2&3, 3&4 or 4&5? That is the Question.

Bruce Krasting's picture
I think this day chart of the 30 year says it all. After the very stinky
NFP numbers the bond made a predictable jump higher. But it wasn’t long
after that the air started leaking out and the bond closed on the lows.

Why the stinky price action when we get a big miss on NFP number? QE and
the talk of stimulus done it. The numbers were so bad that by 9:30
talking heads and pundits concluded that the tax cuts were coming and we
might just get a break on Social Security payroll deductions any day.
Forget about restraining QE-2; the talk went straight into high gear
with the only question; “How big might QE-3 be?”

So with that gibberish in mind bonds headed to the crapper while gold
set new highs. The confirm that QE is now driving bonds lower came late
in the day when there was a convenient leak of a Sunday TV appearance by
Ben B. The only quote leaked was: “We might do more”. Stocks liked that talk and ended up; while the bonds ratcheted down another notch.

I am pleased that the market has made the connection that more QE and
more stimulus is bad for bonds. The market is the only discipline left
that may slow the insanity creeping over D.C. When market forces turn on
the “New Monetarism” and shut the door on the insanity, the policies
will change. Until they get hit hard over the head the Fed will continue
to print. We are getting closer by the day. Consider this graph of the
long bond since QE-2 was announced:

Long rates have backed up by 40 bp in just the past month. The exact opposite reaction that ‘the Bernank’ wants.
How deflationary is this increase in interest rates? Mildly so. My
guess is that the impact of rising rates exactly offsets the stimulative
benefit of keeping short rates at historic lows. Yes, more debt is
financed short term than long, but a back up in mortgage rates and the
increase in long term fixed rate capital for municipalities and
corporations will offset any benefits from ZIRP.

On the question(s): “Will interest rates fall from the current levels
of ~3% for ten-year and ~4% for thirty-year to the 2%/3% that Bernanke
is trying to engineer? Or will they rise to the 4%/5% that is staring us
in the face?

In my opinion we are headed to 4% for the tens and at least 5% on the
30- year. QE is going to produce the exact opposite results of what was
intended. Consider this chart of where the US stands on debt. Please do
not point to Japan as the example of why rates will have to fall in the
US. Japan is/was in a much different position than America.

At the heart of Bernanke’s dilemma is the following graph on the labor
force participation. Bernanke wants to juice the economy back to a
level where the slack in labor participation rises back up to where it
was in 2005. He believes that this is the Fed’s mandate. He wants to
turn the clock back. But he can’t. The lines on this chart gapped down
as a result of the 08 recession, but the trend toward a lower level has
been in place for a decade. Aging demographics, an economy too dependent
on consumer consumption and globalization that makes US workers less
productive make it inevitable that the US faces a much higher level of
un/underemployment. Bernanke is not buying that conclusion. He feels
that it is his mission to push against the laws of nature. The market is
pushing back. The market will win. Ben will fail.

I am not a fan of Greenspan. I think he got us into the mess we are in.
But I do respect his opinion. On the question of whether the US would
change its ways he had this to say recently:

"The only question is, is it before or after a bond market crisis?"

Too bad Bernanke is not listening. A bond market crisis is inevitable as a result.