Wednesday, May 27, 2009

10 Year Yields Moving Up; Why the Bears Cannot be Right

A little short on time this evening. I am in the process of picking a contractor to build a stairway/deck in the back of the house and I am collecting estimates and had to meet with a builder this evening. Why everything has to be so expensive I will never know!

Processed Meat Debate
Economic Disconnect has been having a back and forth with the fun blog Illusion of Prosperity as of late concerning a certain processed meat known as SPAM. I eat salads 3 times a week (Mon-Wed-Fri) and include SPAM as my lunch meat of choice. It seems that there is a basic lack of understanding of the wealth of products offered by the Hormel company in this space, so I thought I would wade in.

First off, there are many SPAM's. There is turkey SPAM, Lite SPAM, Low Sodium SPAM, and SPAM made with Bacon, which really is a masterpiece. You may also be interested to know that SPAM now is available in single serve packs so you do not have to open an entire can! Its true, see them here. SPAM is the perfect guilty addition to my salads as I hate salad dressings but find I need a little substance to the lunch.

The company Hormel Foods (HRL) and I can offer my full endorsement of SPAM. The stock as things stand I like as well and am thinking about taking a small position to protect my SPAM source. Of course, if I like a stock then Tim Knight hates it, and so HRL is a leading short candidate for Mr. Knight. I say buy what you like!
Full Disclosure: Love SPAM and this may influence my judgement on the stock; looking to start a position soon.

Mr. Practical from Minyanville
I really miss the writings of Mr. Practical on the Minyanville site. While he still offers posts from time to time, his writing has dropped off in frequency. Today his insights were spot on as usual:
Those declaring the economy is now recovering do not understand (still) the problem: we are stuck with too much debt. The government’s solutions are to create more debt, as their next to be announced PPIP does. But an economy grows from production, not lending at the wrong price. This is a long term problem; the government has only addressed the short run symptoms.
Let me give you an example. Sixty to 70% of our economic growth depends on consumption. In order to “reflate” an economy (still the wrong way to do it but I will give the bulls the fact that you can drive up nominal asset prices by devaluing a currency), you need people to borrow money and spend it. In 2002 consumer debt as a percentage of disposable income was an all-time high of 90%
Apparently that was still low enough to spur consumers into borrowing money against their houses and spend it. This drove the ratio up to 135%! By the first quarter of 2009 the ratio dropped to about 130%. Just look at what damage that did as consumers tried to get out of some debt. The ratio is still at least 125% (we will know for sure in at the end of June as the numbers are quarterly). There's no way to know for sure, but logic says to reflate from that high level of debt is going to be virtually impossible.

Mr. Practical hits the nail on the head.

Trying to reflate assets prices may have worked if those asset prices were at some lower to medium level. As things stand, homes and many stocks were at all time highs and thus cannot participate in a reflation campaign. At least not with an intact dollar. Simple analysis often is the best, see Occam's Razor.

10 Year Yields Moving Up; Why the Bears Cannot be Right
The big story of the past two days has been the monster move up in yield (lower price) for the 10 year treasury (^TNX). A 20% move up is very substantial, though it is from extreme lows.

The coverage of this move has been very broad, with both bloggers and mainstream media joining in. From the blogroll, Jesse's Cafe had these comments and this chart:

And Mr. Denninger at Market Ticker had this to say and had this chart:

To start let me say that I agree in total with what Jesse and Karl are saying. I think that the move up is a repudiation of US debt and signifies a bond market revolt against money printing. Let me be clear, that is what I think.

And thus, I am most likely totally wrong.

For this kind of reasoning to be the catalyst behind the drop in 10 year prices would amount to something making sense in the markets.

We know by experience that this is unlikely. Perhaps impossible.

The FED's plan is to keep loan rates (especially mortgages) depressed at all time lows to allow further debt expansion and roll over. They have been explicit on this point. We can debate the merits of such a plan ( I hate it) but it is what it is.

So how does this fit in with the current market action? Is this the bond market dislocation many (myself included) have been looking for?

I say it is not.

In last Friday's post I linked to work done over at Housing Doom that showed foreign buyers for debt were on a record tear as of late. We know that for foreign debt holders to grow a brain in regards to the dollar and their overweight treasury holdings would signal a real change in thinking. I cannot imagine anything of the sort is going on. So what is?

My first hint comes from a blip in this Yahoo Finance story from today:
Some traders fear demand for Treasuries could weaken as the government issues massive amounts of debt to fund its financial and economic rescue programs. The Federal Reserve has said it would buy up to $300 billion in Treasury debt this year as part of its efforts to keep borrowing costs low. But investors are now concerned that the central bank isn't buying as much as some had hoped.

Catch that?

Traders are concerned that Ben Bernanke is going Quantitative Easing lite, and not QE on steroids with protein shakes on hand!

Now there is a "market" reason I can understand!

The 10 year is going up in yield (and down in price) because the market wants Bernanke to really get the money printing going. The market wants lower rates. The markets needs lower rates. The market wants an open ended commitment to lower rates. That this process is self destructive and may outright collapse has no meaning to the market, those are rational thoughts.

Any two day span in any instrument is too short a time to make a firm judgement. At this point I would attribute the jump in 10 year yields to market forces putting pressure on the FED to make good on their promise to go "all in" with QE. With green shoots flying up all over the place, the recovery must not be disturbed, less anyone really start to look at the stock markets valuation against expected earnings. I mean, no serious disconnect there, yes?

So what I think is happening is the FED is being gamed into buying as many treasuries as the market deems necessary to ensure low rates. The recent examples of profligate spending by the US seems to have made many think we can indeed spend (borrow) whatever we want and there will be no one to do anything about it. Maybe they are right.

Today, the bears are wrong. Next week they may be right. When they are right, things are going to get all post Lehman-esque in a hurry.

Have a good night.


getyourselfconnected said...

I had to hit "refesh" and this post showed up. So strange. Conspiracy theories anyone??

watchtower said...

"Conspiracy theories anyone??"

How 'bout the GEICO conspiracy theory i.e. I've got a feeling somebody's watching me : )

Stagflationary Mark said...


Note the action between TIP and IEF. Both are treasury bond funds of similar duration. The first has inflation protection. The second doesn't.

The two funds are trying to regroup after a rather brutal deflationary hunting accident. Note that when deflation set in, I was caught in the crossfire. IEF did well. TIP did not.

Now that the threat of deflation is easing somewhat, the roles have reversed. In my opinion, I think that actually explains a lot of the interest rate moves.

I'm personally not going to read too much into the bond market's action yet (other than how it may cause more pain to the housing market). I'm more interested in what happens if and when the two funds get back in sync.

One last thought. My deflationary hunting accident pales in comparison to the brave Spartans of the S&P 500 though. Not many of them made it back alive.

"There will be no glory in your sacrifice. I will erase even the memory of Sparta from the histories! Every piece of Greek parchment shall be burned. Every Greek historian, and every scribe shall have their eyes pulled out, and their tongues cut from their mouths. Why, uttering the very name of Sparta, or Leonidas, will be punishable by death! The world will never know you existed at all!" - Xerxes, from the movie 300

Well, let's give them something to drink! To the cliffs! - King Leonidas

Forget the Standard and Poor's 500. I'm talking the Spartan and Persian's 300! Same results, different era. D'oh!

Anonymous said...


Personaly I don't care for SPAM to eat or in my inbox but I won't hold that against Hormel or you.

As far as the bond market is concerned I don't care for US treasuries either.

“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”
James Carville

Maybe Benny and the O-man are going to see the wisdom of Carvills insight, the bond market put a dagger in Hillary's universal health care on her hubby's watch.