|
June 10, 2005
Mr. Greenspan dominated a no-data, all-talk week. He made it plain that the Fed intends more increases in the overnight cost of money, and would be pleased if long-term rates rise. So they did -- not much, but mortgages are now above 5.50%, and the 10-year T-note is back above 4.00%. Going higher, says here.
The Chairman is paid to know what we are doing with money. In two appearances this week, one in China and one in Congress, he explained that he does not know what we are doing with money. Or so he says.
Granted, he is not well-paid. Potential successors should note his $180,100 salary, the same as the Cabinet. The Secretary of Defense is paid better than the generals he is supposed to keep track of (ours and the other guys’), but the Chairman is paid no more than the annual wine bill of the people he must outwit.
The Chairman repeatedly noted the “pronounced decline in long-term interest rates... despite a 2% increase in the Federal funds rate”, and then examined the five commonly cited causes of the phenomenon: (1) a portent of economic weakness, (2) pension funds buying bonds to offset extraordinary liability from an aging global population, (3) foreign central banks buying to hold down their currencies’ values, (4) China and India coming on-line as low-cost providers of labor and manufacturing, and (5) market faith in very low inflation into the distant future.
He then dismissed them all, and offered no alternate hypothesis; although he did say that he has expected long-term rates to rise since last year. I assume that he has an alternate hypothesis that he would rather not say out loud: these super-low long-term yields are more irrational than true conundrum, but in either event are generating speculative and inflation pressures. Mr. Greenspan intends either to force long-term yields higher, or to take the overnight Fed funds rate high enough to offset the stimulus from existing bond yields.
A visibly aging Chairman -- frail, even -- still has the gravitas to make a confused Fed do what he wants until he leaves in January. He refuses to say where he will stop, or by what calculus he will determine the stopping point. “We will probably know it when we are there, because we will observe a certain degree of balance that we have not perceived before, which would suggest to us that we’re somewhere very close to what that rate is.” The bond market rallied briefly on that gobbledygook, misunderstanding the last clause as meaning that the Fed is close to neutral now. No, it isn’t -- not near Mr. Greenspan’s neutral.
The Chairman’s hammering with the Fed funds rate will soon put intolerable pressure on long-term rates. If the short-term cost of money reaches the yield on bonds, it will become painful or impossible to finance long positions in bonds or mortgages. In a “negative carry” environment, leverage unworkable, the market tilts to dumping bonds on arrival, and the constant selling pressure ratchets bond yields upward. The Fed is barely four quarter-point hikes away from inversion, and I fear a bond-market lurch upward during the approach, well before the event.
I hear the rocket scientist in the back of the room... Yes, you can make good money holding bonds during a pre-recession yield-curve inversion in anticipation of a general decline in rates. However, here the Chairman is pounding toward neutral, trying only to restore rational short and long-term yields, not (yet) trying to slow the economy, insisting that he sees solid economic growth ahead.
Mr. Greenspan’s public service and epic triumph over inflation have made him a hero to me. However, at the moment, he is playing with fire in his determination to tighten to his own opaque notion of neutral (Fed Chairmen have no toys but fire).
He failed to intercede in one bubble, and this time may be determined to intercept a bond and housing one that isn’t there.
|
