Mar 14th 2012, 16:50 by Buttonwood
ARE we witnessing one of those historic turning points in markets, on a par with March 2000 (when the dotcom bubble burst) or March 2009 (the post-Lehman low)? The issue is not so much with equities which are continuing the stop-start recovery that has lasted for three years. The interesting issue is the bond market which (as a regular commenter astutely noted on the last post) has seen a steady decline, taking the 10-year Treasury yield to a five-month high. Gold is also weaker, down at around $1640 an ounce, and a long way below the $1900 peak reached last year.
Treasury yields have been falling for around 30 years, first as the great inflation of the 1970s was eliminated, then as deflation fears set in, and then finally in the face of quantitative easing. If we are heading for a Japanese scenario, they could fall further, to 1% or so.
But the mood seems to be that the US economy seems to be managing a decent, if not electrifying, recovery. As a result, the Fed seems less likely to have a mandate for more QE, as yesterday's Fed minutes indicated. the danger is that the entire support for the bond market (low rates till 2014 as well as central bank purchases) might be removed. At ING, Rob Carnell, chief international economist, comments that
Markets are beginning to (rightly in our opinion) view the Fed's commitment on Fed funds as a worthless promise, and price futures markets accordingly.
While Alan Ruskin of Deutsche Bank says the market context is similar to that of 1993, the end of another period when the Fed had suppressed rates to bail out the financial sector.
the biggest single concern is the worry that we will relive a period of bond market turmoil, that accompanied the Fed's tightening from the 3% funds rate low at the time. Back in 1992-3, the Fed was not artificially suppressing bond market volatility in the way it is today, but the market became used to what was seen as an unusually long period of steady very low interest rates. This time around we have not only had an even more prolonged period of low rates that will not change soon, but the direct 'intervention' of long-end bond purchases.
It is too early, of course, to be sure that the trend has changed decisively. We still need to remember that much of Europe is flirting with recession and the impact of higher oil prices could also sandbag the recovery. A very sharp rise in bond yields could be bad news for growth on its own.
A final thought. You can view the reaction of the authorities to events post-2008 as the frantic activity of a one-armed waiter trying to serve a full restaurant on his own. They have just about avoided a smash, although in Europe it has been a close-run thing. But they are still balancing a lot of plates, trying to keep bond yields and short rates down and equity markets up while simultaneously manipulating exchange rates.
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"...1993...suppressed rates to bail out the financial sector."
Which led a few years later to the Y2K bubble. Then the bank printed to bail banks out of Y2K deleveraging, which led to the housing bubble. Now banks are printing to bail banks out of the housing bubble deleveraging.
Banks using the printing press to bail out banks is an abuse of printing. It has disastrous long run consequences. Each serial Minsky mania printed to bail banks out of the last Minsky deleveraging is more problematical than the one before it.
A Japanese scenario won't occur simply because we have a population growth rate of 1% a year, which builds in 1% GDP. Also, Bernanke is the A-team compared to Japan's central bank. So the low in bond yields in the US won't be 1%. Likely we have seen it, although we could revisit it. Rising bond yields are clearly going to be the long term trend. I think the key question is: what is the optimal rate of inflation if you want to inflate away debt? If you can deduce that, you will know where we are headed. I'm thinking a gradual rise to about 4.5% on the 10 year is optimal.
We had a similar runup of yields/price declines in October last year, which peaked at 2.39% as a close.
That was when the SP500 ran up to near 1300, then a pullback in November.
Thursday PPI (est. 0.4%) comes out, Friday CPI (est. 0.3%).
Maybe traders were unloading, thinking the news would be bad.
Regards
To me, the trend doesn't seem to have changed. Still, a Japanese scenario is unlikely in other economies, because their respective domestic productions (incl. roundabout production) of consumer goods are not as robust as Japan's. When it comes to inflation, not only the monetary side but the real side matters. China might follow Japan if the economy is still full of production capital when a recession comes. (But, the question is whether Beijing will accept a recession. I fear of war.)
I wish I had confidence that the Germans will not screw it all up in Europe, but whenever they have been in a dominant position before, that's exactly what they've done.
In this blog, our Buttonwood columnist grapples with the ever-changing financial markets and the motley crew who earn their living by attempting to master them. The blog is named after the 1792 agreement that regulated the informal brokerage conducted under a buttonwood tree on Wall Street.
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