I want to set Fed Pres Bullard up on a date with the bond market
The WSJ is reporting that Fed Pres Bullard is saying that he sees rates on hold near zero in ’10, but asset sales are possible and he said it’s “too early” to change the language of ‘extended period. Assuming he was quoted right and he believes that rates will be near zero in ’10, I would like to set Bullard up on a date with the Treasury market. I think they should get together and get to know each other. I say this because the comment from Bullard reveals an opinion that ignores or doesn’t believe market signals, signals such as the steepest yield curve ever and 16 month highs in inflation expectations to name a few. The bond market seems to want to tighten policy for the Fed irrespective of how the Fed wants to calibrate short term rates, thus a sit down makes great sense. I believe the benefits of the date would be a smoother process of Fed unwind that if done right, will benefit us all and limit the inevitable disruptions.
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December 23rd, 2009 at 1:51 pm
Not so dumb questions:
1) Are there any other times in history the Fed ignored the long end?
2) What happens if they refuse to budge and long rates keep rising, due to either better economy or lack of demand for the bonds?
December 23rd, 2009 at 2:32 pm
Looking back at yield spreads – the 2-10 relationship goes back to ’76 – only two other times were the spreads over 200bp – 12/91 to 5/93 and 7/02 to 6/04. The current 200bp+ spread has “only” existed since May. Instead of high inflationary periods following the wider than normal spreads, it could be argured that what followed were better than average market returns AND marked by a bubble (technology and real estate). Could the huge spread be indicative of another bubble forming somewhere? Only time will tell.
Further data is available for the 1-10 year spread (1962). Here too, the only times of excessively wide spreads coincided (roughly) with the above periods – no other periods came close.
Allowing for some artistic interpretation, since 1988 the spreads traveled moved in an orderly fashion, while prior spreads were much more volatile, twice moving from 200bp positive to -100bp within a year or two.
Implications? To me, it is obvious the Fed is trying to get the financial sector healthy and is willing to keep spreads wide in order to do so. The major question: will the wide spreads create yet another bubble as we saw following the other two very wide spread periods?
December 23rd, 2009 at 2:54 pm
@BigDaddy
Thanks…another bubble…if you are around 55, if the market crashed again, that would be your 4th…1987, 2000-2002, 2008 and the next one. I think that would finally kill this infatuation with stocks for this generation and finally return us to sane multiples.
December 23rd, 2009 at 4:20 pm
The problem is that businesses can’t borrow at the rates the banks get. If the spread is wide, it will probably crash the markets again.
December 23rd, 2009 at 5:34 pm
As Dr Greenspan recommends:
The best cure for a burst bubble is a bigger bubble.
December 23rd, 2009 at 7:22 pm
Well, anecdotal evidence from China:
1) pig farmers hoarding copper
2) Empty cities
3) World’s largest shopping mall sitting empty
4) Huge car sales but no increase in gasoline usage
suggests that is a huge bubble already…Nasdaq at 45 times earnings again is probably a bubble. Amazing how fast they pumped it back up. But again, I think the next bubble pop is the last for at least 80 years.
December 23rd, 2009 at 7:57 pm
@Mike in Nola:
I think Deninger agrees with you…makes sense to me too…
“If anything Bernanke has made the situation markedly worse with his “quantitative easing” programs, in that he has created a circumstance where banks can make plenty of money by engaging in “risk-free” trades by borrowing at zero and buying Treasuries! This of course beats lending to some small (or large!) business who might go under and not repay his or her debts.”
http://market-ticker.denninger.net/archives/1787-A-Short-Treatise-On-The-USeless-Economy.html
December 24th, 2009 at 3:34 pm
The notion that markets know something that the rest of don’t is highly over rated. What was the Nasdaq telling us about the “New Paradigm” in 2000? Or what was the stock market telling us about the credit crisis in October 2007, when it was making new all time highs? Or was the negative yield curve in July 2006 right about a recession that wouldn’t start for more than 18 months? Markets reveal what perceptions of reality are, not the actual reality. And too often those perceptions are wrong, as these few examples show.
December 24th, 2009 at 10:31 pm
@Jim:
The yield curve has done a decent job of pointing to periods of market underperformance. The yield curve went negative (2 vs 10) starting in feb ’06 until june ’07, which was not a bad time to begin unwinding stock holdings – the next 3 year rates of returns were poor. The curve was also inverted Feb ’00, again a decent heads up for poor performance ahead.