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April 7, 2006
March employment data were just as strong as expected, consistent with a briskly expanding economy, and long-term rates moved up in anticipation of more hikes from the Fed. The 10-year T-note is up to 4.96%, and low-fee 6.50% mortgages are fading in the rear-view mirror.
The slowdown in housing, widely expected to slow the overall economy, has yet to show the slightest sign of doing so. The burden of proof is now on the theorists.
During the first 18 months of Fed tightening from 1.00% to 4.25%, long bond yields remained stationary at 4.50% or below. In January bonds changed behavior, rising in yield just before each of the last two Fed meetings to the level of the next .25% hike. The pattern has changed again. The Fed went to 4.75% last week, and bonds immediately began to move to the 5.00% to which the Fed will go on May 10.
Having done so, bonds now in the habit of jumping the Fed gun, and in knowledge that 5.25% at the Fed’s June 29 meeting is highly likely, will bonds sit around here at 5.00% (mortgages approaching 6.75%), or keep right on going up?
The low-volatility bond market since 2002 has been unnatural, and the product of the Fed. Post-Bubble, the Fed set out to prevent the advent of deflation; it would not only hold the cost of money at a 50-year low, but would also try to hold down long-term rates. Having no machinery to suppress long-term rates, it deployed its trusty jawbone, Mr. Greenspan saying the Fed would stay easy for “an extended period.”
The Fed got what it wanted, and then some. When Mr. Greenspan began to raise the cost of money in 2004, no one was more surprised than he that long-term rates did not begin to move up also. Eight months later, in evident frustration (when the Fed removes “accommodation”, it wants to remove all accommodation), the Maestro described the predicament as a “conundrum.”
Everybody has offered answers to the riddle (Perfesser Bernanke two weeks ago offered about a dozen, and then wholly or partially demolished them all), and here is one more. The Fed told the bond market that it wanted yields to stay put, and they did; it has taken 15 quarter-point kicks in the butt to get long-term rates moving again. I suspect that now moving, they will resume normal behavior: rising to produce a positive spread versus the Fed, and trade in normal, chaotic volatility. If this long-rate rise does continue, the Fed will stop quickly.
Enough of ominous notes on bonds. This week brought entertainment, too.
On Wednesday, the bond market briefly crashed when Treasury Secretary Snow said today’s job numbers would be “very good.” Insiders are never, ever supposed to hint in advance of crucial data releases. However, the market quickly recovered, remembering that Mr. Snow is an idiot. The Bushies have so strongly hinted that it is time for him to go that the next time he goes to his office the furniture may be gone.
Every sensible person trying to analyze bonds and the Fed thinks from time to time that we can’t possibly have enough information, that the Fed must have insights that we can’t imagine, let alone understand, and then… then…. The Fed this week released verbatim transcripts of its meetings in 2000. That fall, Mr. Greenspan and the Fed’s research director in painfully clueless language dismissed any prospect of weakness in technology, or the stock market, or the economy. Wow.
Engraving the nation’s leadership vacuum, John Kerry offered his Iraq plan. Tell the Iraqis: Form a government immediately, or we’re leaving on May 15! But, if you do form a government, we’re leaving in December.
I have no particular objection to leaving, but it would be nice not to sound any stupider on the way out than we have so far.
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