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"ALL I KNOW IS WHAT I READ IN THE PAPERS," the late humorist Will Rogers insisted. And what the newspapers agree on is that U.S. bond yields have nowhere to go but up.
That's what Sunday's New York Times said on its front page. Moreover, this week's Current Yield column in Barron's expressed much the same view. And while a feature in Saturday's Wall Street Journal highlighted the wide variance in outlooks for bond yields, the balance tipped in favor of their moving higher.
That would mean that long-term bonds would produce negative returns as their rising yields would translate into lower prices. That's what happened in 2009 when the jump in 30-year Treasury bond yields resulted in a 26% negative return, its worst year on record, which goes all the way back to 1927, according to Bianco Research. And even though the 30-year Treasury basically broke even over the first quarter, only the Mets shape up as bigger losers than long bonds this year, according to this bearish consensus.
That view also extends to the Treasury futures pits in Chicago. Apparently following the advice from Nassim Nicholas Taleb, author of The Black Swan, who said a couple of months ago that "every single human being" should bet on a decline in Treasuries, speculators are heavily short T-note and T-bond futures.
"When the view of higher interest rates comes to dominate the media as it has in recent days, you know that something else is bound to happen," avers David Rosenberg, the chief strategist of Gluskin-Sheff.
Much of this bearish consensus reflects the views of Morgan Stanley's economists, who have been insisting that real interest rates (that is, after deducting inflation) are on a steady march higher. As the economy recovers and, most importantly, the debt markets have to absorb record volumes of securities issued to finance the trillion-dollar-plus federal budget deficit, yields will be pressured higher. This supply onslaught will push the benchmark 10-year Treasury note yield to 5.5%, from 3.84% Monday, says Morgan Stanley's team.
The counter to the bond bears' argument is that the supply of Treasury debt isn't the most important factor in the direction of bond yields. Moreover, the sustainability of the economic recovery is open to question.
As for the supply factor, Rosenberg points out the Treasury market got hammered in 1999 when the government was paying down debt rapidly with budget surpluses. And bonds rallied strongly in 2002, when the deficit exploded.
The key is what the rest of the economy is doing. "If the deficits and bond issuance are occurring at a time when the economy is approaching full employment and private-sector balance sheets are expanding, then for sure interest rates will be on a rising trend, Rosenberg writes.
"But fiscal deficits that are designed to cushion the blow from a credit contradiction, especially among households, generate far different results. With credit contracting, rents deflation, the broad money-supply measures now declining and unit labor costs dropping at a record rate, it hardly seems plausible that inflation is a risk any time on the near- or intermediate-term horizon," he concludes.
As for the economy, the National Bureau of Economic Research's Business Cycle Dating Committee has declined to declare an end date for the recession. Indeed, one of its members, former Council of Economic Advisors Chairman Martin Feldstein, reiterated in a Bloomberg television interview that the risk of a double-dip remains.
Despite two quarters of expansion in gross domestic product, liquidity is shrinking, which could portend the double-dip Feldstein fears.
"Clearly, the legacy of the credit crisis lives on," the Bank of America-Merrill Lynch economic research team writes.
"Large corporations have a relatively easy time borrowing in the capital markets and reasonable spread and relatively low interest rates. For these firms, slow spending and hiring are due to a lack of confidence rather than a lack of funding. However, household and small business remain credit constrained. A full recovery is only likely as both banks and their customers work their way through the inventory of bad loans."
The divide between the big haves and the little have-nots is visible in the massive gap between the Institute for Supply Management's manufacturing purchasing managers' index and the National Federation of Independent Business' optimism index. That difference can been traced to the tightness of small-business credit, according to Ian Shepherdson, chief U.S. economist for High Frequency Economics.
Indeed, real, broadly defined money is experiencing the "worst annual contraction in modern reporting," according to John Williams' Shadow Government Statistics. That signals "looming deterioration in U.S. business conditions, an intensified economic downturn or 'double-dip recession' in popular terminology.
Shadow Stats' estimate of the broadest measure of the money supply, M3, which the Fed stopped publishing four years ago, shows a record year-on-year contraction of 3.7% through March. Adjusted for inflation, the shrinkage in real M3 is estimated at 5.8%. (M3 consists adds institutional liquid assets to M2, which consists of currency and checking accounts, which comprise M1, plus consumer savings and money-market funds.)
The broadest M3 measure generally is most relevant, according to SGS' Williams. Changes in M1 and M2 often reflect nothing more than cash flowing between different accounts in the various measures. It's also apparent that M3 captured the credit bubble from 2005 to its peak in 2008, and then the subsequent collapse.
The Fed's official estimate of M2 also has been sliding since the beginning of 2009. And that hasn't been solely a U.S. phenomenon. BofA Merrill points out that throughout the Organization for Economic Cooperation and Development (except for four high-inflation economies), M2 has been sliding since the start of the credit crisis.
The contraction in the money measures is in stark contrast to the popular notion of central banks around the world "printing money" by expanding their balance sheets through massive purchases of securities and other assets. But the banks have not used that central-bank liquidity to expand credit and the "shadow banking system" of securitization remains moribund.
The initial doses of fiscal and monetary stimuli pulled the economy and the capital markets out of their nosedives and powered their ascents. Now those doses are wearing off. The money supply is shrinking while taxes are certain to rise in 2010.
The 10-year Treasury note yield appeared to bump into a ceiling at 4% early last week, which has marked the high end of its trading range going back to last June. Those yields were sufficient to elicit strong demand for a record supply of Treasuries last week. Before that yield hits 5%, it may well first head back toward 3%.
Comments: randall.forsyth@barrons.com
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Dow Jones Reprints: This copy is for your personal, non-commerical use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, use the Order Reprints tool on any article or visit www.djreprints.com
"ALL I KNOW IS WHAT I READ IN THE PAPERS," the late humorist Will Rogers insisted. And what the newspapers agree on is that U.S. bond yields have nowhere to go but up.
That's what Sunday's New York Times said on its front page. Moreover, this week's Current Yield column in Barron's expressed much the same view. And while a feature in Saturday's Wall Street Journal highlighted the wide variance in outlooks for bond yields, the balance tipped in favor of their moving higher.
That would mean that long-term bonds would produce negative returns as their rising yields would translate into lower prices. That's what happened in 2009 when the jump in 30-year Treasury bond yields resulted in a 26% negative return, its worst year on record, which goes all the way back to 1927, according to Bianco Research. And even though the 30-year Treasury basically broke even over the first quarter, only the Mets shape up as bigger losers than long bonds this year, according to this bearish consensus.
That view also extends to the Treasury futures pits in Chicago. Apparently following the advice from Nassim Nicholas Taleb, author of The Black Swan, who said a couple of months ago that "every single human being" should bet on a decline in Treasuries, speculators are heavily short T-note and T-bond futures.
"When the view of higher interest rates comes to dominate the media as it has in recent days, you know that something else is bound to happen," avers David Rosenberg, the chief strategist of Gluskin-Sheff.
Much of this bearish consensus reflects the views of Morgan Stanley's economists, who have been insisting that real interest rates (that is, after deducting inflation) are on a steady march higher. As the economy recovers and, most importantly, the debt markets have to absorb record volumes of securities issued to finance the trillion-dollar-plus federal budget deficit, yields will be pressured higher. This supply onslaught will push the benchmark 10-year Treasury note yield to 5.5%, from 3.84% Monday, says Morgan Stanley's team.
The counter to the bond bears' argument is that the supply of Treasury debt isn't the most important factor in the direction of bond yields. Moreover, the sustainability of the economic recovery is open to question.
As for the supply factor, Rosenberg points out the Treasury market got hammered in 1999 when the government was paying down debt rapidly with budget surpluses. And bonds rallied strongly in 2002, when the deficit exploded.
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