Is a Bernanke "gift" coming your way?
Dec. 16, 2008
Yesterday, Bernanke said the Fed could directly intervene in markets to stimulate the economy, saying it could purchase U.S. government bonds to drive down yields or private sector debt to narrow spreads and lower borrowing costs.
More market intervention ... and less free market balancing forces is a bad idea. While we understand what Bernanke is trying to do, there is no free ride in the end.
As 30 year yields are driven down by the Fed, bond prices will be forced into an unsustainable bubble. Fix the immediate problems now and deal with the repercussions later seems to be the only strategy that the Fed and Government can think of.
Bernanke wants to drive down mortgage costs to 4.25% to 4.5%. That would help the housing sector and start to whittle down the huge unsold inventories. Banks aren't exactly playing the same game yet. While 30 year yields have dropped sharply, banks held the 30 year rate at 5.12% for days without budging.
Yes, they did give in on the points, reducing new loans from 2 points to 1 point. And then yesterday, many banks moved the mortgage rates down to 5% with a 1 point charge.
This whole scenario reminds me of an old Corvair I had as a kid back up in the cold New England winters. I would crank the engine and it would sputter for 3 seconds and die. The next try would sputter for 6 seconds and die. Ten tries later, the battery died.
I hope this doesn't turn out to be the scenario on forcing low yields into play ... lower yields and the economy shows noises of trying to crank up, but it fails. The Fed intervenes and buy bonds ... and we crank things up for a little longer. After a while, the battery runs out of its charge as too many Bernanke cranks on the engine leaves him with a dead battery and a bond bubble that can't be sustained.
In the meantime, enjoy the ride. If yields drop to 4.25% with 1 point, or 4.5% with no points, reduce your monthly mortgage payments and take the deal if your home is not paid off. Of course, that presumes that you will have a good enough credit rating and a job. ( I now am hearing of employed friends being told that they will not be laid off ... BUT, they will be given pay cuts.)
Let's now look at the 30 year yield (TYX) chart and see what's going on. A quick look and you can see how 30 year yields have plummeted since the end of November. The Fed still wants the 30 year mortgages to drop a half to three-quarters of a percent, so they have more work to do. Pushing the current drop further will put 30 year bonds in a bubble that will not unwind pleasantly.
Yesterday, the TYX movement had our Accelerator drop while being in negative territory. So, for now, Bernanke has the upper hand as he turns his key and cranks the engine, hopping it will catch and start up the economy.
Is a Bernanke "gift" coming your way? It sure looks like it. In the meantime Bernanke's strategy is also saying: "Let's create a bond bubble ... won't that be fun?"
A Nightmare Before Christmas
Dec 15, 2008
Like many pragmatic economists I have always warned that rapid expansions of government debt would result in inflation and higher interest rates. The explanation was always simple: rising supply of government debt inflates the money supply and weakens the government's ability to service its debt through legitimate means.
But in recent months, government has flooded the market with hundreds of new Treasury obligations and telegraphed its intention to increase the deluge even more. In response, both bond prices and the dollar have risen. This benign reaction has led many to the happy conclusion that the doom and gloomers are wrong and that bailouts and economic "stimuli" can be financed with deficit spending without any adverse consequences on interest rates or consumer prices. Recent action in the foreign exchange markets suggests these hopes will prove illusory. The renewed strength in gold, together with the long overdue rupture of the correlation between the movements of foreign currencies and U.S. equities, is further evidence that recent market dynamics are changing.
When the financial crisis of 2008 kicked into high gear in September, the U.S. dollar began to rally furiously. While America's economic ship was sinking from stem to stern, its currency was becoming the must have asset for public and private investors around the world. The dollar benefitted from the positive flows that resulted from massive global deleveraging. Treasuries got an added boost from a reflexive flight to "safety." As a result, politicians were able to fill out their Christmas wish lists with complete confidence that Santa would deliver. However, as these dollar-positive forces appear to be giving way, the Grinch is about make an unwanted appearance.
Last weekend Barack Obama announced his intention to implement a New Deal-style stimulus and public works program. What he somehow forgot to mention is that the United States is wholly dependent on the willingness of foreign creditors to supply the funds. But a weakening dollar makes continued foreign purchase of U.S. Treasuries a much more difficult decision.
Once the dollar begins to collapse beneath the weight of all this new deficit spending, accumulation of contingency liabilities, and the socialization of our economy, commodity prices and interest rates will head skyward. In addition, once all the going out of business sales at U.S. retailers are over, and excess inventories have been reduced, watch for big price increases at the consumer level as well.
Once the government runs out of foreign and private sector bidders for new treasuries, the Federal Reserve will be the only buyer, and the hyper-inflation cat will be completely out of the bag. Sensing this, the Fed has recently indicated a desire to begin issuing its own bonds. However, since dollars are already recorded as liabilities on the Fed's balance sheet (dollars are in actuality Federal Reserve Notes) the Fed already issues debt. The difference now is that they are proposing to issue interest bearing debt. Perhaps the Fed feels this will make holding its notes more appealing. However, since the interest will be paid in more of its own script, I do not believe this con will work.
In the end, rather than filling our stockings with Christmas goodies, our foreign creditors will likely substitute lumps of coal. Of course given how high coal prices will ultimately rise as a result of all this inflation, in Christmas Future perhaps our stockings will be stuffed with nothing but our own worthless currency. It might not burn as well as coal, but at least we will have plenty of it.
Dec 12, 2008
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.