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September 26, 2003
A remarkable bond rally developed this week.
Remarkable in the magnitude of the rate drop (mortgages to 5.75%, the ten-year T-note as low as 4.00% today), in its stealth (the financial chattering class either hasn't noticed or doesn't want to talk about it), in the absence of apparent cause (unlike stocks, bonds usually move in response to real-world events), and in its uncertain future (short-term technical correction, or something with legs, going deeper in another mortgage-hedging cascade, or following stocks down?).
The week opened with a rise in rates in the aftermath of a G-7 meeting at which the US demanded that our trading partners stop intentionally weakening their currencies versus the dollar. This long-standing practice, especially among our Asian trading partners, makes their goods artificially cheap here and ours expensive there. They cheapen their currencies by spending their export-earned dollars to buy US securities, especially Treasurys.
This recycling machine has worked very well ever since WWII. Exporters to us sell under-valued goods in exchange for over-valued dollars which the exporters reinvest in American markets which pay a higher rate of investment return than the exporters can earn at home.
For fifty years, fear-merchants have insisted that this machine would break down any day; exporters would sell their dollar holdings, wreck the Treasury market, drive up inflation and interest rates, and impoverish America. During the same time span, politicians of both parties feeling heat from industries hurt by cheap imports have made absurd demands of the kind the Bushies did last weekend.
Someday, if something goes wrong with the rich investment returns available here, the recycling machine will break down. With any luck, before then the cheap-export nations will have raised their standards of living and developed appetites for American exports, just as our European partners did thirty years ago.
Until one of those long-term events comes to pass, ignore all dollar-panic stories as the flapdoodle they are. The Asian exporters nodded in agreement over the weekend, but the Asians can no more abandon export-dollar recycling than stop breathing. The dollar will vary widely in relative value for good economic reasons (shifting growth-rate, inflation-rate, and interest-rate differentials), but the exporters holding all those Treasurys can't dump them -- if they tried, America couldn't afford to buy anybody's exports. Suicide is not a good trade.
Consider worthwhile things, instead. This bond rally.
There is a chance that the explosion to 6.50% mortgages and 4.60% ten-year T-notes was a passing panic, and the rally underway is the return of good sense in what will be a gradual up-trend in rates, not a fast one. I joined the stampede, and was wrong to announce the demise of five-something mortgages.
There is another possibility. Bond rallies correlate with economic weakness. Yet, for months, you haven't been able turn on the telly without getting hit with a barrage of economic optimism. I lost track of how many Fed governors were out this week (eight?, nine?) spewing superlatives about the economic future (cheers at football halftimes nationwide this weekend will be led by the Fed's Briefcase Drill Team). But, bonds don't rally when the economy is taking off. They just don't. Not like this.
Economic data this week weren't bad: orders for durable goods slipped, but the housing market is still smoking. Something else is going on: consumer confidence is steadily slipping, and the cause seems to be worries about jobs, the deficit, and Iraq.
Big new data come out Wednesday-Friday next week, and it's prudent to lock now, even at the risk of missing another leg down on weak reports.
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