Here is a follow-up on that scenario from today's paper.
Bond traders get the deflation jitters
As the global economy falters, an old foe is moving out of the shadows: deflation.
On the heels of a financial crisis in which governments printed money and spurred fears of inflation, investors are now moving in growing numbers to protect themselves against the threat of deflation.
Nowhere is that story playing out more clearly than in the bond market.
http://www.theglobeandmail.com/report-on-business/economy/bond-traders-get-the-deflation-jitters/article1623557/
On Tuesday, the bond market sided decisively with the deflationary camp, as U.S. interest rates crashed through a pair of psychologically important milestones. While the trend had yields moving lower, the yields on 10-year U.S Treasury notes dropped below 3 per cent on Tuesday, and those on the U.S. government’s 30-year bond fell below 4 per cent.
These are levels that have never been seen before, except during the worst periods of the 2008-09 market panic. Not to be outdone, yields on two-year bonds fell to new record lows, a paltry 0.59 per cent. Interest rates also dropped on government bonds around the world in countries as varied as Japan, Germany and Canada.
The bond market’s moves signal that a growing number of mainstream investors are lining up behind what was until recently a marginal view of the economy – the deflationist view. That camp has long taken a contrarian view of the global outlook, arguing that the world’s economy is actually on the verge of collapsing and that we're looking at a future where deflation, the dangerous condition of falling consumer price levels, becomes the new normal.
A deflationary scenario poses a threat because falling prices tend to lead to lower production, which spirals into lower wages and demand, which then puts further pressure on prices. It’s a viscous environment that is likely to pull the economy into a renewed recession, some market players believe.
Most economists and investors have been fretting about out-of-control government deficits and the supposed inflation threat all that red ink posed. But now, some are taking a closer look at the deflation argument.
Those who say bond yields are signalling economic weakness and deflation contend that the trend is being driven by de-leveraging, or consumers and businesses paying off their debts. Shifting money to debt repayment undermines the demand for goods, leading to weak economic conditions and intense pressure on companies to cut prices to win business.
Yields go down when bond prices are bid up. Investors have been snapping up the securities, despite the fact that the yields, like those on the U.S. two-year notes, are vanishingly small and close to zero. In a falling price environment however, protecting the money you have is often your best defence.
The immediate cause of Tuesday’s yield plunge was news that the U.S. Conference Board’s index of consumer confidence sagged in June, which placed the idea of a deteriorating economy in the United States starkly in front of investors. But that only added to the ongoing jitters over the health of Europe and worries that China, the world’s big growth engine, is sputtering.
Now the big question for investors is whether yields can fall even lower.
For some of the biggest bond bulls and deflation watchers, yields have much further to go on the downside because they see the economy remaining moribund.
“I think we’re heading for lower yields here,” predicts Gary Shilling, the eponymous head of A. Gary Shilling & Co. Inc., a New-Jersey based economic consulting firm.
Mr. Shilling has been a long-term bull on bonds, first calling on investors to snap them up in the early 1980s, when yields on ultra-safe long term U.S. Treasuries were 14 per cent and he sensed inflation was peaking. Now, he says the U.S. economy is on the cusp of having a deflation rate of 2 to 3 per cent a year, making the securities a good buy even with their current skinny yields.
“I’m still a fan of the long bond, the 30-year. I’ve loved that baby since 1981,” Mr. Shilling said.
He said the 10-year yield could fall as low as 2 per cent and the 30-year yield to 3 per cent.
Under the inverse relationship between bond prices and yields, Mr. Shilling’s bond forecast, even though it is for only a small one-percentage-point drop, would produce juicy returns from interest and capital gains in the long bond of about 25 per cent, or close to 40 per cent if the trade were done through the purchase of zero coupon bonds. “That’s a very, very attractive return for what still is the best piece of paper in the world,” Mr. Shilling says.
The process is likely to drive the economy into renewed recession, some market players believe.
Growth in the U.S. will peter out in the second half of the year “with a high probability of recession in 2011,” says Van Hoisington, president of Hoisington Investment Management Co., an Austin-based money manager who is bullish on bonds.
Mr. Hoisington says Treasury prices can continue going up (and their yields down) even though the U.S. has a huge federal deficit of more than $1-trillion (U.S.). This is happening because the stimulatory effects of the government spending are being overwhelmed by a massive contraction of debt in the rest of the economy.
He said debt is currently being repaid in the U.S. non-federal sector at a rate of about $2-trillion a year, weighing down on the overall economy and increasing the odds of deflation.
Bond traders get the deflation jitters
As the global economy falters, an old foe is moving out of the shadows: deflation.
On the heels of a financial crisis in which governments printed money and spurred fears of inflation, investors are now moving in growing numbers to protect themselves against the threat of deflation.
Nowhere is that story playing out more clearly than in the bond market.
http://www.theglobeandmail.com/report-on-business/economy/bond-traders-get-the-deflation-jitters/article1623557/
On Tuesday, the bond market sided decisively with the deflationary camp, as U.S. interest rates crashed through a pair of psychologically important milestones. While the trend had yields moving lower, the yields on 10-year U.S Treasury notes dropped below 3 per cent on Tuesday, and those on the U.S. government’s 30-year bond fell below 4 per cent.
These are levels that have never been seen before, except during the worst periods of the 2008-09 market panic. Not to be outdone, yields on two-year bonds fell to new record lows, a paltry 0.59 per cent. Interest rates also dropped on government bonds around the world in countries as varied as Japan, Germany and Canada.
The bond market’s moves signal that a growing number of mainstream investors are lining up behind what was until recently a marginal view of the economy – the deflationist view. That camp has long taken a contrarian view of the global outlook, arguing that the world’s economy is actually on the verge of collapsing and that we're looking at a future where deflation, the dangerous condition of falling consumer price levels, becomes the new normal.
A deflationary scenario poses a threat because falling prices tend to lead to lower production, which spirals into lower wages and demand, which then puts further pressure on prices. It’s a viscous environment that is likely to pull the economy into a renewed recession, some market players believe.
Most economists and investors have been fretting about out-of-control government deficits and the supposed inflation threat all that red ink posed. But now, some are taking a closer look at the deflation argument.
Those who say bond yields are signalling economic weakness and deflation contend that the trend is being driven by de-leveraging, or consumers and businesses paying off their debts. Shifting money to debt repayment undermines the demand for goods, leading to weak economic conditions and intense pressure on companies to cut prices to win business.
Yields go down when bond prices are bid up. Investors have been snapping up the securities, despite the fact that the yields, like those on the U.S. two-year notes, are vanishingly small and close to zero. In a falling price environment however, protecting the money you have is often your best defence.
The immediate cause of Tuesday’s yield plunge was news that the U.S. Conference Board’s index of consumer confidence sagged in June, which placed the idea of a deteriorating economy in the United States starkly in front of investors. But that only added to the ongoing jitters over the health of Europe and worries that China, the world’s big growth engine, is sputtering.
Now the big question for investors is whether yields can fall even lower.
For some of the biggest bond bulls and deflation watchers, yields have much further to go on the downside because they see the economy remaining moribund.
“I think we’re heading for lower yields here,” predicts Gary Shilling, the eponymous head of A. Gary Shilling & Co. Inc., a New-Jersey based economic consulting firm.
Mr. Shilling has been a long-term bull on bonds, first calling on investors to snap them up in the early 1980s, when yields on ultra-safe long term U.S. Treasuries were 14 per cent and he sensed inflation was peaking. Now, he says the U.S. economy is on the cusp of having a deflation rate of 2 to 3 per cent a year, making the securities a good buy even with their current skinny yields.
“I’m still a fan of the long bond, the 30-year. I’ve loved that baby since 1981,” Mr. Shilling said.
He said the 10-year yield could fall as low as 2 per cent and the 30-year yield to 3 per cent.
Under the inverse relationship between bond prices and yields, Mr. Shilling’s bond forecast, even though it is for only a small one-percentage-point drop, would produce juicy returns from interest and capital gains in the long bond of about 25 per cent, or close to 40 per cent if the trade were done through the purchase of zero coupon bonds. “That’s a very, very attractive return for what still is the best piece of paper in the world,” Mr. Shilling says.
The process is likely to drive the economy into renewed recession, some market players believe.
Growth in the U.S. will peter out in the second half of the year “with a high probability of recession in 2011,” says Van Hoisington, president of Hoisington Investment Management Co., an Austin-based money manager who is bullish on bonds.
Mr. Hoisington says Treasury prices can continue going up (and their yields down) even though the U.S. has a huge federal deficit of more than $1-trillion (U.S.). This is happening because the stimulatory effects of the government spending are being overwhelmed by a massive contraction of debt in the rest of the economy.
He said debt is currently being repaid in the U.S. non-federal sector at a rate of about $2-trillion a year, weighing down on the overall economy and increasing the odds of deflation.
...You don't understand! I coulda had class. I coulda been a contender. I coulda been somebody, instead of a bum, which is what I am.. Marlon Brando 'On the Waterfront'.
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