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Saturday, May 23, 2009

Green Shoots Or Leafhoppers?

Leafhoppers are a class of insects which are plant vampires. They can do a lot of plant damage. When I look at T-Bill movements so far in May, I see leafhoppers.

The left points are the average yields by each term from 5/1 to 5/6. The right points are the average yields for each term from 5/19 to 5/22.

The 6-mo, 1yr, 2 yr and 3yr yields are all falling, which strongly implies that the market expects a poor economy over that time frame. The 5 to 30 yr yields are rising, probably as a result of worries over US debt.

You can see current and past treasury yields at the Treasury site here, or you can pull them from the Fed's H.15 archive. Treasury yields are, IMO, pretty accurate measures of the current projected real demand for future money. That doesn't mean that they are always correct, but it does mean that they are a very fundamental indicator. ing smaller CDs in banks all over the nation.

If you doubt this, check out the movements of the 3M, 6M, 1Yr & 2Yr from the beginning of 1990 to mid 1991. The 1991 recession is dated by NBER as beginning in July 1990 and ending in March 1991.

At the beginning of 1990, yields were close to flat from 3 months to 5 years. Needless to say, this indicated a problem.

By March of 1990, markets had come to a depressed decision that life sucked, and 3 month yields had dropped comparatively, 6 month and 1 year yields were bickering but hanging together, and a healthy break had developed on the 2 year.

By June of 1990, 3 and 6 month yields had converged, there was a weak step up at 1 year, and the 2 year remained a civic booster.

In December of 1990 a big argument developed, with a week by week slugout fest in which a flat to rising range over the 3, 6 and 12 month bonds was negotiated.

The big change came between February and March of 1991. During later February and early March, a consensus emerged that spreads between the 1 and 2 year should be about 50-60 basis points, and by the end of March, the spread between the 6 month and 1 year (12 month) had suddenly more than doubled, signalling the end of this recession. April opened up with a 10-20-70 pattern of spreads between the 3M, 6M, 1Y & 2Y.

Any time the stock market is "forecasting" something different than T-Bills, it would be wise to dump LEI in favor of the Treasuries. What is important is not just the direction but the relative movements of the various maturities, and if anyone looks at the movements of the near-terms so far this year, it's clear that an unfavorable change in expectations occurred from March to May.

Reassuring (in a grim way) to know that the bond market also thinks that the stock rally is a sucker's rally. There's too many more problems coming down the pike to see a turnaround soon.
In the past, the Treasury Yield curve has been a pretty good forecaster of the Economy. However, It currently argues against your conclusion. Allow me to explain.

A steep yield curve, as we now see, says that the low short rates today will stimulate economic growth, and down the road, rates will be higher to reflect the increased demand for money and Fed tightening.

A Flat Yield curve forecasts a slowing economy as fed tightening is pushing up short rates, thereby reducing the demand for money and causing longer rates to fall in anticipation of slower future growth.

That's the traditional thinking. If foreward rates were always right, I wouldn't live in a big house and have a jet.
CF - I understand your point, but what I was trying to get at with this post is that the recent moves don't look like a quick pickup - they conflict with the idea that the US economy will be turning around this year. In Feb-Mar they said something more optimistic.

A much more interesting question is whether the long term predictor of Treasury yields is working any more.

I suspect it isn't, because I can't see a future in which this amount of debt doesn't suck money away from the real economy and lead to much higher rates for private borrowers. Therefore I think we are in the process of breaking the normal relationships, and I suspect we will deeply regret this in about two years.

I think our private economy has lost the ability to absorb more debt. Thus the policy is to substitute cheap debt for expensive debt. However, the risks are such that the only way to do it is to print money to buy or guarantee debt, which is going to drive a return of high real inflation rates for basic economic imports.

The result will be the equivalent of imposing a highly regressive tax upon about 70% of the population. Getting $200 or $150 off your mortgage every month is fine, but if you are giving it back in fuel, food and clothing, there is no net stimulus.

It is quite possible to produce a depression while inflating the money supply if the increase in the money supply is not effectively pumped through the economy. We've got a closed loop system going that isn't working the cash through the system - it is being cycled back to the creditors and being used to cover credit losses.
Yes, I agree with your point. The most dangerous words in investing are "It's different this time", but I believe it is. Seems to me a fundamental change in supply/demand dynamic has happened. Overwhelming demand for short term paper has driven short rates to zero. Overwhelming supply has pushed prices lower in the long end. Does not seem that will change any time soon. Good news is it will help the banking system quite a lot.
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