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When the Bond Market Goes Boo?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
Friday
morning at 8:30 a.m. Eastern, traders around the world will all be
glued to their Bloomberg terminals eagerly awaiting the release of the
first US jobs report of 2010. According to a buddy of mine who trades
currencies, Bloomberg's mean consensus forecast is at zero, with
estimates all over the map.
"Kind of makes you wonder why we pay
these economists big bucks for!", he lamented. He's right, most
economists are fence sitters and can't make a call. I laid it all out
in my Outlook 2010. I expect huge job gains (even higher than the number
posted on Zero Hedge) with substantial upward revisions to the previous
reports. I also expect the greenback and crude to rally but gold will
get hammered on the news.
Barring some shock, tomorrow's job
numbers will likely further jolt the bond market. Matthew Brown and Wes
Goodman of Bloomberg report that Treasuries’ 2-10 Year Yield Spread Nears Highest in 20 Years:
The
difference between two- and 10- year Treasury yields widened to within
4 basis points of the most in at least 20 years as the Federal Reserve
signaled it will hold its target interest rate at a record low.
The so-called yield curve steepened after minutes of the Fed’s last
meeting showed officials believe economic growth will be “rather slow
relative to past recoveries.” The Treasury will announce plans for next
week’s debt sales today.
“Growth
and inflation concerns are pushing up longer yields, while market
participants are betting that the central bank will keep rates on
hold,” said Michael Markovic, a senior fixed-income strategist in
Zurich at Credit Suisse.
The 10-year note
yield was 3.83 percent as of 8:25 a.m. in London, according to BGCantor
Market data. The 3.375 percent security due in November 2019 was little
changed at 96 9/32.
The rate is 2.82 percentage
points more than two-year securities. The spread was 2.84 percentage
points earlier today, within 4 basis points of the biggest gap since at
least 1990. The curve widened to a record 2.88 percentage points on
Dec. 22.
The government will sell $10 billion in
10-year Treasury Inflation Protected Securities on Jan. 11, $40 billion
of three- year notes on Jan. 12, $21 billion of 10-year securities on
Jan. 13 and $13 billion of 30-year debt on Jan. 14, according to
Wrightson ICAP LLC, an economic advisory firm in Jersey City, New
Jersey.
Growth Indicator
The spread indicates
the chance of a U.S. recession by year-end is “very low,” according to
a report Jan. 5 by Joseph Haubrich and Kent Cherny, researchers at the
Fed Bank of Cleveland.
A steep curve indicates
strong growth and a flat one suggests a weak expansion, the report
said. A sloping yield curve gives banks incentive to borrow at
short-term rates and make longer-maturity loans, providing stimulus to
the economy.
The three-year sale amount
estimated by Wrightson ICAP would match the most ever, while the rest
of the auctions would fall short of records.Fed
officials discussed whether the economy is strong enough to allow their
$1.73 trillion of asset purchases to end in March and differed over the
risk of inflation, minutes of their last meeting showed.
Differing Opinions
A few policy makers said it “might become desirable at some point” to
boost or extend securities purchases aimed at lowering mortgage rates,
while one person sought a reduction, according to minutes of the Dec.
15-16 meeting of the Federal Open Market Committee released in
Washington yesterday.
On
inflation, some officials said slack in the economy will damp prices,
and others saw risks from the central bank’s “extraordinary” stimulus.
The Fed is buying $1.25 trillion of mortgage-backed securities issued
by housing-finance companies Fannie Mae, Freddie Mac and federal agency
Ginnie Mae. The central bank began the program in January 2009.
The central bank separately purchased $300 billion of Treasury
securities from March through September 2009 and is buying, through
March, $175 billion of corporate debt issued by government-backed
Fannie and Freddie and the government- chartered Federal Home Loan
Banks.
‘Extended Period’
Fed policy makers
maintained a pledge to keep interest rates low for an “extended period”
following their meeting on Dec. 15-16. The promise is helping anchor
yields on two-year notes, which tend to track the central bank’s target
for overnight lending because of their short maturity.
The Fed is targeting a range of zero to 0.25 percent for overnight loans between banks.
The
likelihood of a raise is rates at the Fed’s June 23 meeting fell to 24
percent yesterday in New York, according to Federal Funds Implied
Futures. The probability was 41 percent a week ago.
The difference between yields on 10-year notes and Treasury Inflation
Protected Securities, or TIPS, a gauge of trader expectations for
consumer prices, widened to 2.41 percentage points, within 2 basis
points of the most since July 2008.
Inflation
will be “fairly low” in the U.S. this year, said Bob Doll, chief
investment officer for global equities at BlackRock Inc. in New York,
the world’s biggest money manager with about $3.2 trillion in assets.
American stocks will outperform cash and Treasuries, he said on
Bloomberg Television yesterday.
Susanne Walker of Bloomberg reports that U.S. Breakeven Rate Reaches 18-Month High on Growth, Inflation:
The
gap between yields on U.S. 10- year notes and inflation-indexed debt
reached the widest since before Lehman Brothers Holdings Inc. collapsed
as investors bet that consumer prices will accelerate as the economy
strengthens.
The breakeven rate on
10-year Treasury Inflation Protected Securities, or TIPS, increased as
much as six basis points to 2.46 percent, the widest since July 2008,
as the U.S. announced it will sell $10 billion of the debt next week.
Yields on other government securities were little changed before a
report tomorrow forecast by economists to show that the U.S. didn’t
lose any jobs for the first time since December 2007.
“There’s
some worry about how we absorb the supply and some are worried about
inflation,” said Lawrence Dyer, an interest-rate strategist in New York
at HSBC Securities USA Inc., one of the 18 primary dealers that trade
with the Federal Reserve. “Even if you are bullish about the long-term
rates outlook, you don’t want to buy cheap bonds that will get cheaper,
so people have limited risk appetite.”
The breakeven
rate, which rose from 0.04 percent in November 2008, shows the
improving economy may change sentiment and spark further losses in
bonds. Yields on the benchmark 10- year Treasury note hit 3.91 percent
last week, the highest level since June.
Move ‘Sooner’
Policy
makers are considering how to exit from unprecedented stimulus and
emergency credit programs amid signs the U.S. economy is rebounding.
Fed
Bank of Kansas City President Thomas Hoenig said the central bank
should move “sooner rather than later” to reduce stimulus, with a goal
of eventually boosting the benchmark interest rate to “probably between
3.5 and 4.5 percent.”
“Maintaining
excessively low interest rates for a lengthy period runs the risk of
creating new kinds of asset misallocations, more volatile and higher
long-run inflation, and more unemployment -- not today, perhaps, but in
the medium- and longer-run,” Hoenig, who votes on monetary policy
decisions this year, said today in a speech in Kansas City.
U.S. regulators including the Fed warned banks to guard against possible losses from an end to low interest rates and reduce exposure or raise capital if needed.
So how long will the Fed stay on the sidelines? There too, economists are all over the map, but the majority see no rate increases before the end of the year:
More
than 80% of economists participating in the Blue Chip survey believe
the Fed will begin to raise the federal funds target rate by the end of
this year, with the first increase not coming until late September or
early November. The target is now at a record-low level of 0% to 0.25%.
The key remains a
healthy labor market, Gertler said. "It is hard to imagine anything
changing until there is positive and robust employment growth," Gertler
said.
The Fed could tighten with the unemployment rate high but not if employment growth is not sustained, he said.
Ideally for the Fed, the bond market would start to gradually push
interest rates higher allowing the central bank to follow behind.
Dean Maki, chief U.S. economist at Barclays Capital Inc., predicts the Fed will tighten in September.
The
"extended period" language will be changed "at one of the next few
meetings," Maki said, maybe even at the bank's next meeting on Jan.
26-27.
Glassman at JPMorgan Chase doesn't
think the Fed will tighten for the next two years. "Nothing in the way
they describe the outlook makes you think they believe it is time to
get moving," Glassman said.
The economy will be too
fragile this year and the Fed will be reluctant to tighten in 2011
because the federal government is likely going to try to get the budget
on a sustainable path, leading to the biggest fiscal adjustment ever,
Glassman said.
My views are mixed. On the one
hand, given the pension crisis and the fragility of the financial system, I believe the Fed would rather err on
the side of inflation instead of risking a deflationary episode. They
will try to keep a steep yield curve for as long as they possibly can,
allowing banks to repair their balance sheets and trade in all sorts of
risk assets.
On the other hand, robust figures in the labor
market will shift market expectations, forcing the Fed to react sooner
rather than later. So the big surprise in 2010 will come if the Fed
starts raising rates in the second half of the year.
On that
note, hold on to your hat, the bond vigilantes will be out full force
on Friday. And when the bond market goes 'boo', its chill will be felt
across all asset classes.
***UPDATE: US sheds 85,000 jobs***
BOO! U.S. employers unexpectedly cut 85,000 jobs in December, government
data showed on Friday, cooling optimism on the labor market's recovery. Need to check revisions to previous reports, but I still expect hiring to pick up significantly in the first quarter.
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Hard enough to make predictions over the course of a year, let alone 10 years. Given the low level of 10-year bond yields, it's safe to assume stocks will not experience a stellar decade, but that doesn't mean you will not have spectacular rallies, especially in the new emerging sectors (lots more leverage built in the system now). Waiting in cash is an option, but I prefer to make money, buying the dips on the sectors where I have the strongest conviction. I stay very nimble but when I have conviction, I go in heavy. That's my style.
bad prediction, but good analysis. Still, I am trying to understand where these predictions of US job growth come from, and I have an economics degree from a famous institution. There are absolutely no job drivers out there, and the "health care" bill and taxes, if passed, contains all kinds of job destroyers.
If you have an economics degree from a "famous institution" (lol), let me ask you something: with ISM New Orders above 60 for November and December and business investment and profits up strongly in Q3 (still waiting to see Q4), how long will it be before firms start hiring again?
Like I said, significant job growth in Q1 2010. I stand by this call. My mistake was not factoring the huge auction next week and the fact that nobody really hires in December. Jan, Feb and March will be different. Stop looking at the past to forecast the future. The funny thing is everyone is now going to jump on the "double-dip" bandwagon, scooping up bonds and they're going to get whacked in Q1.
and not only does nobody really hire in december
nobody really hires during a depression no matter
what the quarter is....
Oh dear, oh dear, oh dear!
You should go get a job on Bloomberg!
buy deez nutz
Cursive, stop flagging my comments, and giving my posts one star. At least I put my balls on the table, which is more than I can say for most of you. KEEP BUYING THE DIPS ON STOCKS IF THEY OCCUR!!!!!
"This blog is a one stop center for information and insight pertaining to pension funds and financial markets. It is intended for a wide audience, including plan sponsors, pension fund managers, board of directors, government supervisors, financial reporters, individual investors and most importantly pension plan beneficiaries who want to understand where their contributions are being invested and how their pension plans are being managed."
I ran the above verbage from Leo's site through Google translator (selecting the option Canadian to American) and the result was, "Me long only, eh."
Regards,
There are few things as unintentionally hilarious as making a virtue out of putting one's incompetence up for public consumption.
A little bit of self-awareness goes a long way, Leo.
Leo: I gave you a junk rating just on principle, because you whined. I agree that as long as the Fed keeps monetizing all the crap out there and gives free money to 'banks', stocks will rise. However, I am not a day trader and do not wish to experiment with my hard-earned stash. Please avoid drinking too much holiday egg nog in future. It, apparently, has blurred your thinking.
Hi Leo,
1st of all thanks for your posts. It takes some courage to contribute to ZH. I wish people would be more professional in their comments with that fact in mind that people don't have to be contributors and take abuse.
Nonetheless your optimism in your very last paragraph puzzles me. I just don't see it.
My chats with people and reading of the fed, as well as some of Bernanke's papers indicate, to me, that we will see some sort of interest rate increase toward the end of this year.
Leo;
Here is some friendly advice CHILL THE FUCK OUT!!! The accuracy or inaccuracy of your post subtracts not one bit from you as a person. It just means your human just like everyone else.
Pedant-O-Meter alert reminds you that it is "you're" not "your".
Thank you for your cooperation.
Using bold font, underlining and exclamation points when trying to sell people assets is exactly how we all got in this mess in the first place.
+1
//snickers//
BOO! U.S. employers unexpectedly cut 85,000 jobs in December, government data showed on Friday, cooling optimism on the labor market's recovery. Need to check revisions to previous reports, but I still expect hiring to pick up significantly in the first quarter. In any case, buy any dip in stocks, if it dips at all.
double post :(
It boggles the mind that you're not one of the 85,000. How do you maintain employment with calls like these?
Read more. Post less.
Your prediction of real, robust, bona fide US employment growth in 2010 Q1 is a hookah pipe dream. Where are you based, Canada? Maybe things look, er, Rosier up there - now wait Rosie has it right, and he's from Up There. I'm not sure why you don't see this as reality is staring you in the face on this one. Frankly, any optimism is not only misguided, but suspect of being malicious and intentional at this point. I understand puffery, team spirit, and cheerleading - but there comes a time when it wanders into intentional or reckless misrepresentation.
you just lost all credibility, not that you had much to begin with
Bear Markets are for selling rallys.
The S&P 500 just rallied 50 or 60% and it is has made it back to where it was in June 1998. Adjust for inflation?
Leo...your credibility is slipping away faster than Bill Gross' hair.
Still, I give Leo credit for being a genial guy and for being willing to go out on a limb and make verifiable predictions.
The Drudge Siren is up. How can this be "unexpected" (there's that word again), when payroll processing from ADP was down 80K?
I am not counting on a robust labor market to push interest rates up but an increase in rates due to a push from monetary stimuli into increasingly fiscal stimuli. Providing free meal for financial sector has not worked in terms of giving us a boost, so "they" will try something else.
Another factor could be deterioration of the world trade. Trade barriers could contribute by pushing inflation since imports will become more expensive. (still think there is no other way, especially with the Chinese but a trade war. their mercantilism went way too far, even Mr Krugman has noticed.)
If you look at the Japan, they had insane side action for all markets (including labor) most of the time. And while we repeat their course of actions and mistakes, they had us as a cushion and destination of their exports, we have no one. Hopefully having no one, will eventually be a wake up call.
Still, an excellent analysis Leo, thanks.
Leo,
I hope you are right. However given the Chinese peg to the dollar, the degree of toxic assets on books of banks that will hinder any meaningful small business lending, I have my doubt.
At any rate, please ignore the haters down below... emotions while are unavoidable are not always our friend.
p.s. Do you think the relative illiquidity of alternative assets was a factor that attracted some of the pension funds into those? Some of the benchmark chasing administrators might have liked the idea of keeping those on books so the total fund value wouldn't jump too much. It might have worked as window dressing tool for some time until the lack of liquidity .. proved 'em fools.
I expect huge job gains (even higher than the number posted on Zero Hedge) with substantial upward revisions to the previous reports. I also expect the greenback and crude to rally but gold will get hammered on the news.
Leo;
The huge gains are gonna be 43% MOM in EUC and everybody will figure it out by 9AM.
China set the bottom on gold at $1000 remember. So buy the dips Leo, hammered isn't gonna happen. Gold isn't really connected to the dollar anymore.
ICE might throw some more futures back and forth. But don't call $40 oil at $80+ a rally. It's just G.S. doing what they do.