Thursday, June 11, 2009

The End is Not so Nigh?

Yesterday there was a debacle in the bond market, the Treasury Department's auctioning off of $19 billion of 10-year notes went badly with the yield hitting 4% at one point. It added fuel to Niall Ferguson and John Taylor's arguments that the rise in interest rates signal that investors are signaling the government that they're not eager to lend it money in the face of fiscal irresponsibility (and do not simply signal optimism about economic growth).

There was much anticipation to see what would happen when Treasury issued $11 billion in 30-year notes today. Jansen predicted more gloom. However, the auction went relatively well. The yield declined (price rose) from overnight levels and 50% of the issue was reportedly bought by foreign central banks. This is huge because some economists have been making noise about foreign governments shying away from longer-term U.S. securities. If they're still buying, that is a huge vote of confidence in the U.S.

Jansen also reports that corporate bonds are in high demand today. So, it appears that today was not the beginning of the end of the world. Perhaps the steepening of the yield curve really does signal optimism about economic growth and not simply fears about monetary and fiscal policies.

Financial economist Scott Grannis argues that the rising yields are a good thing and supports the claim made by Martin Wolf and others that borrowing costs aren't really rising and that mortgage rates are still low by fairly recent measures. The key thing now is reading what the TIPS tells us about expected inflation. So long as expectations don't rise above the 2-3% range, things look good.

Matt McKee retweeted this USA Today article where they unveil a new forecasting index created by IHS Global Insight. 7 of their 11 leading indicators are positive (hard to tell from their charts). Basically, the indication is that we might have hit bottom and are now rebounding.

Nouriel Roubini cautions that these "green shoots" might be "yellow weeds" (HT: David Beckworth). Time will tell.

What do I think? Well, the data say that we've likely already hit bottom. But, it doesn't mean that the recovery will be as steep as we'd like. Many economists, including Ben Bernanke, are predicting below-average growth for at least a couple years. The unemployment rate will continue to rise through 2010 and will take years to get back to 5%. We've still not completely fixed the problems in the financial market that gave rise to the recession and housing prices have not hit bottom in several cities. Some areas (Nevada, Michigan, California) will be struggling economically for a while. Other countries are in worse shape than we are, so global recovery will take a long time.

The Fed's unwinding of their inflated balance sheet could pose some potential problems, they'll be charting new territory there. The fear recently has been that inflation was a problem so the Fed was going to have to tighten policy sooner than anticipated, potentially dampening economic recovery. Some of those fears can be quelled if today's bond market results really do indicate positive feelings toward strong recovery.

One big question: Do we return to the status quo as a nation of non-savers borrowing from other countries to fuel our consumption? Do China, Russia, and everyone else return to the same dance as before? Those questions have yet to be answered. If the answer is "no" then our economy will fundamentally change.

Medicare's potential insolvency after 2017 and the debt-to-GDP projected thereafter is still a huge problem. So, while growth may be positive the next couple years it is a little like saying it will be mostly sunny before the big tornado hits.

1 comment:

JDTapp said...

Note: Wall Street Journal article yesterday said that 2/3 of economists surveyed subscribe to the "optimism" reason for rising interest rates while 1/3 stuck with the fears over repercussions of monetary & fiscal policy. Either way, bond market had another good Friday.