The 10-year T-note is riding a hair under 3% tonight and may crash
through that key level. 3% is psychologically important, although charts
suggest that there is no significant buying support until the note falls considerably farther, perhaps
to 3.10% or thereabouts. That's a very long drop, and may imply a return to retail mortgage rates above 5%.
The 30-year T-bond is at 3.68%. Very soon we'll be taking about a new issue, the 7-year note, which is interesting because heavy issuance at that maturity (should it materialize) suggests that the Treasury is planning to finance mortgage-backed securities, possibly the toxic ones everyone keeps talking about.
People are getting very concerned about these high rates. Of course they're a sign of deflation, but it's very important to be correct about the source of the weakness. Everyone has a theory, and not everyone is right.
The 30-year T-bond is at 3.68%. Very soon we'll be taking about a new issue, the 7-year note, which is interesting because heavy issuance at that maturity (should it materialize) suggests that the Treasury is planning to finance mortgage-backed securities, possibly the toxic ones everyone keeps talking about.
People are getting very concerned about these high rates. Of course they're a sign of deflation, but it's very important to be correct about the source of the weakness. Everyone has a theory, and not everyone is right.
I think a very big part of the weakness is simply caused by friction.
We're in the process of steadily replacing huge amounts of private
indebtedness with public indebtedness. This isn't necessarily a bad
thing, since it makes the aggregate deficit position of the US more
favorable as regards both term structure and cost. My evidence for this
is the so-called swap yield curve. You plot the prevailing swap rate
against time instead of the interest rate. Beyond the two-year maturity
(to the left of which you have major participation by sovereigns and
central banks), the swap curve gives a different and perhaps more realistic picture of
industrial credit conditions.
The 30-year swap rate is currently a negative number, and has been for much of the past three months. On the surface this is absurd. Literally, it says that the market considers your average AA-rated bank to be more creditworthy than the US Treasury. You have to explain a persistent anomaly like this somehow. If you accept that swaps are more liquid than Treasury bonds, then the swap rate may be reflecting a more true market price for this credit, and the actual bond rate reflects the fact that the taxpayers are selling too large into a saturated market so they have to get screwed somehow.
There's too much noise, and we're too early into the epoch of trillion-dollar deficits to know much for sure, but this is the question I ultimately want answered: where exactly is the interest rate (and term structure) we need to offer in order to suck in enough capital to fund our consumption and investment? We know it must be higher than it is today, for the truistic reason that we're in a recession. If rates need to go far higher as our borrowing needs grow, then it will be that much more difficult to make investments that will pay off at the higher rates. And consumption will necessarily fall. There's a reason why economic activity falls as real interest rates rise.
Somewhere, there's an equilibrium between much higher public borrowing and a sustainable, corresponding level of economic activity. For three reasons, I expect that long-term equilibrium point to be considerably below what many people expect. (The expectations are being set by policy makers who are implying a return to near normalcy, as long as we pass a huge fiscal stimulus package.) The reasons are: that the spending will be government-directed and therefore more like consumption than investment; deflation; and higher secular capital costs due to deleveraging.
On the plus side of the ledger is the substitution of public for private indebtedness that I mentioned. The near-total end of private credit formation creates the opportunity for public debt to expand into the available demand for assets. But over time this is also a negative, because it means that private credit has no room to come back.
If Tim Geithner, Larry Summers, and the rest of the Obama brain trust really think they can somehow induce private banks to start lending again, they're just not doing the math. The banking crisis is permanent.
The 30-year swap rate is currently a negative number, and has been for much of the past three months. On the surface this is absurd. Literally, it says that the market considers your average AA-rated bank to be more creditworthy than the US Treasury. You have to explain a persistent anomaly like this somehow. If you accept that swaps are more liquid than Treasury bonds, then the swap rate may be reflecting a more true market price for this credit, and the actual bond rate reflects the fact that the taxpayers are selling too large into a saturated market so they have to get screwed somehow.
There's too much noise, and we're too early into the epoch of trillion-dollar deficits to know much for sure, but this is the question I ultimately want answered: where exactly is the interest rate (and term structure) we need to offer in order to suck in enough capital to fund our consumption and investment? We know it must be higher than it is today, for the truistic reason that we're in a recession. If rates need to go far higher as our borrowing needs grow, then it will be that much more difficult to make investments that will pay off at the higher rates. And consumption will necessarily fall. There's a reason why economic activity falls as real interest rates rise.
Somewhere, there's an equilibrium between much higher public borrowing and a sustainable, corresponding level of economic activity. For three reasons, I expect that long-term equilibrium point to be considerably below what many people expect. (The expectations are being set by policy makers who are implying a return to near normalcy, as long as we pass a huge fiscal stimulus package.) The reasons are: that the spending will be government-directed and therefore more like consumption than investment; deflation; and higher secular capital costs due to deleveraging.
On the plus side of the ledger is the substitution of public for private indebtedness that I mentioned. The near-total end of private credit formation creates the opportunity for public debt to expand into the available demand for assets. But over time this is also a negative, because it means that private credit has no room to come back.
If Tim Geithner, Larry Summers, and the rest of the Obama brain trust really think they can somehow induce private banks to start lending again, they're just not doing the math. The banking crisis is permanent.
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