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September 11, 2009
Long-term rates are very close to breaking the post-May lows, the 10-year at 3.28%, and mortgages are doing even better, sliding toward 5.00%.
We are moving into the next economic phase as well as the next stage of understanding, the two working together to change the credit markets. There is always some gap between economic reality and our grasp, but this two-year event, so extreme and out of prior pattern, has produced a chasm between competing theories.
The winner is a tad improbable, or at least counterintuitive. The recession has clearly bottomed, which in normal times would mark the beginning of interest rate increases, especially long term -- and instead they are falling. How can this be?
First, the inflation freaks are gradually coming down from their trees. In the long run inflation is always a risk, but there is no evidence to support current fear. The data say deflation is the problem, vast overcapacity a lasting protection against inflation.
Second, although there is no resolution among Green-Shooters, “L”-recoverists, and “W” double-dippers, it is now beyond arguing that recovery will be low-slope. Headlines overblow any shred of good news, mistaking thin growth for recovery. Bank of England Governor Mervyn King: “It’s levels, stupid. It’s not growth rates. It is levels that matter here.” Germany’s top central banker, Axel Weber, estimates that it will not regain its 2008 GDP until 2013. An underwater homeowner understands better than anyone: if half of value has been lost, 5% growth, or 10%, or 20% is not recovery.
Then there is the relaxation of panic. It began two years ago, reached crescendo last fall and winter, and now... what am I doing holding all these T-bills paying nothing? Institutions refused government-backed MBS because the government might renege, or rates rise fast, killing those who bought at low yields. Today’s net 4.50% or 4.00%, guaranteed, looks okay. And so investors still in their bunkers, peering from periscopes, send brave scouts to pick up the nearest, safest things paying better than Treasurys.
Panic becomes pointless when counterparties understand that global government will not allow systemic failure. Hence the now-recurrent and triumphant non-stories describing the Fed, Treasury, and FDIC folding up emergency programs: bank loan guarantees, money-market backstops, and asset financing. No triumph: the financial system is still in terrible shape, but once panic breaks the programs are irrelevant.
Voice from the audience: “You lie! If panic is gone, all this money will slosh out of Treasurys, and rates will go up!” The most direct counter-argument: since rates are going down, you might try to figure why, instead of deny.
We face tremendous economic drag ahead, far beyond the capacity of central banks to release. First “deleveraging,” then withdrawal of stimulus, then fiscal repair -- not just here, but global -- and all the while struggling to restore financial-system capital.
We borrowed too much, and now we must un-borrow. Ideally we would grow our way out of debt (inflating our way out will not work, and will not be tried), but in a messy situation, some absolute un-borrowing is inevitable.
Most data this week were distorted by the Labor Day holiday, but one market-mover stood out: the unprecedented contraction in consumer credit. July collapsed at a 10.4% annual rate, $20.5 billion in a single month, five times worse than estimated (all estimates since March have been wrong by double or triple), three times the rate of shrinkage last winter. Total consumer credit has rolled back almost to 2006 levels.
Deleveraging is necessary, but this is too fast. Some is due to new-found frugality, but not so much new-found moral virtue as a mass attempt by families to compensate for lost value in homes, investments, and retirement funds. The largest cause of credit shrinkage: the shutdown of community and regional banks by regulators stuck on reflex, observation and imagination impaired.
Improbable, unprecedented, but so it will go: we get low rates in trade for years of rehab ahead, sometimes overdone by energetic but rookie therapists. |
