market is going lower, maybe a couple of thousand Dow points lower, and that the economy, contrary to what a lot of economists are saying, will not bounce back very much in the second half,” he says. “Yet, I’ve been reducing cash reserves and buying some stocks fairly aggressively,” he tells me. “Only an idiot would do that.”

Then why buy? Because the performance pressures from clients are enormous, he explains. “My phone is ringing off the hook at all hours of the day and night. My clients all know the market is up about 30% from its March lows and all they want to hear is how much money I’m making for them after a lousy 2008. With the kind of explosive rally we’ve had,” he says, “they can’t imagine my not being an active participant in it, and you really can’t explain to people something they don’t want to hear — that it could be a buying trap or a bear market rally.

In one of this week’s posts published here, the legendary and incredibly modest Jeremy Grantham, of GMO, as interviewed by Smart Money (May 21, 2009) discusses why he changed his mind about the market after over a decade of being characterized as a perma-bear:

SM: Why were you so certain things were going to get so ugly?

G: There wasn’t a whole lot of doubt where I was coming from. I thought the fair value of the S&P was 925; the S&P went to 1500. And by 2006 the housing bubble was at a 100-year peak. This was the 32nd asset bubble that we’ve tracked, and all but the U.K. housing bubble have popped.

SM: … for the first time in years, you like US stocks.

JG: We think a fair price for the S&P 500 index is 900. By sheer divine intervention we bought into the market on Mar. 6, the day it hit the recent low of 666. It’s likely, but far from certain, that we’ll go back and make a new low. You aren’t going to get to buy at the absolute low unless you have a time machine.

SM: Anything else besides US stocks?

JG: US stocks were nicely cheap, and frankly, the rest of the world was even cheaper. In early March, when we bought, we invested only in stocks we thought would have a 10 to 14 percent average annual return after inflation. That’s magnificent. We haven’t seen anything like that in 20 years. It was somewhat disappointing that prices moved up so fast in just a couple of weeks. The odds are a bit more than 50-50 that we will go back and test that low.

SM: So you’ve made a quick buck. Now what?

JG: You have a set of possibilities. First, if the market nosedives, it’s easy: You buy. The second is confusing, when the market just goes sideways, between 700 and 800. The market is irritatingly cheap then, but not super cheap. The longer that goes on, the less probability we will set a new low, so we’ll ultimately put money each month into the market.

SM: What if stocks keep rallying?

JG: If the market goes higher, above 950, and then starts moving sideways, between 950 and 1050, we probably do very little. Then the market is moderately overpriced.

David Rosenberg, Gluskin Sheff’s Chief Economist (ex-Merrill), has the following to say in yesterday’s Breakfast with Dave:

Okay, the gloves are off. Just as was the case in the summer of 2007, the bond bears are coming back out of hibernation, and we see and hear that they have a new set of pencils and rulers out and declaring, yet again, the end of the secular bull market in Treasuries. Not so fast.

About longer-term Treasury Bonds…

We think that this sharp correction in Treasuries (4.5% loss so far this year) started off as a flight-out-of-safety when the Obama economics team put a floor under the financials, then the second stage were the ‘green shoots’, followed by recurring asset mix rebalancing, and then by talk and technicals — the exact stage when the blowoff occurs; and the blowoff is what provides the opportunity.

Let’s not forget what the upcoming round of data releases are going to look like after GM declares bankruptcy — jobless claims are likely going to test the old highs, ISM the old lows, and the boom in consumer confidence is going to seem like a distant memory by Labour Day.

About equities

Well, we have a sneaking suspicion that the nearby peak was May 8 when the yield on the 10-year T-note was 3.29%. That was the tipping point for the stock market, which has only done backing and filling ever since; and some wild swings (three triple-digit up Dow sessions; four triple-digit down days).

We would have to think that a 4.63% yield compares quite favourably with a 2.6% S&P 500 dividend yield — the spread hasn’t been that wide in at least eight months. Not only that, but the stock market has become increasingly “less cheap” — over the last six months, 2009 consensus earnings estimates have been pared from +30% growth expectations to a mere +9%. The S&P 500 is trading at multiples of around 17-18x, which is no bargain in our view.

Now for the rock and the hard place. Do you stay invested in equities as though its a new bull, or do you take the precautionary measures in case the bears are right?

Its not always clear, but after reading through a fair bit of opinion it seems that the simple, sensible thing to do next, may be to rebalance from equities to bonds. Equities and government bond yields have had quite a run up on the ‘green shoots’ and Obama’s ‘floor-under-financials’, and upcoming economic data may be, very mildly put, uninspiring.

Finally, some advice on seasickness:

There are three things which trigger sea sickness, and it is advisable that you avoid them, if you are prone to it, or try to do as little as possible: if you go below the deck for a long time (there the wag is bigger), if you look through binoculars or other optical device, and finally - if you read a book, look at a compass or do any work that requires gazing at one point for a long time. Just try to keep your peripheral vision on objects that your brain will interpret as stable (because in fact they are not, and there will be clash in the sensory information and it will end in sea sickness).

Tags: Asset Manager, Barron, Bear Market, Corporate Earnings, Dan Dorfman, Earnings Forecasts, Economic Outlook, Financial Challenge, Great Inventions, Hindsight, Investment Advisors, Market Rally, Money Managers, Motion Sickness, Place Money, Poison Pen, Reporting Season, S Green, Seasickness, Treasury Yields
Posted in Economy, Markets | No Comments »

10-Yr Treasury Yields: Higher or Lower?

Friday, April 24th, 2009

Econompic Data looks at the possible direction for 10-Year Treasurys. On one hand you have the supply issue; on the other hand you have deflation and further deterioration, combined with the Fed’s impetus to purchase lond-dated treasurys which could drive yields down further:

Higher –> Supply: Across the Curve

Treasury bonds are taking a severe drubbing and the yield on the benchmark 10 year note is approximately at the level which prevailed on the day when the Federal Reserve announced quantitative ease (2.96 percent currently).

One participant noted that the 200 day moving average on the Long Bond was 3.798 percent and the market penetrated that level this morning as a sharp knife would melting butter.

The yield curve has steepened sharply and participants are deeming the belly of the curve particularly odious. The 2year/10 year is once again close to 200 basis points and the 2year/5year/30 year butterfly has returned to 93 basis points after a foray into the low 100s.

Dealers report rate lock selling and fear of very heavy Treasury supply next week. As I have mentioned too often the Treasury will announce around $ 100 billion of new supply tomorrow. It will consist of 2year,5 year and 7 year notes.

Lower –> Quantitative Easing / Continued Economic Deterioration: Zero Hedge

n light of next week’s scheduled meeting of the Fed, we thought we would look at the potential for further announced quantitative easing. Last month, the Fed rocked most major markets with the announcement of a major purchase of long rates to push down yields. Since then, many have dismissed the purchases as a one-time event that are not likely to repeat. However we have to question that thinking as it is very much in line with the pre-crisis mentality that quantitative easing is the equivalent of a nuclear bomb in a central bank’s arsenal and the unpredictability of any resulting inflation would destroy all credibility that a central bank may have to price stability.

There has been a lot of criticism of Big Ben (us included) but one thing that has come out is he is not afraid to take relatively risky moves to combat whatever he perceives as the biggest threat. As we have noted before, he has clearly revealed his playbook in the past and we see little indication that he will stray from it going forward. On the balance between inflation and deflation, much has been made of the Chinese response if we try to print our way out of this situation but the much larger problem has always been deflation. Combining what we know about the available policy options and the effectiveness of the last round of QE, we have to believe that more purchases of long rates are on the table as a serious consideration.

We are not saying that the Fed is deaf to the concerns of price stability; indeed, the specific concern is addressed in last month’s minutes.

Also, some participants were concerned that Federal Reserve purchases of longer-term Treasury securities might be seen as an indication that the Federal Reserve was responding to a fiscal objective rather than its statutory mandate, thus reducing the Federal Reserve’s credibility regarding long-run price stability. Most participants, however, saw this risk as low so long as the Federal Reserve was clear about the importance of its long-term price stability objective and demonstrated a commitment to take the necessary steps in the future to achieve its objectives.

However, consumer spreads continue to stay at high levels.

Additionally, long rates have given back much of the gains made from the time of the previous announcement.

In light of the minimal impact of the announced $300B bond purchase last month, we have to think that the Fed will give it at least one more go. The Fed can really only directly control the benchmark - if the Treasury figures out a way to strong arm banks into flowing credit again, that may put a stop to further QE but that isn’t a likely scenario in the short-term.

At this point the issue of deflationary pressure does seem to be the 800-pound gorilla in the room.

Source: Yahoo

Tags: 10 Yr Treasury, Basis Points, Credibility, Crisis Mentality, Drubbing, Economic Deterioration, Federal Reserve, Foray, Impetus, Lond, Moving Average, Nuclear Bomb, Price Stability, Sharp Knife, Time Event, Treasury Bonds, Treasury Yields, Treasurys, Unpredictability, Yield Curve
Posted in Bonds, Credit Markets, Economy, Markets | No Comments »

Quantitative Easing: A Guide and Outlook to the ‘Nuclear Option’

Sunday, March 22nd, 2009

Last week, Ben Bernanke announced the Fed’s decision to employ ‘Quantitative Easing’ (QE), the ‘nuclear option,’ to save the credit market and the economy. On the news that the Fed will buy back up to $300-billion worth of long dated US treasury bonds, and acquire an additional $750-billion of mortgage backed securities, the US dollar plunged, the euro surged, Treasury yields nose-dived, gold bullion exploded, and stocks, oil and commodities gained handsomely.

We know what the immediate reaction has been to this, but what does it all mean in the longer term?

The main design of QE is to supply the money, by printing it, that is required to fulfill current demand for money arising from the deleveraging of balance sheets. Buyers need to be able to access credit and cash in order to purchase assets from distressed vendors. If purchasers cannot be facilitated via the market, the bids for the assets will keep falling until they can. QE means to provide the stop-gap measure. The other purpose of QE, is to make it possible for the Fed to enlarge its own balance sheet by assuming or acquiring ‘toxic’ assets in return for retiring debt from banker debtors, so that they can be freer to resume lending.

Until now, the deleveraging of market assets in favour of debt reduction has resulted in strong demand for cash, such that it has given the dollar a disproportionate boost - hence the strangely strong dollar.

Prior to the Fed’s move last week, this quote describes the current nature of the strong US dollar, from FT.com:

Hans Redeker at BNP Paribas said under normal circumstances, a rising deficit works against the domestic currency. “However, in this environment, deleveraging by institutions in order to clean up balance sheets will provide the dollar with a natural bid,” he said.

This deleveraging helped create a dollar shortage that drove the US currency sharply higher against the euro after the collapse of Lehman Brothers last September. Analysts said a similar situation seemed to be developing as equity markets plunged below their lows from last autumn.

The following is an excellent tutorial from Marketplace.com on Leveraging and Deleveraging:

Leveraging and deleveraging from Marketplace on Vimeo.
Quantitative easing supplies the cash via the printing press to those institutions in need of cash in return from the sale of levered assets, in the form of credit for buyers of liquidated assets. With credit for the purpose of re-purchasing distressed assets unavailable to would-be buyers, the market for those assets has suffered immensely; stocks, bonds, real estate, etc. As for the CDOs, only a daring breed of investors have shown interest, but they too may find it hard to get the credit to make it worthwhile, or the concessions and covenants.

The following is a tutorial from Marketplace.com on Quantitative Easing:

Quantitative easing from Marketplace on Vimeo.

Effectively, when you sell (or short) assets, the end result is that you end up long the cash. For those seeking to reduce debt, the cash disappears into the money pit, returning to the lender’s balance sheet. For those selling assets because they are risk averse, the money ends up for the time being in now zero-interest treasuries and short term cash equivalents. Therefore you end up with a strong dollar. When the market was over-using credit, it was short the dollar and the dollar was weaker. Now that the market is in a debt-reduction or deleveraging mode, it is long the dollar, therefore the dollar gains strength.

The Feds decision to employ the ‘nuclear option’ of QE sends a signal that there may be a great deal more deleveraging in store for the economy and there is substantial need to supply the money.

The immediate reaction is the weakening of the dollar, but that just provides temporary breathing space until the subsequent rounds of deleveraging sop up the slack created by QE, and what follows is a revitalized dollar, strengthened yet again by the deleveraging.

Graduated QE will periodically and gradually weaken the dollar, as it is dilutive, but the take up created by graduated deleveraging will gradually renew dollar strength. Ideally, if all the central banks in the G6 resort to this, there will be balance, but the timing may at times prove to be skewed by the independent agendas of the UK and the ECB.

The bottom line is that this first round of QE is just that. The first round. Bill Gross, Managing Director, PIMCO, points out that while it is a good move, it may not be enough, and that the Fed may have to expand its balance sheet to $5 or $6-trillion, as it takes $4 of debt to generate $1 of GDP growth.

Bill Gross: No, I agree with all of that. Its just a question, Kathleen, of ‘how big of a kick?’ There are a number of ways of looking at this. Goldman Sachs has approached it from the standpoint of the Taylor Rule, the deficiencies of output relative to their own particular index.

We look at it a little bit differently at PIMCO, we look at it from the standpoint of the amount of debt that’s required to produce a dollar’s worth of GDP growth. And up until 12-18 months ago in terms of our existing economy, that was about $4 of debt for $1 of GDP growth.

This $1-trillion dollars to our way produces $250-billion of GDP; that’s just under two percent real growth. That`s good, that produces in our opinion about 1-million jobs, but we need more than that.

KH: Is it enough to avoid the mini-depression you were talking about last month when I joined you for an interview out there at Newport Beach?

BG: We think so, you know yesterday’s move by the Fed were in recognition of this recessionary economy that could have resembled a small depression unless credit markets and risk taking were revived. And in fact the Fed labelled their policies ‘credit easing’ and you mentioned the obvious intent to lower mortgage rates to homeowners and lower credit card rates, auto loans, commercial rates as well so, you know, its very much of a positive push. We have sense that the $1.8-trillion balance sheet that the Fed has, that’s now growing to $3-trillion, probably will have to grow to $5-trillion and $6-trillion in order to keep us on a trend line that produces positive as opposed to negative growth.

Because QE measures may not yet be sufficient to completely overcome the problems facing the banking system in terms debt reduction the outlook continues to be tilting towards deflation.  As long as the need to deleverage balance sheets exceeds the availability of credit, assets could continue to deflate. Therefore, our sense is that the Feds first QE move is preliminary, and primes the pump for more QE in the next 6-12 months.

So, is the Fed’s move a signal that we are at an inflationary or deflationary inflection point for the moment? Watch the debate unfold between Hugh Hendry, and Liam Halligan. Then you decide…

We like to err on the side of reason and validity.

At the moment the political will to carry out this process fully, and further, faces significant opposition, especially to the idea of bailing out Wall Street and the US banking system, and is hobbled by the public outcry against the AIG bonuses debacle, and government has done as much as it can to suitably convince constituents of what it needs to do, for now. Today, the US Treasury announces a $1-trillion ‘public-private investment programme’ to absorb the toxic assets into what amounts to a ‘bad bank.’ One of the big issues is the competence of those in the private sector (which is meant to be a checks and balances component) to price these assets. Another issue remains whether or not this will get banks to release their chokehold on credit and resume business as usual in the lending business. The White House is expected to follow up this week with its comprehensive financial plan. This administration’s public relations programme has reached a crescendo; 60 Minutes, Jay Leno. Will they be able to finally stop talking and actually get down to work on it?

Does Geithner have the political ammunition to take further measures? Geithner must convince the market and constituents that this move will complement the Fed’s quantitative easing.

From today’s Globe and Mail: Nobel Prize-winning economist and Princeton University professor Paul Krugman blasted the strategy as a rehash of former treasury secretary Henry Paulson’s discredited solution to the banking crisis, first proposed six months ago. “It’s not new; it’s just another version of an idea that keeps coming up and keeps being refuted,” Prof. Krugman wrote over the weekend on his New York Times blog.

“It’s just horrifying that [U.S. President Barack] Obama - and yes, the buck stops there - has decided to base his financial plan on the fantasy that a bit of financial hocus-pocus will turn the clock back to 2006.”

The only way out of the banking crisis is for the government to offer a sweeping guarantee of problem debts and to seize control of banks with too few assets to cover their debts, Prof. Krugman argued.

The current crisis, he argued, isn’t just a panic, but a fundamental realignment of a financial system that foolishly bet big that house prices and consumer debt would continue rising forever.

For these reasons, QE and other measures will be a gradual process and could work, but only if taxpayers are willing to be saddled with the burden.

Tags: Balance Sheet, Balance Sheets, Ben Bernanke, Bnp Paribas, Cdos, Collapse, Covenants, Debt Reduction, Debtors, Distressed Assets, Domestic Currency, End Result, Feds, Gap, Gold Bullion, Last Autumn, Last September, Lehman Brothers, Lows, Market Assets, Mortgage Backed Securities, Nuclear Option, Printing Money, Printing Press, Qe, Redeker, Stocks Bonds, Stop Gap, Strong Dollar, Treasury Yields, Us Treasury Bonds, Vimeo
Posted in Bonds, Commodities, Credit Markets, Economy, Gold, Markets, Oil and Gas, Outlook | No Comments »

Fed Employs Nuclear Option

Friday, March 20th, 2009

Financial markets were dominated this week by the announcement by Fed Chairman Ben Bernanke to buy as much as $300 billion of long-term Treasuries and acquire an additional $750 billion of mortgage-backed securities. On the news, the US dollar plunged, the euro surged, Treasury yields nose-dived, gold bullion exploded, and stocks, oil and commodities gained handsomely. What an announcement, what a week!

A few of the more interesting video clips that attracted my attention are shared below. In addition to Bill Gross stating that the Fed’s purchases are still not enough, AIG remained in the news as payment of bonuses to its executives from bailout money stirred up emotions. This culminated in the House passing a bill to tax TARP bonuses by 90%.

As far as the stock markets are concerned, with indices running into resistance levels the debate intensified on how enduring the recent gains will be.

The video clips feature the likes of Bill Gross, Steve Forbes, John Lonski, Mario Gabelli, Ron Paul, John Bogle, Barry Ritholtz, Doug Kass, Gary Shilling, Meredith Whitney, Marc Faber, Jim Rogers and Stephen Roach.

John Authers (Financial Times): Fed’s shock and awe
“John Authers on market reaction to the Federal Reserve’s decision to buy $300 billion in long-dated Treasury bonds.”

Click here for the article.

Source: John Authers, Financial Times, March 18, 2009.

Bloomberg: Pimco’s Gross says more Fed buying needed to spur growth
“Bill Gross, co-chief investment officer of Pacific Investment Management Co., talks with Bloomberg’s Kathleen Hays about the Federal Reserve’s plan to buy more than $1 trillion in Treasuries and mortgage-backed securities in an effort to help revive the economy. Gross also discusses the Fed’s balance sheet, currency concerns and the need for a ‘healthy level’ of inflation.”>

Source: Bloomberg, March 19 2009.

60 Minutes: The Chairman - Ben Bernanke
“In a rare interview with a sitting Fed chairman, Ben Bernanke tells Scott Pelley what went wrong with America’s financial system, how it caused the economic crisis, what the Fed is doing to help fix it and when he expects the recession to end. If you think your job is tough, consider Ben Bernanke’s. As Chairman of the Federal Reserve, the task of reviving the US economy falls largely on his shoulders.

In Part 2 of the interview Bernanke candidly speaks to Pelley about his personal life, and how the current financial crisis is affecting Main Street America.

Source: 60 Minutes, March 15, 2009.

Bloomberg: Geithner says US to move quickly on “legacy assets”
“US Treasury Secretary Timothy Geithner talks with Bloomberg’s Lizzie O’Leary about the US government’s plan to ‘move very quickly’ on impaired ‘legacy assets’ clogging bank balance sheets. Geithner also discusses planned action by the Group of 20 nations to end the global recession, executive compensation and US cooperation with China. They talk following a meeting of the G-20 finance ministers and central bankers today in Horsham, England.”

Source: Bloomberg, March 14, 2009.

CNBC: Forbes - Geithner, Bernanke have “the slows”
“Ben Bernanke and Tim Geithner both have a bad case of ‘the slows’, Steve Forbes, Chairman & CEO of Forbes, tells CNBC’s Martin Soong. Both of them have been slow to take decisive action on the banking crisis.”

Source: CNBC, March 20, 2009.

The Wall Street Journal: Sorting through the latest batch of economic data
“John Lonski, chief economist at Moody’s Capital Markets, interprets the latest economic data on housing starts and the producer price index. MarketWatch’s Kelsey Hubbard reports.”

Source: The Wall Street Journal, March 17, 2008.

Bloomberg: Mario Gabelli sees stability returning to US economy
“Mario Gabelli, chief executive officer of Gamco Investors, talks with Bloomberg’s Betty Liu about the outlook for the US economy. Gabelli, who oversees more than $20 billion in assets, also discusses American International Group’s decision to award some of its traders $165 million in bonuses.”

Source: Bloomberg, March 17, 2009.

Charlie Rose: A conversation with Nancy Pelosi, Speaker of the House

Source: Charlie Rose, March 13, 2009.

Charlie Rose: A conversation about AIG
“A conversation about AIG with Hank Greenberg former chairman and CEO of AIG, Carol Loomis Senior editor-at-large of ‘Fortune’, Gretchen Morgenson of ‘The New York Times’ and Meredith Whitney.”

Source: Charlie Rose, March 18, 2009.

Bloomberg: Ron Paul says AIG bonus money was stolen from taxpayers
“US Representative Ron Paul, a Texas Republican, talks with Bloomberg’s Carol Massar about American International Group paying $165 million in bonuses to its executives after accepting a $173 billion government bailout. Paul also discusses the role of the Federal Reserve and his recommendations for tax policy and spending.”

Source: Bloomberg, March 17 2009.

CNBC: Bonus tax - good or bad?
“Discussing House voting on bill to tax TARP bonuses at 90%, with CNBC’s John Harwood; David Min, Center for American Progress; Stephen Moore, WSJ; and CNBC’s Erin Burnett.”

Source: CNBC, March 19, 2009.

CNBC: Bogle-izing the hedge fund industry
“Thoughts on an investable index for the hedge fund industry with John Bogle, The Vanguard Group founder/former CEO. On the bonuses paid to AIGFP, Bogle says, ‘Off with their heads’.”

Source: CNBC, March 18, 2009.

The Street: Inside Bear Stearns collapse
“In an extended interview, William Cohen, author of the bestselling book House Of Cards, reveals the truth about what happened during Bear Stearns’ final days.”

Source: The Street, March 14, 2009.

Forbes: Barry Ritholtz on whether the stock market is near the bottom

Source: Forbes, March 16, 2009.

The Wall Street Journal: Trying to call an enduring bottom
“Trying to call an enduring bottom Barron’s Mike Santoli says the market has seen a 12% jump in a week while fewer stocks have made new lows, eliciting calls that we’ve finally seen an enduring bottom. Is this being too optimistic?”

Source: The Wall Street Journal, March 17, 2009.

CNBC: Kass & Shilling - has the bottom bottomed?
“Douglas Kass, of Seabreeze Partners; Gary Shilling, of A. Gary Shilling & Co.; and CNBC’s Larry Kudlow discuss today’s market action.”

Source: CNBC, March 18, 2009.

CNBC: Forbes - suspend mark-to-market accounting
“Mark-to-market accounting should be suspended says Steve Forbes, Chairman & CEO at Forbes. He tells CNBC’s Martin Soong the reasons why and how this has been a bipartisan disaster.”

Source: CNBC, March 20, 2009.

CNBC: Meredith Whitney - credit crunch & financials
“Weighing in on consumer credit and why mark-to-market will not really help banks, with Meredith Whitney, Meredith Whitney Advisory Group CEO.”

Source: CNBC, March 17, 2009.

Bloomberg: Rogers, Faber, Cheng on gold’s outlook
“Marc Faber and Jim Rogers talk about the outlook for gold prices and their investment strategies. Gold’s failure to rally to a record in recent weeks disappointed some investors, analysts said. Last month, the price climbed to $1,007.70, the highest this year. The all-time high of $1,033.90 was reached on this date last year. Schroders plc’s Christopher Wyke, Credit Suisse Group’s Tobias Merath and World Gold Council’s Albert Cheng also offer their views.”

Source: Bloomberg, March 18, 2009.

Financial Times: Oil price crash shifts balance of power
“Carola Hoyos reports from the Opec seminar in Vienna on how the collapse in oil prices has shifted the balance of power between oil producers and consumers and the companies within the sector.”

Source: Financial Times, March 18, 2009.

CNBC: Can China achieve its 8% growth target?
“China is dreaming, says Marc Faber, editor & publisher of The Gloom, Boom & Doom Report, when asked whether it can hit its 8% growth target. Faber & Jerry Lou, China strategist at Morgan Stanley assess the road ahead of China’s economy, with CNBC’s Martin Soong.”

Source: CNBC, March 17, 2009.

RGE Monitor: China now expected to grow 6.5% in 2009
“In a series of downward revisions, the World Bank is the latest to reduce its forecast of 2009 economic growth in China. As with many export-led economies, China has been hit hard by the precipitous decline in export demand, falling 25.7% in February 2009. For this reason, the World Bank reduced its 2009 growth forecast for China 1% to 6.5%.”

Source: Rebecca Wilder, RGE Monitor, March 18, 2009.

CNBC: Roach - China needs internal demand
“China needs to change its structure to an internal demand driven economy, says Stephen Roach, chairman for Asia at Morgan Stanley. He tells CNBC’s Martin Soong & Amanda Drury that China is hugely dependent on external demand as a major source of economic growth.”

Source: CNBC, March 18, 2009.

Financial Times: Bank of England pins hopes on quantitative easing
“Roger Brown, global head of rates research at UBS, says the Bank of England is in effect creating cash to kickstart lending in the UK. However, he tells FT’s David Oakley that the Bank must increase the amounts involved.”

Source: Roger Brown, Financial Times, March 13, 2009.

YouTube: Gold for bread - Zimbabwe
“MDC activist Sam Chakaipa returns to his village in Zimbabwe to find his friends and neighbours starving. As the Zimbabwean dollar becomes ever weaker, gold has become the currency of choice.”

Source: YouTube, March 9, 2009.

Tags: Barry Ritholtz, Chief Investment Officer, Doug Kass, ETF, Gary Shilling, Gold Bullion, Gross Co, Jim Rogers, John Authers, John Bogle, Marc Faber, Mario Gabelli, Meredith Whitney, Mortgage Backed Securities, Pacific Investment Management Co, Resistance Levels, Shock And Awe, Stephen Roach, Steve Forbes, Treasury Bonds, Treasury Yields
Posted in Bonds, Commodities, Credit Markets, Economy, Gold, Markets, Oil and Gas, Outlook | No Comments »