Prices of Treasury coupon securities staged a powerful rally as the soothing and dulcet tones of Ben Bernanke speaking to a New York gathering of economists was a powerful force inducing investors to buy bonds and to buy bonds with longer maturities.
The speech by the Chairman provided intellectual cover for agnostics and disbelievers on the oft stated premise that the funds rate would remain at extraordinarily low levels for an extended period of time.
The Chairman noted that the money markets have stepped back from the brink and avoided the abyss. Capital markets are functioning and spread levels are narrowing.
However, that comfort level has not extended to the bank lending market and the availability of credit for small businesses and consumers has remained constricted even as other credit sectors recover.
The Chairman noted that banks are holding greater levels of cash as a buffer against some future crisis. I do not believe that he made the statement, but I will, that there has to be some concern that there has been a significant shift in the supply of credit that banks will make available to any but the most pristine credit.
To lubricate a self sustaining recovery the central bank must find some way to ensure that credit flows to all sectors. If it does not flow evenly the recovery can only attain a halting and hobbled gait.
Separately, the Chairman noted the fragile state of the CMBS market and the very large chunks of refinancing that would be necessary in the near future.
The situation he described would not be improved by raising short rates even a single basis point.
The Chairman also trod a similarly bond-friendly path on the topic of the labor market. He noted the rapid pace of job destruction and ventured that we would face another jobless recovery.
After reading through that section of his talk I find it hard to believe that the FOMC would raise rates with the unemployment level at 10.2 percent and rising.
I think that there is or will be a political dynamic at work next year, too. It is an election year and in my opinion the Federal Reserve will risk becoming the object of the political debate next year if it were to jack up rates with unemployment at or near current levels.
I think the Federal Reserve would become a bureaucratic pinata for faux populists such as Barney Frank or Maxine Waters who could use it (and the Congressional leadership’s) failure to address the fundamental problem posed by the string of deficits which stretch as far as the eye can see.
I believe that the FOMC would not desire to sit at the center of that conversation.
The yield on the 2 year note has declined 4 basis points to a paltry 0.77 percent. The yield on the 3 year note dropped 5 basis points to 1.29 percent. The yield on the 5 year note declined 7 basis points to 2.18 percent. The yield on the 7 year note tumbled 8 basis points to 2.87 percent. The yield on the 10 year note also dropped 8 basis points and stands at 3.33 percent. The Long Bond’s yield shed 9 basis points and is closing the session at 4.26 percent.
The 10 year/30 year spread narrowed a solitary basis point to 93 basis points.
The 2 year/10 year spread narrowed 4 basis points to 256 basis points.
The 2 year/5 year/30 year spread opened the day at 64 basis points and is closing at 67 basis points.
One final point regarding the Bernanke declamation. He glossed over the dollar and its weakness. He used words like monitor and attentive and spoke of the Fed’s dual mandate of promoting full employment and guarding against inflation. He offered nothing to stem the greenback’s decline.
In his defense, those actions in defense of the currency are the bailiwick of my friend Timothy Geithner, and defense of the greenback does not seem to be at the top of the list of the Obama Administration.