Kessler Market Commentary

For one of the most insightful perspectives on long bonds, we present Bob Kessler's most recent, "Full economic recovery, U.S. inflation, and the Fed removing accommodation – still years away" masterpiece. Absolute must read.

h/t Frank

Comments

[Nolsgrad]

awesome!  does anyone have any data on how short duration tips <4years perform in a deflationary environment?

[Anonymous]

Lots of solid thinking - I was unaware of Kessler before this post, and once again ZH has brought me something new and outstanding.

One thought/question, however. This piece, with its excellent description of the current parlous state of the US economy, should really be about why you SHOULD NOT own Treasuries, in any form. After all, fiat currency economies (one area where the US is the undisputed leader) have only confidence to backstop their promises. This piece left me with no confidence that the country will be able to pay all off all the debt that has been and will be issued. And then there is monetization of debt by the Fed (which ZH has so well cataloged). That cannot be good for Treasuries either.

So I read this as a huge red flag, although it comes from someone who appears to run large Treasury portfolios.

Am I reading this correctly?

[Bolweevil]

bond nerds over here "reading" while all the cool kids are over at Marla's

[Nolsgrad]

the cool kids ARE the bond nerds. also the ones with the bigger bank accounts

[Bolweevil]

too true

[hp12c]

+1..Most of the mental horsepower in investment houses goes to fixed income... The chaff goes to the equites side of the house..

My motto is if you understand the direction of the credit markets, the rest is easy...

[Anonymous]

need an article on the industry pumps happening sequentially

[digalert]

So we are in la la land and we aint seen nothing yet. I have no debt and have serious doubts about investing, holding doing anything. I can only keep informed.

[Ruth]

Thanks also for bringing Angela and Dan to our attention, keep up the excellent guest posts, guess there's way more story behind every price, and I hate that word assuming.  Bites me in the ass everytime! 

[Nolsgrad]

I wonder if HeliBen will be dumb enough to offer 30year TIPS.....

[contrabandista13]

Thanks....

This blew my already blown mind...  I've got a mother f%$king headache... I prefer Maria B's gibberish... A very well framed market comment leaving out a great deal of silent evidence...

Best regards,

Econolicious   

[Hansel]

I don't know about this.  Kessler says we need even lower rates right now so the economy can recover, but it seems like the recovery would be in the the parts of the system that are unsustainable.  He says we need lower rates for housing and private equity, but they are the problem.  Kessler then says that unless rates on deposits are higher, more housing supply will hit the market from people living on fixed income.  So do we need lower rates or higher rates?  IMO it isn't so much interest rates that are the problem, but overpriced assets that can't be carried by the economy.  Kessler's perspective is one of a rent seeker and it shows.

[Anonymous]

you basically pre-empted my comments...i thought
that he made some good points very early about
the integral of the curve being more important
than the differentiation of the curve but then
i came across what you noticed and said oh crap -
he blew it...

the problem is not that interest rates are too high
- although in a shrinking economy they are not
cheap - but that there is too much debt to be
serviced by the general level of personal and
economic activity....thus the solution is too
liquidate where insolvency exists...

i thought he was basically defending fed policy
and as such thought this article was definitely
not a must read even though i agree with him that
economic prospects are much less promising than
the pom pom girls cheer...

i totally agree about your rentier comment -
a preference which needs to be expunged from
our economy in order rebalance labor and
productive activity with the fire economy....

[gmrpeabody]

+1

[Anonymous]

I don't think you comprehended his rationale very well.

from his summary "Lower costs or carrying debt / borrowing will be necessary for consumer spending to be renewed -- whether policymakers get rates and yields down sooner (the easy way), or a worse recession and “bust cycle”
mechanisms drag them down later (the hard way).

His essential point is that the banks' spread is too high - they should lower the rates they charge debtors & raise the rates they pay creditors.

the rates they are charging their still credit worthy customers is too high (because they desperately need to pump up profits to try to replenish their MBS-loss devastated capital) but by doing so they are effectively hurting consumers & themselves & thus the economy.

and by not offering a reasonable rate to creditors (eg. CDs) banks are hurting those on fixed incomes (who likely have no mortgage but may decide to scale down their current house to maintain their std of living & thus add to the glut of housing inventory.

if the banks continue to this path, they are making things worse & will affect more people (like subprime has morphed into affecting prime, etc.)

if you took the time to read carefully, it isn't that hard to follow.

[Anonymous]

"the rates they are charging their still credit worthy customers is too high (because they desperately need to pump up profits to try to replenish their MBS-loss devastated capital)...."

Actually, the excessive spread has nothing to do with the banks' MBS or other secuitization follies. It has to do with the increasingly tight oligopoly of major banks--aided and abetted by the USG & Fed.

The bank spreads are high because THEY CAN BE! Until someone (the out to lunch USG?) breaks up the TBTF banks, the spreads will remain wide if not widen.

[Anonymous]

This is like getting a fat person to eat more food in the form of celery to lose weight. May seem counterintuitive to eat more but it's all about the poop that comes out in the end.

[I need more cowbell]

Mauldin's latest, some good stuff.

http://www.frontlinethoughts.com/pdf/mwo100209.pdf 

[Anonymous]

Thanks for the link. Very interesting.

Now, the question is whether BB, Timmy, et al. are any more able than a pile of sand at identifying and removing fingers of instability. So far, it seems they are dumb as dirt, as they pile on more sand.

[Sqworl]

Volker on economy...very telling story about present administration...Interview on Bloomberg with Charlie Rose.

http://www.youtube.com/watch?v=saHfJhZWJmg

[SDRII]

Kessler is a treasury investor - and thus talking his book at a very basicv level - particularly the short end. What would be interesting is tio hear his comemnts on the money market collateral issues via reverse repo.  Regardless, the one thing that he doesn't address is the dollar which is easily understood. He implicitly assumes the constant. He gives no consideration to the magnitude of debt being accumulated and thus the argument, most of which is factually correct, falls short. Yet again he talks about a rising savings rate that is being driven by transfer payments alone.  

[AN0NYM0US]

Julian Robertson

video

http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/...

text

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asSDUJVN0eDs

and for a limited time this bonus video from October 13, 2008 where the same Mr. Robertson talks about his favorite investment  at that time (please excuse the CNBS link)

http://media.cnbc.com/i/CNBC/components/Syndicated%20Video%20Player/vide...

but wait that's not all, we'll also include my all time favorite Kudlow/Kneale/Gartman video on the eve of Lehman going down

http://media.cnbc.com/i/CNBC/components/Syndicated%20Video%20Player/vide...

[Sqworl]

But Wait!!!!!!...if you order now, we will send you a free set of Geithner Press on nail Tax vouchers!!

[Hephasteus]

Free copy of Turbo Tax. 1 free get out of taxes illuminati voucher. No computer required as there won't be  a tax return generated.

[Anonymous]

Simply outstanding analysis.

All I can say is thank you.

[AN0NYM0US]

Volker on Charlie Rose from earlier this week (two one hour interviews)

http://charlierose.http.internapcdn.net/charlierose/092909.wmv part I http://charlierose.http.internapcdn.net/charlierose/093009volcker.wmv part II

(of course they're kind of irrelevant as no one is listening to him)

[Anonymous]

"It's no surprise the dimensions of the contraction are comensurate with the extent of the expansion", The consumer has carried the ball for about 15yrs...now they punted to the fed for 15yrs. Forget tresuries I'm building a root cellar for bullion

[mrhonkytonk1948]

Gosh, what happened to the idea that we would all get rich taking in each other's laundry? 

[Sqworl]

Heard David Letterman is looking for interns. Be beautiful and professional. Ready for business, risky business experience not required.  Priority to SEC applicants..lol

[AN0NYM0US]

has HuffPo been acquired by infowars?

The IMF Catapults From Shunned Agency to Global Central Bank

Read more at: http://www.huffingtonpost.com/ellen-brown/the-imf-catapults-from-sh_b_306665.html

[Hephasteus]

I'd like to burn the IMF. With gasoline and oh throw in some pee for extra smoke and steam affects. No thats a waste of gasoline. Rat turds.

[Sqworl]

LOL..the urine is a nice touch....lol

[MsCreant]

Disagree. Total waste of urine. Good plant nutrition in that urine.

For your consideration. There is some cute stuff on google, though I guess you have probably looked. This came up in a girl squirrel search:

http://marvel.com/universe3zx/images/thumb/6/63/SquirrelGirl442.jpg/440p...

http://fullbodytransplant.files.wordpress.com/2009/04/squirrel_girl_by_a...

And just squirrel:

http://media.photobucket.com/image/squirrel/scottdavenport/super_squirre...

http://beaconwm.files.wordpress.com/2009/05/squirrel-eating.jpg

http://www.costumedogs.com/wp-content/uploads/2007/07/squirrel4.jpg

[Anonymous]

"Good plant nutrition in that urine."

exactamundo mscreant
cheapest fertilizer you can get your hands on.
literally...

[Hephasteus]

Here's a good one.

http://icanhascheezburger.com/2007/12/18/funny-pictures-secret-squirrel-...

http://icanhascheezburger.com/2008/06/19/funny-pictures-this-one-is-for-...

But your first marvel one just says SQWORL to me.

Though it could bring out hentai furry porners after her. I'm just saying. I know what is out there and I never even watched x-files.

[Anonymous]

rat turds are not big enough to brun the
vampire squids at the imf....buffalo and elephant
shit would provide a nice slow burn fuel....

and when buffalo crap runs low - and it will -
start throwing in federal reserve governors....

[Anonymous]

This is an excellent piece, but as others have noted, what is missing is a consideration of the position of the US in the global economy. Yes, there is a comment about overseas call centres taking jobs from US workers, but nothing deeper.

When the author talks about the inflationary effect of the baby boomers reaching economic maturity in the 70s but says there is nothing similar this time, I must disagree. Firstly, if we take a step back from the current economic situation and the drop in demand, we are still faced with the fact that the US have been responsible for something like 25% of economic activity, with only 5% of the population. If the rest of the plant increases its consumption by one third, this will compensate for the US economy in it's entirety and yet this per capita consumption would still only be about a quarter of the current US levels. And all of this assumes static population levels.

The plain and simple truth is the world is developing and developing fast. The US centric argument that prices won't rise because Americans can't afford to pay more is a delusion. If this is added to the decline in the dollar, ignoring any short term spikes, over the next few years, things are going to get an awful lot more expensive. It is clear that the US is facing a far more severe downturn and readjustment than anywhere else, apart from a few basket cases like Iceland, Ireland, Spain or UK. Countries like China, Brazil, Germany etc are coming out of this ok, as we saw with the increase of GDP forecast by the IMF. Billions of people are increasing their spending power and their standard of living, placing a greater strain on resources.

The natural conclusion would be for people to consumer less, i.e. more in line with what they need. The problem with this is the US economy has become a consumption carousel.

I must confess I don't know the right solution, and I am not sure where to start, but I think there needs to be a process of loan renegotiation with banks writing off 10 - 20% of debts so they don't have to write off 60%. This should wipe out bank equity but protect creditors.

As for Treasury yields, all I know is they won't reach 10% as they won't be allowed to. The US cannot afford to pay 10% on it's debt and will repudiate before hand. If there is one thing I do know is there is zero chance of the US doing the honorable thing and will go for the military option rather than having and IMF style intervention that any other nation in the same economic situation would undergo.

[ozziindaus]

Great four part audio debate regarding Inflation/Deflation, treasuries, USD  etc.

http://www.financialsense.com/fsn/main.html

[Anonymous]

"Overly burdensome debt is only resolved by two means of deleveraging:
?
By one means, debt can be eliminated via a process of default on obligations and, alternately, by forced or unfavorable liquidation sales that diminish or wipe out borrowers’ equity;
?
By another means, debt can be paid off slowly from revenues and personal income and more quickly by liquidating assets."

So if we think about this at the national level, and frame it in the context of the U.S., payment through revenues (taxes) don't appear to be the viable option as revenues seem to be going through the floor. So does that mean default or unfavorable liquidation (i.e. currency devaluation)?

[Great Depressio...]

Kessler ignores the 600 pound ELEPHANT in the room like many other deflationists. He ignores the amount of treasury issuance the US is going to have over the next few years. Talk of lower yields is reasonable so long as the net amount of treasury's outstanding doesnt grow so much. However, the US is still having massive auctions month after month. How much more debt can the US issue until the world throws its hands up? Also, how much more can the fed itself monetize? Kessler operates under the assumption that the world will continue to buy our paper, and in the event it doesnt, that the fed will be able to monetize the debt without causing a panic run on the dollar. Comparisons with Japan DO NOT WORK as Japan was a net exporter unlike the US which is a net importer. Also Japan was NOT invading the sands of Arabia when the housing market blew up while the US is on its way to starting a 3rd war with Iran.

Therefore, this analysis only is applicable if the US were to stop issuing insane amounts of treasury paper. However, because the feds wont stop borrowing from abroad or from ourselves it is inevitable that a funding crisis will occur sooner than most think. Look at the latest jobs report: 50,000 jobs were lost from state governments. These layoffs are just starting as bloated state budgets need to be cut. Of course, when 70% of the US economy is based on CONsumer spending the trickle effect from state job cuts will continue to spread into the broader economy. The Feds will be forced (they believe) to pass another stimulus with borrowed or thin air money. Who is going to show up then??

The US NEEDS to have a deflationary period in order to cure itself of the present imbalances. However, since the feds will NOT allow the deflationary period to come forth (too politically inexpedient?) they will break the back of the borrowing binge. Thus, a crash of the dollar is inevitable. Remember, hyperinflation is always a monetary phenomenon, also politically influenced.

[Anonymous]

Hear, hear. Must crash dollar. Must keep printing and keep up the illusion of not only good bill-note-bond sales but that interest payment on past debt can be maintained. And keep warfare-welfare state going.

Must print copiously in the face of contraction and mainstreet depression conditions. Foreigners now barely stomaching even holding short term debt shall soon repudiate fully...AND THE DOLLAR.

'twil be ugly. But one can hope for deflation. Saw spurts of it during last year's panic, but NOT now, prices are being maintained and many are gaining albeit slow and secretively.

NO WAY those stored up and saved dollars are going to be worth more in the future. The system requires their sacrifice at their altar of fractional/fiat too dearly. People will not buy, but that doesn't mean pricing (keeping pace with printing) won't moonshot.

Just look at precedence. It is FED modus operandi. Deny it at your peril.

[Anonymous]

Not trying to be a wiseguy, but who is this Kessler fellow. What is the track record of his group?

[MsCreant]

The chart on the last page was pretty simple math for me. Told me what I already knew, but quite "graphically." The chart is waaaay too optimistic, but then again, that was the point. We will contract, not grow GDP, unless we crank up the war machine.

[aurum]

How can you believe that treasuries forecast inflation when the fed is buying them hand over first? theres no logic

[Apocalypse Now]

Excellent economic eulogy. 

When all the fundamental news is bad (despite hopium), it must be deflation.  The question of course is how quickly it could turn into a currency crisis (the only reason for inflation will be needed goods imported from countries that aren't devaluing at the same rate)- but since so many countries were dependent on exporting into the US, and they are in a tough spot - many countries are printing and spending (devaluing) at a similar rate so higher prices won't show up in all import prices.  If they want to sell into the US they are going to have to lower prices or have excess capacity and no sales.  The fact that the US is devaluing will force any country that wants to maintain US exports to devalue.

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