« Consumption, Imports and the Prospects for US External Balances | Main
The bond market sees an improving economy.
The yield curve has shifted up and steepened over the last 4 months, which I read as a perception that things are not quite as dreary as they appeared a short while ago.
On the other hand, that still leaves the overall level of interest rates a little below where they stood a year ago. Essentially what happened this fall was a reversal of much of the pessimistic sentiment that had been developing in the first 8 months of 2010.
Much of the flattening and lowering of the yield curve in the first 8 months of 2010 was due to a decrease in inflationary expectations. These too have come back up, as the graph below of the spread between nominal yields and those on Treasury inflation protected securities reveals.
Note that since the nominal rates are below the levels of a year ago while expected inflation rates are back where they were, this means that real interest rates have come down. And although the inflation rates implied by the above curve for the next 5 years remain a bit below what the Fed would ideally aim for, this is a better picture than Bernanke was looking at last August.
One goal of the Fed's second round of quantitative easing begun at the start of November was to flatten the yield curve. That obviously didn't happen, and I discussed some of the reasons why a few weeks ago. A second goal was to increase inflationary expectations, which was achieved.
Even so, all we've done is moved back to about where we were a year ago. And a year ago, if you recall, things really weren't that great.
But at least now we're moving in the right direction.
Posted by James Hamilton at December 26, 2010 07:48 AM
Economics in practice seems to regularly offer conclusions that are based in counter-factual assumptions(necessarily perhaps). This for example:
"One goal of the Fed's second round of quantitative easing begun at the start of November was to flatten the yield curve. That obviously didn't happen..."
The counter-factual assumption here seems to be the possibility that that QEII may have kept the yield curve from getting steeper. Which, would suggest something other than the conclusion drawn from assuming that nothing happened. The actual influence of QEII on the yield curve could thereby be misinterpreted altogether. Perhaps, for example, Bernanke & Co. anticipated the steepening of the curve and then underestimated the amount of stimulus needed to reach the desired result. QE is still somewhat experimental after-all? Or... maybe the political pressure against QE by the ROW did not allow the program to be as large as what was thought to be needed, and so, a compromise was necessary?
In any case, it seems that without knowing what would have happened without QEII, that it is possibly misleading to draw conclusions without at least some consideration of the alternative possibilities.
Posted by: rayllove at December 26, 2010 09:33 AM
Nice charts, thanks. Nominal oil was $66.33 in December '09. Brent spot closed Friday at $92.99.
I know I am being a seasonal Grinch. But I essentially learned this from you (not the Grinch part).
Oil prices are in the range where their drag on consumer demand, especially durables and perhaps housing, will become perceptible. This will add to the end of fiscal stimulus as being a major worry in 2011 for the U.S. economy.
Too Grinch-ish?
Posted by: Steve Bannister at December 26, 2010 09:42 AM
Isn't the question whether or not the yield curve is flatter than it otherwise would be? The big tax cut bill surprised a lot of people who thought Congress was going to get tough on the deficit. Maybe with that and without QE2, the curve would be even steeper?
Plus there's the problem that while QE2 has a direct effect on rates, it also has an indirect effect because of how it changes other market participants perceptions. For instance, the crowd worrying about big inflation probably expanded some.
It seems like the Fed was probably right in the 1940s to target rates, not purchases. But the success of that policy might have depended a lot on the patriotism of bond buyers. Good luck with that now-a-days.
Posted by: Bob_in_MA at December 26, 2010 09:57 AM
This is a stupid question, but could you mention the source you use for this data? Thanks.
Posted by: Random Student at December 26, 2010 11:15 AM
Random Student: Click on the last link in the captions under the figures.
Posted by: JDH at December 26, 2010 11:26 AM
The bond market saw that constraints were underestimated in Aug 2009 and wants a higher yields today in compensation.
Posted by: Matt Young at December 26, 2010 12:05 PM
It seems appropriate to me that you mention here, as you did ~Dec 14, that the Treasury is issuing longterm debt in greater quantities than QE2 is monetizing it.
That certainly clouds any conclusion about what the 'market' sees.
Posted by: Bryce at December 26, 2010 01:14 PM
Come on James, yields were down because of the European mess. That is CLEAR now. Little to do with the US economic performance. Matter of fact, they are still much to low considering the "improvement" seen in the last 6 months. They should be higher yet and maybe will during the January-March timeframe.
Yields will chase the financials with them all heading toward zero when the market finally gives up.
Posted by: The Rage at December 26, 2010 01:21 PM
JDH wrote: "One goal of the Fed's second round of quantitative easing begun at the start of November was to flatten the yield curve."
Pardon me, but really?
I can't find anything in the FOMC's official statements indicates that was the purpose. And if that is the purpose, why is that only 6-29% of the puchases are in 10 year or longer terms?
http://www.newyorkfed.org/markets/lttreas_faq.html
It seems to me (despite the fact that Bernanke did nervous cerebral contortions denying it on 60 Minutes) that the real purpose was simply to print money. There are actually other monetary transmission mechanisms than just interest rates (e.g. see Mishkin).
But the sad fact remains that most of this new money will end up as excess reserves anyway thanks to IOER.
Posted by: Mark A. Sadowski at December 26, 2010 01:30 PM
Mark A. Sadowski: See for example Bernanke's statement on Oct. 15:
For example, a means of providing additional monetary stimulus, if warranted, would be to expand the Federal Reserve's holdings of longer-term securities.5 Empirical evidence suggests that our previous program of securities purchases was successful in bringing down longer-term interest rates and thereby supporting the economic recovery.6 A similar program conducted by the Bank of England also appears to have had benefits.
Posted by: JDH at December 26, 2010 01:45 PM
JDH, True, but Bernanke was speaking for himself and not the FOMC on that particular occasion. And I see little evidence from FOMC statements, from the actual implementation of QE II, or, indeed, from the results that support the notion that the purpose was to flatten the yield curve.
Posted by: Mark A. Sadowski at December 26, 2010 01:56 PM
Reading a whole lot into the forcasting ability of the stock, bond or commodities markets is a bit risky in this day and age with the amount of manipulation done by the Fed and Treasury. We can't call it just a liquidity dump, since much of it appears visible as excess reserves held at the Fed doing nothing, but then again on my suspicious days I think Lord Blankfien may be instructing his day traders to use the money during market hours, then put it back at the Fed before going home at market close. Then ZIRP rates are supposed to get our animal spirits going and take risk, presumably inflating asset values, in the case where we aren't predisposed to build a factory somewhere and hire a bunch of people.
So I've got another interpretation for recent bond market action. I agree that inflation expectations are on the rise, but I think it is because faith in the Fed executing the "exit strategy" on a timely basis is coming into question, and not really that we are on the way to real robust growth. Kind of like a stagflation lite scenario, but instead of a domestic wage-price spiral driving it, it's import inflation, oil and commodity inflation, and maybe we can even get a wage-price spiral going in China!
So at least we will do our part again to fight world poverty. Who says macroeconomists don't know what they're doing?
Read Full Article »