Posts filed under “Federal Reserve”

A World of (mostly) Flattening Yield Curves

Lately,  we’ve been discussing the Yield Curve, its flattening and inversion and how its different this time (not). This has been termed a "conundrum" by outgoing Fed Chair Alan Greespan.

Many commentators have cited foreign buying of longer-term treasuries as the reason for this "conundrum."
While the U.S. yield curve has flattened considerably since its August
2003 peak,that period hardly marks the beginning of foreign purchases
of US Treasuries.

Further, if we take a fresh look at curves elsewhere, we see this issue is not limited to the U.S. As the chart below reveals, Yield curves around the globe are flattening.

While numerous rationales try to explain away the US inversion as an anomaly, the excuse making ignores the small fact that the US is not the only country with a flattening Yield Curve: So too are Japan, UK, Germany, Switzerland, Canada and Australia. 

The yield curve inversion naysayers have yet to explain how foreign purchases of U.S. Treasuries are flattening curves elsewhere also.

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click for larger graph

Worldyieldcurves_graphs

Source: Mike Panzner, Rabo Securities

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Funny, those who try to convince you the Yield Curve doesn’t mean anything aren’t mentioning this inconvenient factoid of Global Curve Flattening.

 

To paraphrase Panzner:  "Given that spreads between long and short-term rates in many major bond markets (including Japan) have also fallen recently, perhaps "this time" is not so different after all? Could it be that global bond markets are anticipating an impending slowdown?"

Here’s a typical set of explanations:

1) stock-market investors fled the crash of 2001, and their alternative-investment strategies have soaked up the supply of bonds and other fixed-income securities.

2) China and other Asian countries are parking their dollars to drive up the value of the U.S. currency and keep their export-driven growth booming.

3) U.S., European and Japanese populations are aging, and with age comes an investment preference for security and income.

4) prices for everything except fossil fuels are being held down by productivity increases, international competition and excess manufacturing capacity.

-Peter Morici, international economist at the University of Maryland’s business school

At first blush, these all appear reasonable. However, a closer look reveal the flaws in each of these explanations:

1) This is belied by the enormous amount of cash and cash equivalents — trillions of dollars in money market accounts — hardly equates to "soaking up bond supply;" And, the crash began in 2000;

2) Foreign buying of US bonds cannot explain flattening yield curves elsewhere (See  chart above);

3) True dat; Now what about the very young populations in the rest of Asia and the Middle East? Or do we just pretend they are not market participants, and ignore the fact their equity markets have all soared in 2005?

4) Astonishingly misleading statement: Nothing is going up except oil? How about food, building materials, education costs, industrial metals, healthcare, raw goods, insurance, housing, precious metals — they all have risen dramatically.

While most goods have gone up in price, while a handful of items have come dwn. When we talk about electronics, note that the mechanism that brings their proces down is an economy of scale. The first few units are prohibitively expensive, essentially paying for the factories. The next wave are some what cheaper, and by the thrid iteration, they become mass produced and much less expensive. Think Plasma screens:  They have all plummeted in price — excepting, of course, for the one screen that I want.

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For the numbers geeks, here are the actual changes in the 10-year vs. 2-year government bond yield spreads for selected countries since August, 2003 (which was the most recent major peak, based on weekly data, in the U.S. spread):

Country 8/29/03
Spread %
Current
Spread %
Difference
(Positive Value
= Flattening)
US +2.496 -0.009 +2.505
Germany +1.604 +0.447 +1.157
Japan +1.264  +1.188 +0.076
Switzerland +2.186 +0.506 +1.680
UK +0.438 -0.091 +0.529
Canada +1.773 +0.118 +1.655
Australia +0.557 -0.020 +0.577

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UPDATE 1 JANUARY 6, 2005, 1:31pm

Check out this Sunday’s NYT for more on this phenomena . . .

UPDATE 2 JANUARY 8, 2005, 8:31am

This is in today’s Sunday NYT

The World Isn’t Flat, but Its Yield Curve May Be
Economic View
DANIEL GROSS
NYT, January 8, 2006
http://www.nytimes.com/2006/01/08/business/yourmoney/08view.html>

 

Sources:
Michael Panzner, Rabo Securities

Scatter Shots
THOMAS G. DONLAN (Editorial Commentary)
Barron’s, MONDAY, JANUARY 2, 2006
http://online.barrons.com/article/SB113598713395735177.html

citing Peter Morici, international economist at the University of Maryland’s business school

Category: Economy, Federal Reserve, Fixed Income/Interest Rates, Inflation

Gold & The Wizard of Oz

Category: Commodities, Federal Reserve, Inflation

2 Studies on the Flattening Yield Curve

Category: Federal Reserve, Fixed Income/Interest Rates, Inflation, Technical Analysis

Explaining Yield Curve Inversions

Category: Economy, Federal Reserve, Fixed Income/Interest Rates, Inflation

Inverted Yield Curve: Its different this time (not)

Category: Federal Reserve, Fixed Income/Interest Rates, Inflation, Technical Analysis

Federal Reserve Chairman George Costanza

Category: Federal Reserve

Economists React to Fed

WSJ 

The Federal Reserve, as expected raised interest rates for the
13th consecutive time Tuesday, lifting the federal-funds rate by a quarter
percentage point to 4.25%. The central bank suggested it would raise rates
again, but also hinted that it is less certain on its future rate actions than
it has been in over a year. In the accompanying statement, the Fed said growth
remained "solid", inflation excluding food and energy prices had "stayed
relatively low," and inflation expectations were contained. But it also warned
that the possibility of further erosion of spare productive capacity and high
energy prices "have the potential to add to inflation pressures."

What do
economists and other analysts make of the changes? Here’s a sample of their
commentary:

* * *

The Fed has finally taken the step that we have been
pointing to for a while, in separating the two concepts of reaching neutrality
and finishing the rate cycle. They kept "measured," as we thought they might,
but now it refers to "some further measured policy firming" as opposed to
removing accommodation at a measured rate. So, rather than being on automatic
pilot in raising rates toward neutral, the FOMC now sees itself in the second
stage of the rate hike cycle — further moves will be perceived by Fed officials
as taking policy toward a restrictive stance.

– Stephen Stanley, RBS
Greenwich Capital

* * *

The message from the FOMC appears to be that barring a
major change in the tone of economic data, another 25bp tightening move will be
implemented at Chairman Greenspan’s last meeting on January 31. At that time, it
is quite possible that the "measured phrase" will be jettisoned, leaving
incoming Chairman Ben Bernanke with a clean slate for the next meeting on March
28. Our own view remains that the evidence concerning economic growth should be
sufficiently strong in coming months to spur another three 25bp tightening
moves, lifting the Fed funds target to 5.00% in the second quarter of the year.
We think that growth will then be moderating sufficiently for the FOMC to cease
tightening, even if core inflation drifts up mildly from its current
levels.

– Joshua Shapiro, Maria Fiorini Ramirez Inc.

* * *

The Fed announced: "Core inflation has stayed relatively
low in recent months and longer-term inflation expectations remain contained."
Quite frankly, we do not believe them. We know that beyond the rises in food and
energy prices, nearly everything — from healthcare to building materials to
education costs to insurance to commodities — costs more. And gold, the world’s
best inflation indicator, is well over $500 per ounce. Where ever we look, we
see evidence that prices have limited stability and an upward bias.


Barry Ritholtz, Maxim Group

* * *

 

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