Scotiabank On Treasuries & The Fed: "You Got Some 'Splaining To Do"

Tyler Durden's picture

Via Scotiabank's Guy Haselmann,

There’s Something About Treasuries

Treasuries are still cheap.

The FOMC statement says that “even after employment and inflation are near mandate-consistent levels” the committee may keep “the target federal funds rate below levels” viewed as normal in the longer run.  Whenever I read this, I think of Desi Arnaz screaming, “Lucy! You got some ‘splainin’ to do!”  If the Fed has achieved its mandated goals, then why would it still need to have a less than normal policy rate level? Yellen has not attempted to answer this question, but thinking about the potential reasons unveils some interesting possibilities.

At the moment, the median forecast for the long-run neutral rate (in the Fed’s Central Tendency Forecasts) is 4%.  I wonder if the FOMC is warning that it will be lowered at some point soon.  Such a move would surely cause a swoon in Treasuries.  The 4% level has been the median forecast, because it’s widely believed that ‘normal’ policy rates veer toward nominal GDP (typically near 4%, i.e., 2% real GDP plus 2% inflation).


However, it is possible that a new world order requires a neutral policy rate that is much lower.  If this is true, then Treasuries do not look nearly as expensive as pundits claim.

The combination of high debt, globalization, aging demographics, and technological advancements, should continue to act as structural headwinds for the foreseeable future conspiring to suppress growth and inflation (and thus require low rates).

Lower expected inflation means the burden of repayment is greater in real terms.


Moreover, governments and corporations have taken advantage of the Fed’s ZIRP to significantly expand their total amount of outstanding debt.   Borrowing to consume today means debt repayments and interest charges will reduce future consumption.  (Debt servicing becomes a problem when loans cannot be rolled over, or if payments are hindered by a decline in a debtor’s revenue.)

There have been numerous studies by Fed research departments and academics that try to determine the long-run neutral Fed Funds rate.  Due to such high levels of ZIRP-induced outstanding debt, the price of money and servicing costs of that leverage will be critically important going forward to financial markets as well as being vital for a healthy economy.

Therefore, the extraordinary measures that have been taken, and that will need to be taken, by the Fed are partially a function of trying to prevent an Irving Fisher-type of debt deflation.  He theorized that, when over-indebtedness exists, debtors and/or creditors will ultimately become concerned and trigger a chain of consequences.

Debt Deflation


At the April press conference, Yellen indicated that the FOMC expects the economy to return to full output.  However, she also said that “headwinds from the crisis have taken a long time to dissipate and are likely to continue”.  Which is it?  She talked about other headwinds such as tight credit for many families, tight fiscal policy, and weakness in the global economy.  Is she opening up the possibility that interest rates will have to stay at permanently low levels to have any shot of getting the economy (and keeping the economy) at full output?

Job creation has also been a central focus of the Fed.  The 2008 crisis exacerbated longer-term challenges in labor markets: particularly, globalization, technological change, and international trade.  Failure to invest enough in skill re-training is reflected in elevated long-term unemployment and declining wages.

Falling wages and inflationary expectations worsens economic performance by encouraging consumers and investors to delay spending, and by redistributing income and wealth from higher-spending debtors to lower-spending creditors.  It might be worth re-visiting Larry Summer’s remarks about secular stagnation.

Treasury prices do not care if Q4 is around 4%.  Economic data matters little for the time being.  Prices are being driven more by positions, relative value, and future Fed policy.  Markets know the Fed is ending QE.  What it really wants to know is the terminal Fed Funds level in the new ‘world order’.  In the meantime, stay long.

As mentioned recently by Pimco, “if the neutral policy rate was 2% instead of 4%, then bonds, instead of being artificially priced, would be attractively priced”.  I agree.   Admittedly, there are enormous costs to such financial repression, but a discussion of those costs is a topic for another day.

“And the sand-castle virtues are all swept away in the tidal destruction, the moral melee.”  -Jethro Tull

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fonzannoon's picture

Dear Guy Hasselhoff,

QE was never about jobs. We tried with housing but it's fucked. Whatever.  There is no more point to QE because everyone is plowing into bawnds so why should we drive yields down further with moar QE? We keep telling you there will be growth. But if there ever actually was growth it would be the black swan everyone keeps fearing. Let it go. Buy McDonalds, buy some disgusting mega cap "value" company with a yield slightly higher than the 10yr and shut the fuck up.



The fed

NoDebt's picture

Guy Hasselhoff.... I'm guessing he wrote this article while drunk, eating a cheesburger off the floor of his living room.

fonzannoon's picture

The Germans love Guy Hasselhoff.

NoDebt's picture

And the French love Jerry Lewis.  There's just no accounting for taste.

Pinto Currency's picture

October 23rd 1929 Economist Professor Irving Fischer announced that "Stock prices have reached what looks like a permanently high plateau".


Why is anyone talking about Fischer

Flakmeister's picture

Because he realized the error of his earlier ways and wrote a pretty decent for the time analysis of what happened...

Pinto Currency's picture


Says who?

Paul "we just need another bubble' Krugman?

Has he also seen the error of his ways?

Should we now listen to his latest offering now that Bernake has followed that path?


the lesson ws to abolish the Fed & central money planning but not to Fischer:

Flakmeister's picture

Why don't you read it for yourself...

While it is clear that you don't like the system for pretty defensible reasons, it would appear you are clueless as to how it really works...

Flakmeister's picture

Since you are an expert, could you explain in your own words, in a paragraph or so, why Nixon closed the gold window and ended BW?

I am all ears.....

Pinto Currency's picture

Your first allegation - please support it.

Flakmeister's picture

That is exactly what I am doing....

Pinto Currency's picture


The discussion was about Fischer (who died penniliess when he lost his entire fortune because he did not understand economics) not about Nixon and gold default.

I am all ears.

Flakmeister's picture

If you like, you can write a paragraph on why Fischer was wrong, in your own words mind you...

BTW, Youtube stuff is for lightweights....

Pinto Currency's picture


Good night troll.

p.s. Fischer talking about 'all sorts of cycles' showed that he missed the point entirely in the quoted paper. 

Flakmeister's picture

And he also wrote the first real analysis of what debt-deflation was and how it drove the Depression....

While he clearly was wrong on a number of things, he nailed that aspect of GD...

So, run along you little poseur...

Edit: The only reference one can find to IF dying penniless is from Lew Rockwell, so it would seem that you are a good parrot....

Pinto Currency's picture


He did not nail what drove the Depression.

At the heart of the depression was a mal-structured economy from prolonged loose money compounded also by bad government response.

Please start on the road by reading capital based macro economics paying special attention to the distortion of time preference caused by loose money and how prolonged loose money impacts time preference and cripples the eonomy.

Good night.

Flakmeister's picture

And explain why money was loose....

There was a reason after all...

You know, real world shit and stuff....

Pinto Currency's picture


One more for your reading list.

'Shit' and 'stuff' won't cut it in this important matter.

A final good night.


Flakmeister's picture

Again, bullshit theory from you with little real world value when figuring out what really happened...

So why was money loose in the 20's? 

wallstreetaposteriori's picture

I made a similar argument yesterday and someone (i suspect foneystar) down voted me..... this is your brain.. this is brain on bitcoin..

Flakmeister's picture


The real world is lot different than some people here believe it to be. Context does matter...

Hippocratic Oaf's picture

And here goes the Flak rant.

Where you been all this time?

I guess waiting for an opportunity to insult someone. That's all you're good at.

Flakmeister's picture

It's an insult to ask someone to explain themselves or expound their idea?

News to me...

max2205's picture

I read a lot of words but......WHAT!

CrashisOptimistic's picture

1) Five mos ago rates were at 3% and QE taper began.  All the bullshit about pension funds having to buy never quite explains how they didn't have to buy last year or . . . 5 mos ago.  They didn't suddenly have to buy bonds.  They have always had to buy bonds.

2) Five mos ago oil wasn't north of $100.  The drag on activity wasn't there.  Now it is.  Has been all year.

3) Housing is in freefall because the buy-to-rent-out model has now had enough to time to discover that those who have no jobs can't pay rent, and they damn sure can't pay rent increases, on which all the spreadsheets were based.  "This investment gets better every year as we increase rents" . . . because the economy is going to grow and all those jobs are going to come back.  Didn't happen.  Never will.

4) 0.1%.  Oil hasn't fallen in price.  The Sequester budget passed lasts well past the election, so there can be no fiscal stimulus.  QE is tapering, ie, monetary stimulus is being withdrawn.  Why is that 0.1% going to be 4%?

fonzannoon's picture

Because companies are going to randomly start plowing money into capex and create a shit ton of jobs which will spark immediate demand and validate those newly created jobs and there will be free big titties for everyone. 

that's actually the plan. anytime now.

Dr. Engali's picture

Lol... Overcapacity in every sector imaginable is a bitch.

Flakmeister's picture

And just wait until a $20,000 robot can perform fast-food related tasks...

gatorengineer's picture

To expand on your very valid point Dr. its structural overcapacity.  That overcapacity was supposed to get consumed by the burgeoning middle classes in China and India, that never materialized.


Frankly the only way to create meaningfull demand at this point is an all out war.  Re-miliarization, which is what is being proposed wont do it, thats just another wealth transfer scheme.

NoDebt's picture

If interest rates rise the federal debt quickly becomes unsustainable.  The interest expense on the federal debt as a % of GDP is no bigger today than it was under Reagan.  Only because interest rates are so much lower now than then, depsite the size of the debt in absolute terms and as a % of GDP being radically larger.

Look wherever you want, that's the only reason that really matters.

The elites taking care of themselves at the expense of everyone else.  Is anyone surprised?

Spitzer's picture

These are the same pricks that are feeling the pain of their own inflation... Scotia lol



disabledvet's picture

It's far simpler to me. For some reason everyone has t in their heads "low rates good/high rates bad" so the "policy" simply achieves the low to zero growth "goal" thus "gaining" the low rates.

What in fact policy makers should want is "spread product" (policies that cause the gap between short and long term rates to widen)...something Hank Paulson's "Bazooka" and Bernanke's first QE did in fact do...but then we got too much of a good thing...Bernanke tried to break out of the QE Box Canyon he created...but only succeeded in bursting a bubble in the debt markets.

So now "events" have conspired to create an atmosphere of really low growth including in wages (obviously.)

It could be worse!
On the other hand...I would be very wary here of going out on a limb "financially speaking" because we simply don't know if these really low rates are signaling something really bad or not.

They are not signaling something really good.

NoDebt's picture

"It could be worse!"

It could have BEEN worse.  No doubt Fed policies pulled us out of a more severe downturn.  I have a great deal of difficulty believing that's for the best in the long term, however.

End result if there is no failure/reset... We're all Japan now.

Cognitive Dissonance's picture

"Admittedly, there are enormous costs to such financial repression, but a discussion of those costs is a topic for another day."

The impoverishment of the middle class for starters. But yes, let's put that discussion off to another day when the Fed interest rate boulder has not only rolled all the way down the hill, but has crashed into every single middle class citizen along the way.

<Tisk tisk, such misguided Fed policy. Alas, too late now. No sense crying over spilled middle class blood. It's all blood under the ambulance anyway. Besides, there is an entire Chinese middle class to rape, rob and pillage.>

buzzsaw99's picture

His woman and his best friend --
In bed and having fun.
He's crawling down the corridor
On his hands and knees --
Old Bernanke stole the handle and
The train won't stop going --
No way to slow down.
He hears the silence howling --
Catches angels as they fall.
And the all-time winner
Has got him by the balls.
He picks up Gideon's Bible --
Open at page one --
Bernanke stole the handle and
The train won't stop going --
No way to slow down.

NoDebt's picture

Jethro Tull.  "Locomotive Breath"

Love it.

Wait What's picture

that Wild Turkey headache is going to hurt something fierce when it's all said and done.

Dr. Engali's picture

"If the Fed has achieved its mandated goals, then why would it still need to have a less than normal policy rate level?"

It's called 750 trillion dollars worth of derivatives out there floating in cyberspace. One wrong move and a chain reaction starts that blows up the whole system.

Cognitive Dissonance's picture

But.....but....but net it only amounts to $42.57

What's the big deal?


new game's picture

the trillion dollar balancing act needs some faith rammed up our ass. i'm here to pay you in fig leaves with real figs for the big purchases! nothing changes, except lower rates to keep the locamotive breath breathing for another day. figs for free, chicks with no leaves...

BiPolarFrenchman's picture

The Fed's intervention with QE is our Sulla moment. Sulla was the first dictator of Rome who took control to fix the republic when things were getting bad. After he "fixed" everything, he gave up his job and retired.

Only problem, he set the precedent for men to seize dictatorial power. Then came a coup, Julius Caesar, bloody civil war, and then a Empire system which eventually ate itself.

The next "crisis" will call for even bigger "intervention" on any future downturn.

Cognitive Dissonance's picture

"Then came a coup, Julius Caesar, bloody civil war, and then a Empire system which eventually ate itself."

Yes....but a spoon full of sugar QE makes the medicine interest rates go down. So that's good......right?


<Someone tell me it's right.......please?>

CrashisOptimistic's picture

George Washington had his full army and could have marched to Philadelpha and seized power.  He walked away. 

He was elected first President.  He was then offered the presidency for life.

He turned it down and walked away.

You realize how fucking rare that is?

new game's picture

cog, there is no debate-it is what they are going to do! lower rates following the 30+ year trend.

mathematics say so, and they aren't gonna let the train derail.  at least i hope it don't derail as i don't want a mad max situation going on accross the countryside.

i am somewhat prepared for the worse, but let the spirits of justice prevail if need be...

i can tiddy my house, but i have no control over others, and that seems to be the crux of the problem. no denial here, just facing a grim reality of a future devoid of reality.

Dr. Engali's picture

"The combination of high debt, globalization, aging demographics, and technological advancements, should continue to act as structural headwinds for the foreseeable future conspiring to suppress growth and inflation (and thus require low rates)."

Yeah no shit captain obvious, we are Japan. Growth, for all intents and purposes, is dead. Rates may take a time out here, possibly bounce, but they are going lower.

Grande Tetons's picture

Ever priced out a survivor annuity? Try it at 10,5,2,1 and .05 percent. 

Yep, long body bags. 

Dr. Engali's picture

That's the reason why grannies is investing in junk bonds and bank notes.

Yen Cross's picture

    Hey Schemgly I can smell you? Come play with me.


   Implied rates have an standard deviation of 2%, based on the bottom chart. Top line reading just about 4%, lower reading 1.8%.

      If you're Chinese you hire, Smedly Wax-A_ Sphincter to wipe your HSBS Manufacturing, and O'farcicical services and import #'s every month!

  I'm not China, but the yuan carry looks ugly! ( Hey the yuan fix is only twice a day)

BrosephStiglitz's picture

So QE is to stave off debt-deflation?  Shocker.  Never saw that one coming.

Oh wait. I did.  Deflation hasn't realistically happened in the US since the 1960s.  Who the fuck really believes that you can inflate something to infinity?

Once this debt unwinds we are in for a serious deflationary spiral.  Of course it is very much in vogue to push student-loan debt which cannot be unwound onto the youngest generations now.  In the event of death the debt isn't forgiven it is just transferred to the family.  

This is all a function of the fractional reserve banking system fighting tooth-and-nail for survival in a shrinking global economy- apparently they thought economic growth could and would continue forever.

When the general public finally comes to this realisation it is going to be carnage, because by that time we will be firmly on our way to a neo-feudal state.

If the politicians and central bankers were saying/doing something other than: "Naa Naa Naa Naa, I can't hear you" while jabbing their thumb in their rivals eyes to start proxy wars, we might be able to pull through these tough times as a species.  But no, of course humanity opts for the "Beat each other with sticks" and the broken window fallacy approach.  Now more than ever we should be working together to innovate are way out of this trough.  Hard to do that when the main order of the day is to preserve unnecessary power structures and paper wealth.