Tuesday, September 8, 2009

Copper update

Copper is up 135% from its lows of last year. It's up 378% from its lows of 2001, when tight monetary policy and a recession weighed heavily on the prices of virtually all commodity prices. What a difference a few years—and radically different monetary policies—can make! Copper prices are strongly suggesting that not only is the global economy recovering, but monetary policy is accommodative and potentially inflationary.

Interestingly, despite the strong recovery and inflation messages (e.g., gold pushing through the $1000 barrier) emanating from the commodity markets, Treasury yields remain at levels that suggest the outlook for growth and inflation is dismal. This dichotomy is undoubtedly one of the more interesting developments in the market today. More to come on this subject.


logie said...

Good Morning Scott,

Good note this morning on Copper and look forward to your further notes re deflation and inflation debate.

Please check out our Blog research note on an other interesting factor in the deflation and inflation debate. It maps 20 year olds on a 3 year lag minus 63 year olds.

I have checked the method out with Ned Davis and he believes the correlation is not data mining but true. I would be very grateful if you have any comments.

Best Wishes and keep up the good work,



狂猪 said...

According to Council on Foreign Affair, the risky assets on the Fed's balance sheet may be difficult to unwind in a timely fashion.


Scott, what is your take? Is it hard to unwind only because it will cause the Fed to take a loss? Or is CFR worry that in a year or so the securitization market will still not recover?

Scott Grannis said...

I don't think the Fed's purchases of risky assets have caused a significant distortion in the bond market, because I don't think the amount they have purchased is a significant amount relative to the gigantic size of the bond market. I've posted on this subject before, noting the relatively small size of the Fed's MBS position relative to the existing bond market which is orders of magnitude larger.

Therefore I don't agree that it will be hard for the Fed to sell the risky assets (primarily MBS) that it has purchased.

If the Fed announced that it was going to begin to sell those assets, we would probably see an uptick in yields, but that would likely reflect a market that is adjusting its expectations for economic growth upwards, not a market where valuations would be depressed because of Fed asset sales. The bond market is heavily influenced by the Fed and the Fed's own expectations; if the Fed decided to sell assets the bond market would get the message that the outlook had improved. Rising inflation expectations would also be a factor.

MW said...

"the Fed is buying nearly 80% of government-backed mortgages packaged in securities."

From this morning's Journal. The same article suggests 85% of issuance has been from the GSEs, so the Fed has bought 80% of 85% or 68% of all MBS originated in 2009. That strikes me as a lot.

Why do you think the important point is the Fed's buying in relation to the size of the overall market? Why isn't the issue who's buying at the margin? (forgive my ignorance!)

Scott Grannis said...

MW: Very glad you asked that question! "On the margin" is a key concept, as I've said many times. But it isn't relevant to asset markets, especially bonds. The liquid, dollar-denominated bond market is about $21 trillion in size. (14 trillion of investment grade bonds, and 7 trillion of below-investment grade). The value of these bonds is determined primarily by the interest rates on Treasury bonds of corresponding maturity. If Treasury yields rise, the value of all $21 trillion bonds falls (unless of course something else happens to cause the spread between the other bonds and Treasuries to move in an offsetting fashion).

To argue that the Fed's purchase of $700 billion of MBS, while a huge portion of MBS issuance on the margin, has caused a significant distortion in the value of $20 trillion of bonds is a stretch, in my book. How can buying 3% of an existing asset market result in a meaningful change in the total market value of those assets?

In addition, consider this: Conventional wisdom seems to be saying that the Fed has kept interest rates artificially low by buying MBS. But if anything, Fed purchases of bonds (which monetizes debt) should cause the bond market to expect higher inflation in the future (and indeed, inflation expectations have risen significantly this year), and that in turn causes interest rates to rise. And it is a fact that since the Fed began purchasing MBS, both mortgage rates and Treasury yields have risen.

MW said...

Thanks for responding, Scott. I don't think it's valid to compare the MBS buying with the size of the bond market: MBS are not comparable to other (non-callable) bonds. One could of course argue that the relevant comparison is the stock of outstanding MBS (5-6tn at a guess).

Re: conventional wisdom: really? I thought conventional wisdom was that the Fed has (tried to) distort spreads, not rates. For the 15y prior to mid July 07 (when the crisis began), the FRE 30y current coupon - UST 10y spread averaged c. 124bp. From mid July 07 to 2009/03/17, the spread averaged c. 171bp. Since then, it's averaged c. 106bp. Of course, this does not prove anything, but it's worth noting (IMO). It is a fact that since the
Fed began purchasing MBS, spreads have declined.

I will let someone else do the checking on the Agency data!

Scott Grannis said...

MBS spreads are down because all spreads are down. HY spreads have fallen dramatically, without any help from the Fed. MBS spreads are at reasonable levels, just as are swap spreads. I don't see any sign that Fed purchases of MBS have artificially boosted the price of MBS.

MW said...

Appears the Fed's thinking on this is as below:


Scott Grannis said...

Regardless of what they say, I don't believe it. On the contrary, big purchases of bonds are more likely to increase borrowing costs (because they would raise inflation).