Odd goings on
Oct. 26th, 2010 02:08 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksUnusual occurrences in the land of finance are always fun and usually indicate odd things are afoot. Inverted yield curves, when people apparently irrationally are prepred to accept a lower interest rate for tieing up their money for 10 years than they are for tieing it up for two years, are one such an occurrence that we have seen a few times in the past decade
But I don't recall anyone in the recent past accepting a negative yield on Treasury Bonds. So much for Government Bonds losing their triple A status! Yesterday we had the position of investors being prepared to accept less on a US Bond than they would on Gold.
It's all the fault of the Federal Reserve, of course. Not only are the markets convinced that the Fed will go ahead with QE2 at a hell of a rate, but they seem at least half-convinced that the Fed will "succeed" rather more effectively than it hopes. That, in turn, will raise inflation. And it was Treasury Inflation Protected Securities (TIPS) that benefited yesterday. Investors accepted a yield of minus 0.55%, with the quid pro quo that they are compensated if inflation rises.
TIPS were one of my better investments a couple of years ago (an investment made solely because my Schwab Money Market account yield dropped to 0.001% or thereabouts). They've risen by about 25% since, as well as paying something like 2% a year in interest (that's the bit that has moved to minus 0.55% at current prices and terms). Even that rise in price, given the long-dated maturity, expects inflation to average less than 3% annually over the next 15 years.
The paradox here is that bonds, non-index-linked bonds, are still expensive. It makes no sense for investors to be diving into bonds if they think that inflation is going to go through the roof.
The explanation(s) are rather prosaic. One is that the bond investors might be buying non-index bonds on trend and index-linked bonds on fundamentals. They assume that they will be able to get out of the non-index-linked bonds before the shit hits the fan.
The other is that the TIPS market is much much smaller than the ordinary Treasuries market. So if you "hedge" just 10% of your non-index-linked investment into TIPS, you have a much bigger impact on the yield available on TIPS than you have on the yield for non-index-linked bonds.
So, it's a classic example of a situation that cannot hold true for the long term, and a case of the short term being longer than you think.
With the current, equally unsustainable for the long term, situation of 0.5% base rates and negative real interest rates for savers of about 3.5% and real interest rates for borrowers varying from minus 1.5% to plus 3.5%, the impact of QE in the UK and the US looks to be one of consumer debt reduction. And, where the consumer doesn't have any debt, of putting money into equities. Meanwhile, bond prices are supported by government purchases, and commodities are supported by other "floating money".
All this is ok, until the music stops and the QE can go no further. That seems to be a recipe for the "shit economy, rising prices" scenario, although much depends on pricing power on the demand and the supply side.
If it wasn't going to cause so much misery in the economy as a whole (excepting civil servants taking voluntary redundancy, of course) it would be quite fun.
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But I don't recall anyone in the recent past accepting a negative yield on Treasury Bonds. So much for Government Bonds losing their triple A status! Yesterday we had the position of investors being prepared to accept less on a US Bond than they would on Gold.
It's all the fault of the Federal Reserve, of course. Not only are the markets convinced that the Fed will go ahead with QE2 at a hell of a rate, but they seem at least half-convinced that the Fed will "succeed" rather more effectively than it hopes. That, in turn, will raise inflation. And it was Treasury Inflation Protected Securities (TIPS) that benefited yesterday. Investors accepted a yield of minus 0.55%, with the quid pro quo that they are compensated if inflation rises.
TIPS were one of my better investments a couple of years ago (an investment made solely because my Schwab Money Market account yield dropped to 0.001% or thereabouts). They've risen by about 25% since, as well as paying something like 2% a year in interest (that's the bit that has moved to minus 0.55% at current prices and terms). Even that rise in price, given the long-dated maturity, expects inflation to average less than 3% annually over the next 15 years.
The paradox here is that bonds, non-index-linked bonds, are still expensive. It makes no sense for investors to be diving into bonds if they think that inflation is going to go through the roof.
The explanation(s) are rather prosaic. One is that the bond investors might be buying non-index bonds on trend and index-linked bonds on fundamentals. They assume that they will be able to get out of the non-index-linked bonds before the shit hits the fan.
The other is that the TIPS market is much much smaller than the ordinary Treasuries market. So if you "hedge" just 10% of your non-index-linked investment into TIPS, you have a much bigger impact on the yield available on TIPS than you have on the yield for non-index-linked bonds.
So, it's a classic example of a situation that cannot hold true for the long term, and a case of the short term being longer than you think.
With the current, equally unsustainable for the long term, situation of 0.5% base rates and negative real interest rates for savers of about 3.5% and real interest rates for borrowers varying from minus 1.5% to plus 3.5%, the impact of QE in the UK and the US looks to be one of consumer debt reduction. And, where the consumer doesn't have any debt, of putting money into equities. Meanwhile, bond prices are supported by government purchases, and commodities are supported by other "floating money".
All this is ok, until the music stops and the QE can go no further. That seems to be a recipe for the "shit economy, rising prices" scenario, although much depends on pricing power on the demand and the supply side.
If it wasn't going to cause so much misery in the economy as a whole (excepting civil servants taking voluntary redundancy, of course) it would be quite fun.
______________
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Seemples
Date: 2010-10-27 12:09 pm (UTC)I mean, that's obvious, and I apologise for stating the obvious, but one needs a premise to work from.
Classical economic explanations never made much sense to me, however, because this assumes a rationality that is not obviously present. At one ragged end of this you've got the "greater fool" concept, which assumes that you can sell your high-yield short-term bonds to an idiot or to a regulation-trammeled pension fund, whichever comes first, and then effectively swap them for long-term bonds at a profit. At the other ragged end, you've got the factors you identify: in a suitably small market, with suitably large players, the short-term pricing signals do not adequately measure even short-term performance. A jolly good recipe for the arbs, though ...
I liked your (previous) comment on the inelasticity of either demand or supply in re Chinese exports to America, btw. Not only can even an economic illiterate like me instantly understand it, but it only takes ten seconds of reflection on previous knowledge of either the PRC economy or of American consumers to realise that this is absolutely central to the issue.
And of course I haven't seen a whisper of it in the mainstream media. We live in cretinous times.
Just to pursue that latter observation (inelasticity, not chrono-cretinism) a little further, the demand-side is particularly inelastic. Indeed, it would be quite reasonable to argue that it is in China's best interests to pauperise Middle America. My reasoning? Ignore the concept that the Great American Consumer Society is a continuum, and consider it as two groups: one group habitually buys Chinese goods, because they are cheaper, and the other group buys American or European instead, because they are "better quality." (Or for political or moral or religious reasons; it doesn't really matter.)
It doesn't take much imagination to see that, if there is price resistance in the second group, it's because the members of that group can afford to be price resistant. Remove that affordance, and all of a sudden the whole "middle class" switches to buying Chinese goods -- because that's all they can afford to match their lifestyle.
If I'm right on this, then it's a case where "perfect inelasticity" on the demand side actually tips over into uncharted territory, and you've got a sort of elastic expansion into a whole new market. It's already happened in wood furniture, which is not normally touted as a Chinese speciality, but which is dear to the heart of the white picket-fenced. Practically nobody buys furniture from North Carolina any more.
I'm not actually sure what middle-class markets are still available for cannibalisation by Chinese exporters, but I'm pretty sure there are a few substantial ones.