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The Phantom Bond Market Vigilantes

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July 07, 2011 – Comments (5)

Excellent piece. Absolutely right on.

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The Phantom Bond Market Vigilantes
from naked capitalism by Edward Harrison

http://www.nakedcapitalism.com/2011/07/the-phantom-bond-market-vigilantes.html

    Assuming current fiscal policies remain in force, our economic model suggests that interest rates will rise considerably over the next decade, with the yield on the 10-year Treasury note reaching nearly 9% by 2021.

    – Private interest rates will rise as federal borrowing competes for saving that might otherwise finance private investment.

    – In addition, yields could rise if there is growing risk associated with current fiscal policy. If such risk is systemic, it raises yields generally. If it reflects a growing probability of sovereign default, it raises Treasury yields relative to private yields.

    – Rising rates would be a precursor to something worse: a full-fledged fiscal crisis with further sharp increases in yields, declines in stock prices, and a plummeting dollar.

    -Macroeconomic Advisers as quoted by James Pethokoukis

Pethokoukis says “this is bad. Really bad.”

My take: this is bogus. really bogus.

At a time when the US government is getting free money, borrowing on the short end for zero percent and interest rates are 3%, not 9%, why would anyone believe this stuff? Riddle me this: why aren’t Japanese JGBs yielding 9% instead of 2% all the way out to 30 years when they have debt to GDP of 200%?



I’ll tell you why: this piece from Macroeconomic Advisors is another example of bogus, junk economics driven by ideology. The purpose is to scare people into supporting spending cuts to bring the debt burden down. It’s not like you want the US to be like Japan, so there are plenty of reasons and ways to bring the debt burden down without utilising voodoo economics.

The Federal Reserve controls short-term interest rates through open market operations The yield curve as represented by the term structure of interest rates reflects mainstream market place expectations of future short-term interest rates. We will need to see some serious inflation to get the Fed to start hiking rates enough to justify a 9% yield. More likely, the Fed will remain on easy street for “an extended period”.

If the Fed is destined to keep rates below three percent for the next five years, why would you sell a 3% bond at a yield of 9%. That’s a price that is a massive loss when all you need to do is hold to maturity. It makes no sense at all. That’s why JGBs yield 2% out to 30 years despite a debt to GDP twice that of the US.

But, of course, people worry that the federal government won’t be able to sell its bonds. The Fed just showed us with quantitative easing that they can and will be the buyer of last choice. So unless the Fed is about to allow interest rates to spike and kill the economy, I don’t see how you get to 9%.

Fear mongers want you to be scared to death that interest rates will skyrocket. As I have said many times in the past, long Treasury rates reflect inflation and interest rate expectations. Full stop. The default risk isn’t there since government creates the currency in which the debt is denominated.

It’s only when government acts like it would default for political reasons that you might get a default premium, creating a non-existent problem for ideological purposes. And even then that doesn’t get you to 9%. Ignore the fear mongering and stick to cogent, objective analysis and you’ll be fine.

As for the economy, the scare tactics of bond market vigilantes seem to be working.

5 Comments – Post Your Own

#1) On July 07, 2011 at 2:40 PM, binve (< 20) wrote:

This is worth bolding:

It’s only when government acts like it would default for political reasons that you might get a default premium, creating a non-existent problem for ideological purposes. And even then that doesn’t get you to 9%. Ignore the fear mongering and stick to cogent, objective analysis and you’ll be fine.

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#2) On July 07, 2011 at 7:54 PM, rofgile (99.33) wrote:

Good repost. Naked Capitalism is one of the few idea sources I follow each day.

 -Rof 

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#3) On July 08, 2011 at 12:58 PM, binve (< 20) wrote:

Thanks Rof!

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#4) On July 11, 2011 at 11:04 AM, thanatos2 (< 20) wrote:

binve,

I have been on the buy-side for more than ten years, having read countless economic and analytic reports, and I can say with complete sincerity that you possess a real ability to break down complex ideas into a simple, easy to understand format better than any other published analyst that I can think of.  Your blog is truly outstanding.  I don't know if you publish on any other sites or source materials, but you should if you don't.  Those of us in the industry who debate these ideas back and forth often forget that the general public really doesn't understand then at all, they spend their time focusing on whatever field they work in, so blogs like yours provide a real value.  Keep up the good work.

 

 

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#5) On July 11, 2011 at 11:38 AM, binve (< 20) wrote:

thanatos2,

Wow, thanks! However, I would (respectfully) disagree. I am an avid amateur who studies the market very seriously. But I don't claim to be anything more than that.

I do have another blog (http://marketthoughtsandanalysis.blogspot.com) where I do mostly technical and EW analysis. I post my original macro analysis (and repost other articles like this one that I think are worth highlighting) on this blog. But for a macro analyst who I think understands the big picture far better than I do, I would recommend Cullen Roche (http://pragcap.com/)

Thanks! I really do appreciate the compliment!..

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