Bond Expert: Friday Outlook

Prices of Treasury coupon securities are posting very minimal mixed changes in overnight trading.

The yields on the shorter dated benchmark issues did not budge in the overnight session. The 2 year note yields 0.94 percent and the 3 year note rests comfortably at 1.50 percent. The 5 year note yields 2.36 percent.

There were marginal yield declines in the longer benchmark issues. The yield on the 7 year note slipped a solitary basis point to 3.01 percent. The yield on the 10 year note edged lower by 2 basis points to 3.36 percent and the yield on the Long Bond shed the same 2 basis points to yield 4.16 percent.

The 2 year/10 year spread narrowed 2 basis points to 242.

The 10 year/30 year spread is unchanged at 80 basis points.

The 2 year/5 year/30 year spread which it is my custom to follow is a tad narrower at 38 basis points.

The Wall Street Journal this morning has printed an opinion piece by Federal Reserve Governor Kevin Warsh. He notes that the Federal Reserve has saved the world from financial disaster but that the Fed’s work will not be complete until it unwinds the policy accommodations which the crisis demanded as a response.

There are two particularly noteworthy paragraphs which I reproduce below:

“In this environment, market participants and policy makers alike should steer clear of ironclad policy prescriptions. Nonetheless, I would hazard the view that prudent risk management indicates that policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities.

“Whatever it takes” is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If “whatever it takes” was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Federal Reserve’s institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.”

I have written here many times that I believe that the Federal Reserve will not raise rates as long as the unemployment rate is rising and the labor market is weak. That has been the traditional pattern of the Federal Reserve. I wrote the other day that I had watched some talking heads on CNBC and Bill Gross commented that since World War 2 the FOMC had never raised rates following a recession until the labor market had manifested signs of improvement.

That has been one of the pillars of my macro view. I think the article by Warsh forces me to question that view. He says that the Fed’s job will not be complete until they unwind what they have done and if they do not do so the institution’s credibility will be destroyed. He notes the radical nature of the steps which they took to counter the panic.

He argues also that radical and unfamiliar steps may be taken to unwind the policy accommodations and that they may come more forcefully than expected and they may come sooner than expected.

I think that this is a most important statement by an influential Fed Governor who came from the Street. It is interesting that it appears so near the conclusion of the FOMC meeting. I can not believe that he wrote and published this without the imprimatur of the Chairman and quite a few of his colleagues.

Update: More on the Warsh article

I have heard an interesting theory on the Warsh article.

A portfolio manager with whom i converse, as well as an economist, report to me that there has been a reasonable amount of speculation that Warsh would be leaving the Board in a reasonably short period of time.

The theory is that this is his valedictory address and that his departure will come sooner rather than later with its publication.

If that be the case, it would diminish the policy implications of the content as he would no longer be involved in the deliberations.

I have not previously heard this speculation but it makes some sense in that the opinions he offered are somewhat at odds with the statement released following the FOMC meeting and upon which the ink had not yest dried (I suspect) as he composed his WSJ op ed.

Comments

[PCScipio:]

As usual, there's no crystal ball (i.e., an improving employment picture signalling rising rates).

Sep 25 10:36 AM