Thursday, December 11, 2008

Putting in a bottom (2)

The markets continue to heal, albeit slowly. As this chart shows, the VIX has fallen significantly from the highs that coincided with equity market lows. Swap spreads have been working their way lower from their highs of early October. 2-year Agency spreads have fallen by half from their Nov. 20th high. The dollar is looking very toppy here, having fallen today back to levels not seen since Oct. 21st.

Lower volatility, lower spreads, a weaker dollar and stronger gold all suggest that the Fed's injections of liquidity and Treasury's interventions have made a difference; market confidence is returning, and dollars are becoming less scarce and more abundant. The equity market appears reluctant to buy into this story of improving fundamentals however, perhaps because the resolution of the Detroit crisis is still up in the air, and the news continues to highlight economic weakness all over the globe. Plus, T-bill yields remain at zero, so we know the market remains terrified of the unknown dangers that might show up around the next corner.

Nevertheless, tension builds—between improving fundamentals on the one hand, and market pricing that discounts just about the worst scenario anyone could imagine on the other. My enduring belief in the ability of the U.S. economy to surprise its skeptics remains firm, though, so I think we'll see a positive resolution to this before too long.


jpnmitchell said...


I saw this article, , and was hoping you would comment on it.

What are the implications (long-, medium-, and short-term) of treasury bills trading at, or even below, 0% return?
The article also mentions a "bubble," a term that now makes most shiver in light of our current economy. How would that work in relation to T-notes, and why?

Thanks for your feedback!

Scott Grannis said...

First, I would point you to two earlier posts which already addressed this: "T-bill yields are zero". The short answer is that this means the market is 1) extremely risk averse, and 2) very convinced that we face significant deflation in the future.

The bubble in Treasuries and T-bills refers to the fact that yields are extremely low (and bond prices extremely high) by historical standards, and they simply can't fall (rise) much further, whereas the potential for yields to rise (and the corresponding risk to bond holders of falling bond prices if they do) is enormous. For yields to stay at these levels, the economy has to literally collapse and remain extremely weak for many years.