The following graph tracks the components of the LEI. It is rather messy. I want you to focus on just the green line at the top of the graph. This measures the yield curve (“YC”). It is consistently the highest numeric component in the index.
To be sure a positive and steep yield curve has historically been a good indicator of an expanding economy. The steeper the slope, the better the prospects. Similarly a negative or flat yield curve is a sign a slowdown is coming. The folks who came up with the LEI index were wise to include the shape of the yield curve in their index. It has been a reliable barometer for many years. Up till now.
We are now two years into ZIRP. There can be no doubt but that this policy will last a minimum of another 12-18 months. We have gone through 1.75 Trillion of QE-1. The QE-2 that Bernanke wants to bring us will probably double that.
We are living through a period where the credit markets are a dirty float. From overnight to thirty-years it is all managed by the Fed. The magnitude of Fed POMO purchases distorts supply and demand. Short rates at zero are a joke. The objective is to devalue savings and force consumption. There has never been a time in history where this level of intervention in the capital markets has been undertaken.
The NBER says the recession ended 15 months ago. Short-term rates would normally be rising at this point in the cycle. But the Fed still has the cost of money set at zero. A more reasonable level for Fed Funds would be 2%. On paper that would eliminate most of the steepness we currently see.
With this in mind it is a mistake to study the entrails of the credit market and draw conclusions about the future.
The LEI is not going to change. The shape of the YC will continue to support the index. The question is, “How much should one discount the impact of YC when evaluating the LEI?”
-If you were on talking head on TV you wouldn’t consider any change. If you were a bullish pundit you would be touting the result as an excuse to buy more.
-On the other hand if you were a guy like me you would just ignore YC altogether. There is a strong case to be made that in 2010 it is just noise, not reliable data.
-Others might just haircut the YC by 50% and see what the index is saying based on that.
This is a graph of the LEI from the Conference Board that tracks the index.
This is my graph of the data from August 2009 on. It assumes (1) YC unchanged, (2) YC cut by 50% and (3) YC is excluded from the index.
That YC is overstating the LEI is not a new observation. But I think it is interesting that the index trajectory has turns flat in the 50% YC adjustment and has gone decidedly negative for the past four months if YC is excluded.
Make what you like of this, but here is a bet. At the all-important next Fed meeting the only
“The LEIs are still pointing up. Do we really need to take this extraordinary step (QE-2) at this time?”
And Bernanke will pull out a slide that looks something like mine and he will say:
“Yeah, but….”
The end result will be a very big "QE-2 Celebration Bash" on November 5th for Bernanke and the other “deciders” at the Fed.
Hat tip: JH
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On August 10, 2010, the Fed said that it was going to use proceeds from mortgage backed securities to buy US Government Debt. The next day the 30:10 yield curve, $TYX:$TNX, flattened as investors saw this as a monetization of debt and a move that would drive down long term interest rates.
ReplyDeleteThe 30:10 US Government Yield Curve, $TYX:$TNX, will continue to flatten. An ongoing flattening sovereign debt yield curve, will act to continually destroy bond wealth of all types, including the longer out maturity corporate bond wealth, BLV.
The bond market place called a defacto interest rate hike on September 1, 2010. And the value of bonds, BND, fell lower.
The Interest Rate 30 Year US Government Bond, ^TYX, is rising faster than the Interest Rate on the 10 Year Note, ^TNX ... this being readily seen in the Yahoo Finance chart of ^TYX and ^TNX for the 3 month period ending September 24, 2010.
Rising market place interest rates make business more expensive, especially for the financially sensitive US small caps, that is the Russell 2000 companies, IWM, who use credit to fund accounts payable, buy inventory and meet payroll.
Rising interest rates are going to cause small businesses across the US to shutter. The US is going to be ground zero for adversity and austerity.
Perhaps one enjoy my ChartList of Stocks and ETFs to sell short for a debt deflationary bear market where I present stock charts and economic graphs for which I have provided a link.
Bruce,
ReplyDeleteAgain you say that Bernanke "wants" QE2.
But I don't see anyone stating that QE2 will do much/any good in real economy..
I do see people saying it could drive the dollar down, and drive treasury yields down.
This seems a dangerous thing to "want" to do.
So, what is the motivation to want to take this step now?
what is the motivation to want to take this step now?
ReplyDelete1. Provide cover for the ECB to also engage in "QE". Specifically buying up junk PIIG bonds from French and German banks that would otherwise go tits up when gravity exerts its irresistible force on PIIG bond prices.
2. Prevent the USD from appreciating against the euro while the ECB is debauching it.
3. Revaluing the renminbi up only makes Chinese imports more expensive. The Chinese are resisting this step anyway. Revaluing the USD down makes all imports more expensive. This is far more efficient in providing cover to domestic manufacturers and stimulating exports.
4. Drive 30 yr fixed mortgage interest rates down to 3%. Maybe lower. One aspect of Keynes' doctrine is being implemented, anyway. The rentiers' portfolios are being euthanized. And a lot of pensioners' pension funds along with them.
1. Probably ECB has to continue to engage in QE. I expect Fed and ECB to cooperate somewhat, but I don't see Fed QE providing real cover for that. Can you elaborate?
ReplyDelete2. Not happening now. Why act now?
3. Maybe, but I am not convinced dollar devaluation will make much real difference, based on how much and what we export, and certainly not immediate positive impact. Import cost goes up immediately, discretionary spending gets hit. In short run this actually seems a negative to me. Maybe you can elaborate again.
4.If 30 year is 3%, what is 10, 2, etc. Can you still sell it at that rate? This part is key to my thinking. We must sell debt, now, and for the next decade, huge amounts of debt, and some of it needs to be bought by someone besides Fed.
I see your points, and those things would all be effects to some degree, but the only reason I would "want" to do QE is that I believe:
a) It will help the real economy grow
b) It will not create borrowing problems for US
Do you think those things are true?
This seems a dangerous thing to "want" to do.
ReplyDeleteNot if you're the US Federal government/US Treasury that needs to sell literally trillions worth of debt in the coming years.
Here's what I don't understand about QE II. Isn't the creation of $1.5 trillion of Federal Reserve Notes simply going to be used to purchase the $1.5 trillion of new US government debt created in the last year? Isn't the Fed running the Red Queen's race here?
ReplyDeleteIt's not new money for the financial markets, it's simply handing out cash (FRN's) for Treasuries--Treasuries which are as good as cash for collateral. . .
John B re your a and b points:
ReplyDeleteQE2 will not help the economy grow. We already have ZIRP for two years and it has done nothing.
Yes it makes borrowing cheaper, but it is killing savers like me. I have cut my expenses by $150k per year. This is the amount of lost interest I suffer from. So for me ZIRP means lower consumption, not higher.
As to B. I am convinced that the QE1, QE2.0 Lite and QE 2 will destroy the debt market in the US. Given that we are a big debtor nation and survive on consumer spending financed with debt I believe that the QE mess will destroy our system. It will take us 20 years to recover from the mistakes that are being made.
Bruce,
ReplyDeleteI agree with you completely. I'm willing to bet Bernanke agrees with you completely as well. So my question remains, why would he be anxious to do it?
Its not a big deal in the scheme of things. It just annoys me when people say things like, "Bernanke wants QE, Bernanke wants to kill the dollar." Probably what he wants to do, is sleep at night, and make little speeches nobody cares about, and enjoy being a big shot.
Personally, I can't wish enough misery on the guy, but I do hope he has the courage to go real slow and be real careful here. Because, again I agree, this QE mess will destroy the global system, but we may not necessarily have to come out on the very bottom of the pile.
Japan is very, very interesting in this context. Thats why I read you.
@But What do I Know?
ReplyDeleteIn a very narrow sense very little of QE will ever make it to be Federal Reserve Notes. Only a very small portion of the money supply exists in the form of notes.
I think the idea of QE is to expand bank deposits. If you own a Treasury security and sell it, you have a check that you take to your bank. Voila! Now the bank has more deposits which means more lending. That's the theory anyway.
Alternately the Fed could just buy securities from the Treasury which means the money flows out the other side as expenditures.
Bullard said something recently. I can't recall exactly but it was something along the lines that participants would correctly view Fed purchases of Treasurys as highly inflationary. That's the plan.
@Bruce:
I would say QE is like a saline drip. It keeps the patient from dying of shock. That's a good thing. The problem is that the elected politicos have decided that since the patient hasn't died yet, that the IV is all they need. The patient has real problems and this goes beyond what the central banks of the world can fix.