Odds and Ends

The five-year TIPS closed at +.14% on Friday. I got a laugh out of that price. The low yield a few months ago was -52 basis points, meaning people paid big time just to own it. To those that did buy the negative yield I say, “Suckers!” The yield on the TIPS has backed up by 66 bp in just a few months. In bond land that is a very big deal. It will wipe out a few years of income.

What’s driving the back up in the bond market? Inflation? Inflationary expectations? If that were the case Bernanke would be pleased. Increasing inflationary expectations is a primary goal of QE. How is he doing on that score? Lousy. The chart on TIPs since QE2 was announced.

Note that that the yield on the 10 year TIPS increased pretty much point for point with the 10 year coupon bond. I read this as the market saying, “inflation expectations are not the problem”. That flies in the face of logic, but never ignore the market and what it's telling you.

If inflationary expectations are not the cause of the very sharp run up in rates, what is? Answer:

The market sees the deflationary forces mixed with the inflationary signs and trades it to a draw. The market is shooting bonds because it is afraid and confused about the distortions that QE is causing.

Thanks a lot for that one Ben.

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A quick look at a two-day chart of the bond futures. Just before the tens and thirty year auction the market (aka the primary dealers) took bond prices down by a chunk. My scribbles on this chart show the timing of the actual results of the auctions. In both cases you see a spike up in bonds post the announcement. Yields returned to the level before the market smack down an hour or so after the auctions were finished.

Does this matter? No, not really. This is how it works. The primary dealers are, in theory, taking a risk when they underwrite the Treasury issuance. So the ¼ to ½ point they rip off the Treasury every month is just a cost of financing. However, the Fed is on the buy side of the bonds next week with more POMO, so how much risk do the PDs really have? After all, a ½ point on $33 billion of new issue bonds comes to $150 million. That’s a pretty good payday for the street.

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The CBO produced a report on Friday that is worth a read. The title is: Economic Impacts of Waiting to Resolve the Long-Term Budget Imbalance. (PDF Link)

The conclusions from the report are not all that surprising. Our economy and society will be screwed if we delay in getting our house in order. What else is new? There was one chart from the report that struck me hard. The CBO did an analysis of which age groups would be most affected by kicking the can down the road policies. So who is going to be hurt the most? Children that will be born after 2015. The kids who are not even close to being a twinkle in one’s eyes are going to pay for what we are doing today.

We should be ashamed of ourselves.

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There was no explosion in Ireland this past week. For the time being it looks like the folks running the EU have a lid on things. I don’t see a run on Spain in the near future. For sure the problems will reappear at some point in the next few months. They have to. They are too big to get buried for long.

If we are to have a period of relative calm in the EU it does not bode so well for the dollar. Speculators have to attack something. If the fun is out of shorting EU bonds then it is likely they will move onto something else. Given that the US bond market has been in the absolute crapper for five weeks there is a good chance those bored specs may just lean on it a bit further. There is no better signpost for the US than the bond market. If it looks like there is a fear factor on the 30-year then it will surely translate into some fear of the buck.

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Lots of concern about Chinese inflation. Up a whopping 5.1% in the most recent read. This might be the big story of the week. China is not going to let food prices run up 10 or 20 percent in a month. There are too many mouths to feed.

New reserve requirements, higher interest rates and most likely price supports are likely to come. There is going to be an economic "J" curve when this happens. When Chinese people see that the government is reacting and some allocations are in the future it will result in hoarding. When you have a billion people hoard a few pounds of rice it makes for shortages. And that is when the problems really start. Just a question for all you stock pros; if the Hang Seng drops 15% as a result of this, what does the S&P do?

Note: I am the shopper in my house. Fresh vegetable prices are up a good 20% in the past month or so. I have also noticed that there is not the diversity of produce I am used to. Some of the stuff on the shelves is well past it’s prime.

We live in a global village. If China is going to see significant food price inflation, so will we.