I think this day chart of the 30 year says it all (click to enlarge). After the very stinky NFP numbers the bond made a predictable jump higher. But it wasn’t long after that the air started leaking out and the bond closed on the lows.
Why the stinky price action when we get a big miss on NFP numbers? QE and the talk of stimulus done it. The numbers were so bad that by 9:30 talking heads and pundits concluded that the tax cuts were coming and we might just get a break on Social Security payroll deductions any day. Forget about restraining QE-2; the talk went straight into high gear with the only question:
How big might QE-3 be?
So with that gibberish in mind, bonds headed to the crapper while gold set new highs. The confirm that QE is now driving bonds lower came late in the day when there was a convenient leak of a Sunday TV appearance by Ben B. The only quote leaked was:
We might do more
Stocks liked that talk and ended up, while bonds ratcheted down another notch.
I am pleased that the market has made the connection that more QE and more stimulus is bad for bonds. The market is the only discipline left that may slow the insanity creeping over D.C. When market forces turn on the “New Monetarism” and shut the door on the insanity, the policies will change. Until they get hit hard over the head the Fed will continue to print. We are getting closer by the day. Consider this graph (click to enlarge) of the long bond since QE-2 was announced:
Long rates have backed up by 40 bp in just the past month. The exact opposite reaction that ‘the Bernank’ wants. How deflationary is this increase in interest rates? Mildly so. My guess is that the impact of rising rates exactly offsets the stimulative benefit of keeping short rates at historic lows. Yes, more debt is financed short term than long, but a back up in mortgage rates and the increase in long term fixed rate capital for municipalities and corporations will offset any benefits from ZIRP.
On the question(s):
Will interest rates fall from the current levels of ~3% for ten-year and ~4% for thirty-year to the 2%/3% that Bernanke is trying to engineer? Or will they rise to the 4%/5% that is staring us in the face?
In my opinion we are headed to 4% for the tens and at least 5% on the 30- year. QE is going to produce the exact opposite results of what was intended. Consider this chart (click to enlarge) of where the US stands on debt. Please do not point to Japan as the example of why rates will have to fall in the US. Japan is/was in a much different position than America.
At the heart of Bernanke’s dilemma is the following graph (click to enlarge) on labor force participation. Bernanke wants to juice the economy back to a level where the slack in labor participation rises back up to where it was in 2005. He believes that this is the Fed’s mandate. He wants to turn the clock back. But he can’t. The lines on this chart gapped down as a result of the '08 recession, but the trend toward a lower level has been in place for a decade. Aging demographics, an economy too dependent on consumer consumption and globalization that makes US workers less productive make it inevitable that the US faces a much higher level of un/underemployment. Bernanke is not buying that conclusion. He feels that it is his mission to push against the laws of nature. The market is pushing back. The market will win. Ben will fail.
I am not a fan of Greenspan. I think he got us into the mess we are in. But I do respect his opinion. On the question of whether the US would change its ways he had this to say recently:
The only question is, is it before or after a bond market crisis?
Too bad Bernanke is not listening. A bond market crisis is inevitable as a result.