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February 11, 2005
The 10-year T-note broke below 4.00% for the first time since last fall, but could not hold; mortgages had a couple of days at 5.50% but are now back to 5.625%.
Nothing in economic data accounts for continuously low long-term rates. The stock market is a little shaky, earnings nervous-making, which helps, but claims for unemployment insurance have fallen to the lowest levels in five years.
The Fed is going at least another .50% to 3.00% by May, and 3.50% by August is a better bet. The only way a tightening Fed helps bonds is by creating the hope that it will mash the economy by accident, and the economy is too healthy for that.
Nothing on the political front is a help to bonds. The President's new budget is either a flinch from the dangers of really doing something about federal finances, or a doctrinaire try to limit spending by "starving the beast" of revenue, or a proposal simply divorced from reality. Whichever, the prospect of a four-year Presidential term with zero progress on the deficit and worse from 2009 forward should have hurt bonds this week, but did not.
Any relaxation in international tension tends to take fearful money out of the bond market, not into it. The last two weeks have brought the best hope for peace in Palestine in forty years and the same for Iraq, hope rising even in Europe (Iraq is impossible to read, election notwithstanding; the place is too dangerous for reporters from any straight news service). Some money may be worried enough about US threats to Iran or North Korea to buy some bonds, but it's early, there.
Every financial operator I talk to is either short bonds or thinking about getting shorter, just certain that the near-four T-note is soon headed close to five percent.
This last leg in falling bond yields began as Mr. Greenspan spoke last Friday in London. He spoke to the risks of the trade deficit, in 2004 $617 billion, in excess of 5% of the US GDP, and to routes to correcting the deficit.
The trade deficit is at the very tippy top of bond short-seller's unanimous certainty. They are sure that the world will soon tire of exchanging goods for dollars, and will begin to unload the dollars they already have. As the buck descends to wallpaper, dollar-denominated interest rates must rise, bonds will crash, and shorts will make a fortune in the easiest trade since the Dutch bought Manhattan.
Mr. Greenspan: "...The US current account deficit cannot widen forever, but fortunately the increased flexibility of the American economy will likely facilitate any adjustment without significant consequences to aggregate economic activity." He didn't say that rates will stay down, but an interest-rate moon shot would sure as hell have consequences to economic activity. He did say, in sum, to relax: self-correcting forces are well underway (full text at www.federalreserve.gov).
Another certainty in the bond-short camp: unsustainable intervention by Asian central banks to keep their exports cheap is artificially holding down US interest rates. The Chairman: "...The effect is difficult to pin down." If he can't pin it down, trust me: ain't nobody at a bond desk that's got it pinned down.
As this year passes, remember often that it is Mr. Greenspan's last in The Chair. He is neither a deity nor merely infallible, but he has been the best economic shepherd we have ever had. When he goes, markets will shake at facing the night without a blanket for the first time in 18 years, and at the nomination of his successor: if Marty Feldstein, quickly steady; if Ben Bernanke, fragile with judgment withheld, but okay. If an agreeable partisan hack, for whom Mr. Bush has had depressing fondness, the markets will place the burden of proof on the Fed, and that's the best and maybe only reason to short bonds in quantity. Credibility comes only after a new Chairman raises rates into the pain zone.
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