Posted by WARREN MOSLER on January 7th, 2010
Well stated and agreed!!!
A few highlights(mine), below:
On Thu, Jan 7, 2010 at 8:57 AM, Lando, Joseph wrote:
In a bit of a surprising philosophical shift, Bill Gross came out yesterday strongly bearish and firmly in the camp of the deficit hawks:
Link . My reaction:
1. Any major tightening of financial conditions due to a spike in rates right now, particularly back-end rates, would just be met with more QE anyway. That much was certainly clear in the Fed Minutes yesterday.
2. Given a battle between the fundamental input of deflation and the technical factor of supply, deflation will win hands down. And though many seem to disagree, the data and the Fed and our own economists still think risks are tilted the other way. This input is making the 100-200bp difference in 10yr yields. Supply issues make the ‘1-2 standard deviations rich/cheap’ (speaking in Sudoku terms) differences of 20-30bps. Which wins?
3. I actually think the technicals are the other way. New supply of private label AAA securities is down 1T MORE than Treasury supply is UP. De-levering is, BY DEFINTION, a reduction in the overall supply of investible term fixed income assets. Here’s a picture from a couple months ago from our Global Markets group.
4. The yield curve is offering more yield enhancement than EITHER vol OR credit spread to the investment community. Not to mention Treasuries are 0% weighted (AND state/local tax-advantaged). Where do you think banks will turn to generate NIM? At some point, they will change their behavior. Look at CURVE vs both VOL and CREDIT regression below. Perhaps most notably…
5. The deficit hawk premise is flawed to begin with. Government buys a bridge, bridgebuilder buys a coat, coatmaker deposits or saves the money…it’s a closed loop in which deficit spending CREATES the precise funding for the deficit itself. All that moves around is DURATION as the need for 10yr savings or 30yr savings is swapped around vs the demand for say, overnight savings (like T-bills or banks reserves). Deficits in the US (unlike a Muni or a EU power or a Corporation) don’t have a problem funding. The ‘problem’ is if the Treasury wants to issue 30yr paper and people only really want 5yr paper. Actually, the market sells off when the sum of all borrowers’ duration is longer than the sum of all the lender’s preferences/liabilities. Not when there is a mismatch in AMOUNT. The AMOUNT is the same! Which takes us to…
7. I also respectfully but strongly disagree with Gross’ interpretation of QE. The Fed has actually been swapping the bank and fixed-income universe OUT of their term treasuries and mortgages and into cash. By definition they have actually been crowding OUT overall NIM in the universe. And generating revenue for the Treasury. It’s actually an investor tax not a bailout. When they step away, those (and by parity zero-sum principles they are there) who were swapped out of their investments and into cash will swap back into term duration. Asset transfers themselves are zero sum. Additionally, in getting mortgage rates down, the Fed has been TEMPERING the pace of de-levering by ensuring mortgage refi’s can continue. They ‘made happen’ many of the mortgages that they bought. It’s a very self-regulating supply universe. If they slow down, there are just plain fewer mortgages being originated for people to buy, and the pace of overall deleveraging picks back up, and well…it’s not bearish, for sure.
8. Actually I hope 10s go to 4.25 because that just means there will be more to make in the big rally that I think starts in 6 weeks or so when the data turns back from fiscal stimulus withdrawal, and the Treasury’s ‘extension of average maturity’ program – what is TRULY the cause of the steepening of the yield curve – tapers off. For now, am only tactical in the back-end.
But that’s why we all have a market and life, as ever, will remain interesting in fixed income this year.