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I've argued for awhile now that higher yields on Treasury bonds would not pose a threat to growth or to the stock market, since they would be a signal that the economic outlook was improving. This chart proves my point. 10-yr Treasury yields have increased about 80 bps since the end of last November, and real yields on 10-yr TIPS have increased by almost as much (67 bps). The difference between the two yields is the market's expectation for the average rate of consumer price inflation over the next 10 years (the breakeven inflation rate). Inflation expectations have increased only 13 bps in the past four months or so, even as yields have surged, which means that the rise in yields has been driven primarily by increased growth expectations.
This pattern—rising Treasury yields being matched closely by rising TIPS yields—could continue awhile longer. But before too long I would expect Treasury yields to rise much more than TIPS yields—and TIP yields to stop rising and begin falling, even as Treasury yields rise—as the market begins to realize that stronger and stronger growth brings with it more inflation risk. If nothing else, it should make you nervous today that the economic outlook is brightening but the Fed remains stuck on zero. As today's WSJ points out, Fed governors can't agree on whether inflation risks are rising or falling, so in the meantime they are doing nothing to reverse their quantitative easing. That makes it much more likely that they will fall behind the inflation curve as the economy picks up.
As this chart (above) shows, TIPS have gone from being quite expensive at the end of last November (1.1% real yields), to now being fairly valued according to my estimates. I doubt they will rise much above 2%, since at that point they would be getting increasingly attractive at a time when inflation fears would begin setting in; increased demand for TIPS would tend to push their prices up and their real yields down.
Full disclosure: I am long TIPS and TIP as of this writing, and short Treasury yields by virtue of having a 30-yr fixed mortgage.
19 comments:
growth, V, strong, rising, better, amazing, stupendous, wonderful, perfect.
Scott,
Couldn't rising yields signal an end to Big Government spend and pretend policies???
I guess every coin has two sides as the Big Government spends more and more and more as it borrows more and more and more.
The same people who told us housing prices could never go down...
the same people who said CDO^2 deserved a AAA rating...
the central bankers who told us the subprime contagion was well contained and that unemployment (even by U-3 standards) would definitely not exceed 9%...
the same people who said Bear Stearns was an isolated event, and banks are solvent even though they need a bailout...
the same people who said this was 1933 all over again -- deflation would rule
the roost...
Now these same people are claiming that 1933 is over, and we are having a "V" recovery ... and they base this analysis on yoy comparisons with one year ago when these same people said the sky was falling.
Fool us once, shame on you. Fool us twice, shame on us. But fool us dozens and dozens of times?
Being long TIPs makes no sense if you believe in a strong recovery or that "real" yields will be higher... you are long an asset you think will go down in price?
I think its an unfortunate fact that many people will never again return to risk assets. We all have choices and we live with the results, good or bad. I, for one, do not blame those who have chosen not to believe the recovery Scott Grannis is clearly laying out for us to see. I, too, was burned by the recent bear market and burns heal slowly.
Where I struggle is with those whose only interest seems to be to mock any and all optimistic thought regardless of all evidence presented backing up the opinions, offering no evidence of their own, and barely, barely even posting complete sentences.
I have always felt that being right and not making money on it is a little bit like kissing your sister. Now I understand that everyone isn't in a position to invest in a financial security but we're all familiar with betting on a football game. I have a lot of respect for bearish investors who give me an investment idea to go along with their opinion. Even if it's "I've got my cash buried in the back yard". That's fine. I can respect that. I've had the same feelings myself many times. But those who ridicule, mock, and otherwise denigrate others simply because they disagree with their opinions I have NO respect for. They make no contribution, and only seem to care about spewing their unsubstantiated negativity.
This rant is over. I point out I have mentioned no names. I invite all to moniter the coming posts, if any. Where I come from, its the hit dog that howls.
Thanks, John. I might add that, being a contrarian, I feel much better when I get a lot of comments from people who suspect I'm smoking something or drinking too much Kool Aid. If everyone agreed with me, I'd be very worried.
Mr Grannis retired in 2007, one of many people who got to enjoy the "riches" of a bubble market but did not suffer any of the costs of the decisions he and his generation of "managers" made.
Mr Grannis has never explained how to pay for any of his generation's "success" -- he HATES his children and grandchildren, no matter what he may write on his blog.
Young people are getting stuck with the debt needed to create the illusion of a recovery.
If Mr Grannis only shows half the balance sheet -- it is fraud. If he doesn't even mention the unsustainable cost of his "recovery", never mind how those costs will be paid -- its fraud.
Anyone can show profits if they ignore all costs. This was the essence of the bond "boom" just before the cowards ran for retirement door.
I have no respect for people who grab all the benefits for themselves, and sticks others with the expense.
Mr Grannis -- please explain to your grandchildren how they are going to pay for all your so-called "success" and recovery.
Your parents fought World War II and pretty much paid the bill off in about 10yrs.
Your generation has produced nothing but debt, more debt, and more debt. Your "recovery" is based entirely on still more debt. At this stage, you aren't even pretending you will pay your own bills.
You HATE your grandchildren. Your words are irrelevant -- your actions are what count.
You are sticking the next generation with tens of trillions in debt that cannot be paid.
If you presented a balanced view of your "recovery" that included both sides of the balance sheet - I wouldn't have called you on it.
But you are repeating the accounting fraud that led to the 2007 recession ... you are only showing one side of the balance sheet.
why do you HATE your grandchildren so much?
Gary: have you lost your mind? I lost so much money in the bursting of the bubble that I don't want to even think about it. If you think I'm in favor of big fiscal stimulus packages and larding on debt, then you haven't been reading this blog for very long. I have repeatedly said that the economy is recovering in spite of all the bad stuff coming out of Washington.
Scott - you are continuing to claim a false "recovery", based on looking at only one side of the balance sheet.
You specifically refuted my (actually PIMCO's) assertion that this recovery was nothing more than a sugar high.
Well: take away the 0% Fed funds (available only to politically connected banks, not Main Street).
Take away trillions in artificial asset inflation from the Fed and Treasury (via FNMA/FHLMC) buying of financial assets
And take away trillions more in fiscal "stimulus" - which is the source of all the new jobs that supposedly happened.
Take away the cash (really debt) for clunkers. Debt for caulking. Debt for new appliances.
Take all that away, and the recovery simply does not exist.
If you want to keep any of this accounting nonsense, then you also need to account for all the debt that made this accounting scam appear real.
You have lots of posts discussing government jobs and car sales and what-not.
You have no posts explaining how your grandchildren are going to pay for all this -- and no disclosure that there are no plans to pay any of this debt off before your generation leaves this world.
In short, you plan to stick your grandchildren with the bill for this phantom recovery.
Its not a recovery unless you can pay for it.
Levering up and borrowing against tomorrow's earnings (which rightfully belong to tomorrow / your grandchildren) is not a recovery. Its just debt.
200K jobs, even if they were real jobs not government nonsense, is not going to pay for the trillions of debt taken on to "create" those jobs.
Rising Treasury Yields do not point to stronger growth (as you wrongly claimed). They point to the growing realization that the current leadership has no way to pay its bills -- and for that matter has no intention of paying its bills.
Sticking kids with trillions of debt in order to pay for comparatively meager job creation is not a recovery. These jobs will not even service the new debt load, much less pay it back.
You need to include both sides of the balance sheet -- you can't just look at levered assets and call it a recovery.
Borrowing from the future to pay for the present is not a recovery -- its how we got into this mess in the first place.
Lack of leadership of current business leaders -- mislabeling debt as growth -- was a horrible mistake that your grandchildren (and mine) will spend their entire lives paying for.
It is just dishonest for you to call trillions in increased debt as anything other than trillions in debt.
Gary: you must have missed the numerous and frequent posts of mine over the past year or so that equate to a huge rant over what I call faux fiscal stimulus. Also all the posts (usually once a month) that highlight the status of federal budget deficits and the huge growth in government that is taking place.
I firmly believe that growing government is a bad idea, because it makes the economy less efficient. Government spending that is nothing more than transfer payments (which comprise almost 90% of the trillion plus we have borrowed over the past year can't possibly create growth, and that is a subject of talked about endlessly. I don't believe that transfer payments can create growth; you can't grow the economy by taking from Peter and giving to Paul. I believe the spending multiplier is a lot less than 1 and probably closer to zero or a small negative. I believe this economy is growing despite the debt and despite the spending, and I've said this over and over. I first called for a recovery in late 2008, way before anyone knew about Obama's stimulus plans, and way before the spending actually kicked in. The recovery was apparent back then in key financial market indicators, and it has unfolded almost exactly as I have been expecting. Check out my year end predictions in late Dec. '08.
I also don't believe that monetary policy can create growth out of thin air. This is not some crazy notion of mine, but rather it comes straight out of classical and monetary textbooks, and it's called the money illusion. Printing money just creates inflation, it doesn't create growth.
Can we now forget this nonsense about hating my grandkids and loving trillions of debt? I think it's a huge problem, but I also think it's not the end of the world, and the US economy has consistently shown a dynamism that allows it to overcome problems such as these.
It's also the case that I think the market is realizing that there is a good chance the November elections can mark a big change in the direction of policy. Don't underestimate the market or the US economy.
Scott -- taking out a 2nd mortgage and a home equity loan on the house you inherited from your grandparents is not a recovery, and should not be falsely called such.
I too hope there is a huge change in Congress in November -- hopefully your state will get rid of that smiling botox b!tch currently running the House.
But in the interest of honesty: the number one reason Obama got elected is that he wasn't Bush. And Bush got elected mostly because he wasn't Al Gore (and Howard Dean is crazy).
Political gridlock is vastly superior to having extremists (either party) running the country... but that only stops them from making things worse. It doesn't fix anything. Charitably speaking, it controls the bleeding. We will still need a doctor.
Falsely claiming that increased leverage is a recovery is just plain dishonest. A real recovery would need to stand on its own two feet -- without ZIRP, without fiscal spendthrift debt, and without re-levering consumers either.
There are no politicians with a platform to even form a planning committee to one day live within our means -- never mind pay down debt.
Previously existing entitlement programs (pre ObamaCare and pre Medicare D) were never paid for. They were always a ponzi scheme, and they still are. Both political parties want to talk about what new benefits and spending they can layer on top of the ones the country already cannot afford -- and fraudulent talk of economic recovery enables that thinking.
You, Scott Grannis, are an enabler. I won't for a moment claim you are the only enabler. I am part of the younger generation that will get the bill for this cowardly behavior, but I also work in the financial industry so I can't claim innocence either.
Parents and grandparents in the United States need to stop lying to their kids -- and to themselves. We are not having a recovery, we took out a second mortgage on grandma's house. That is all we did.
Debt based growth is not the same as real growth. Anyone who lived through 2007-2009 without learning that has a very serious problem.
Spendthrifts need to admit they have a debt addiction -- and the rest of us need to stop enabling them.
Whatever growth you think is "coming soon" has already been spent. And that "coming soon" growth isn't real, its just more debt.
Since deficit spending is planned for at least 10yrs, its fraud to finance the debt with anything shorter than 10yr rates... borrow short and "lend" long is what destroyed S&Ls, GE, Lehman, Bear, etc, etc, etc
2% economic growth does not pay the 4% interest on the debt, never mind any principal. yes, I know the actual math is more complicated than simple 2% versus 4%, but that is the big picture. We fall behind each and every year.
Tell your grandchildren you plan to make them into wage slaves to pay your debts -- or pay your debts before you leave this world.
Any claims otherwise is fraud.
I think the cheese slid off Gary's cracker.
Scott,
As always, thanks for your insights, passionate defense of free markets, and articulate denunciations of Obamanomics.
Enough well-informed voices like yours and perhaps we can mitigate some of the damage Gary is heaping upon his children.
I think the cheese slid off Gary's cracker.
Scott,
As always, thanks for your insights, passionate defense of free markets, and articulate denunciations of Obamanomics.
Enough well-informed voices like yours and perhaps we can mitigate some of the damage Gary is heaping upon his children.
Paul -- Columbia used to spend money like drunken sailors (some would say it still does). That is why your new baby was available for adoption.
There is no free lunch. Not if you insult another blog commenter. Not if you elect a black president. Not if you take out a 3rd mortgage on your grandmother's house.
Debt growth isn't real and we all know it. Get a clue
Gary,
I'll take your views on ColOmbia seriously when you learn how it's spelled.
Is there a free lunch when you insult the blog host?
Scott,
You are a patient man.
I actually see where Gary is coming from, although I don't think I would shoot the messenger or otherwise blame you for the country's ills.
I also believe we have been living a little 'high on the hog' for the past decade and like Gary says in his own way, one day the chickens are going to come home to roost and its not gonna be pretty. The debt thing is going to have to be addressed very soon. Both parties are responsible for it and its going to be one nasty food fight to fix it. But it has to be done or someday the rest of the world is collectively going to decide to take their wealth somewhere else (although right now its not clear to me precisely where they would go). We are fortunate we have major elections in this country every two years and when the politcos get nutty we have the opportunity to yank 'em back in line. Scott seems to think that will happen this fall. Anyway Gary, I think you are right to be outraged over the debt. But Scott didn't do it. And somehow I don't get the impression he likes that .....person you so elegantly described either.
Gary, thanks for that last rant. I have to let loose myself from time to time.
Paul -- Christopher ColUmbus was spelled with a "U", and the Spanish more or less imposed their will on all of South America.
It was Simon Bolivar who couldn't spell -- pretty sure he "liberated" what is now ColOmbia, Venezeula, Ecuador and Panama from the Spanish -- who spelled ColUmbus with a "U".
But I have to admit I know more about Latin American economies than I do about Latin American spelling.
I am a product of the US education system. We ***SPEND*** 3x as much per student as any other first world country -- most of that on administrative overhead, not spelling lessons.
We have to press "1" for English or "2" for Spanish to get technical support that comes from a Hindi speaker either way.
We used to be the largest creditor in the history of the world. Our steel companies won two world wars simultaneously. As recently as the early 1960s, our "Big Three" auto companies were essentially unrivaled in the world. We had cities with vibrant middle class economies in every state in the land.
But we started spending like drunken sailors.
By the early 1970s, Bretton Woods collapsed and we started on the path to trillions in debt.
The Big Three became synonymous with ugly wood paneled station wagons. Only Ford is still economically viable (maybe). The mighty steel industry is rusting and abandoned.
Elderly patients at a hospital I volunteer at tell me of the vibrant city economies of their youth -- but warn me those same cities are gang infested war zones now.
Its impossible not to notice the decline started when intelligent, educated people like Scott started believing that debt = growth.
As long as the asset side of the balance sheet was growing, it no longer mattered that the liabilities were growing even faster.
Today, the self delusion is so bad that we seem to have convinced ourselves that meager growth under ZIRP and trillions in deficit spending somehow equals a recovery.
This debt will not be paid during the next business cycle. This isn't Keynesian "counter cyclical" spending. This is just debt and more debt and more debt.
Rising Treasury yields point to increased probability of default (either literal or via inflation).
Gary: if you can't understand that I don't believe that deficits produce growth and that I hate big government spending, then please stop posting and wasting our time. Otherwise I will delete.
Scott,
On your post on Obamacare and swap spreads you postulated that a cause of the spread going negative was a result of fear of the costs of the program and deficits going forward. Couldn't that be a cause of the spike in interest rates rather than a return of stronger growth?
Barry: swap spreads are no longer negative, but I still don't understand what is up with that market. I do think though that growth and inflation expectations are the main drivers of higher yields. We've known about the Obama deficits for a year now, but growth is a more recent phenomenon, as are the higher yields. Plus, you can see the bond market react to news of stronger than expected growth.
I would also note that stronger than expected growth brings with it the expectation of lower deficits, since revenues are critically dependent on the health of the economy.
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