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James Brumley
8 Comments
Rampant Inflation Paints Fed Into a Corner
You asked why would long bond holders be worried about short-term inflation if their time horizon is ten years? Great question - you tell me. You were the one who brought it up initially. My question for you is, why are they not worried about it now, but were worried about it previously? Back to square one.....because they aren't worried about inflation now, but were then. Fine, but it raises the other question...why were they worried then and not worried now? What's different?
You also stated... "just because the thousands of actors in the market have determined the current yield of the 10-year bond, it doesn't mean it's the appropriate level."
That was the whole point I made in the initial article....it's not the appropriate level. You said it was because inflation wasn't a worry, and now you're saying it's not. Make up your mind.
Do I think 74 to 80 is modern history? No, I don't, but I'm glad you do. We had the same inlfation scenario then (inflation higher than funds or interest rates). The market returned (SP500) returned about 10% for the entire span. THAT'S WHY I'M WORRIED NOW! LIke I said, if you don't want to worry, be my guest.
I've read 'Wisdom of Crowds'. Good book. I recommend 'The Art of Contrarian Thinking'...an equally good book.
Final thoughts....
*"Why do you think the dollar is suddenly on the rise?"
Um, because it is.
Is that a serious answer? Try, because Europe bought about $15 billion worth of dollars versus the eurs over the last month.
*"Part of it has to do with weakening currencies overseas."
Weakening relative to what?
Again, seriously? Against the dollar.
*"Most of it has to do with the likelihood of rising interest rates (from the Fed) here in the United States." ...If you're talking about currency moves, I'd say you're leaving out half the story. This kind of change happens due to changes in the relationship between interest rates in two (or more) countries. The Euro is just as likely to weaken against the dollar if the EU is expected to cut interest rates - which it is.
Fair enough - that was half the story. We got word today the eurozone is quite fearful of recession now, which could drive their rates lower. That will fuel the problem. The question is, has it already been priced in? (our rates move higher while their's move lower)
* "The Fed saw what happened in July, and the market factored in the likely action the Fed would have to take. The effect was seen (for the dollar) before the Fed even needed to take action." ...If so, then why haven't rates reversed course since the Fed did not act in the way you think the market expected?
Rates never changed direction to reverse from. Give it time though (for movement in either direction)
* "...the dollar is completely linked to domestic interest rates. Like it or not, interest rates here are on the rise one way or another, or will be soon."...Again, half wrong, the relationship between currencies is linked to the relative rates of return available in different countries.
See previous answer.
Other thoughts....
Sorry about 'if you understand then you agree'. I phrased that badly...you can understand and disagree.
When should the NBER call a recession? If they can't do it until it's half over (or more), they shouldn't at all - unless for academic purposes. That's why I don't really care what they say. The only reason I brought it up was because you brought it up - as evidence that we weren't in one yet because they didn't say so.
Also, you wrote this...
"First off, you again seem to be indicating a causal link between the market (and an inverted yield curve) where there is none. Here's the difference - credit markets were not in the same kind of sire straits they are in now.....The more damaged the credit markets, the more difficult borrowing becomes, the less investment occurs, the slower the economy grows... are you following me? If wide spreads are helping to ameliorate problems in the credit market at this time, great - they need it.
I agree - if it helps spur lending, I'm all for it. There is a causal link though....you said it yourself - tighter spreads diminish investment. Ultimately, that hampers corporate growth. The price to pay is inflation....which also hampers corporate growth.
You said go ask lenders if an inverted yield curve would hurt lending, but I don't have to....I agree with you that it would. Now I'll ask you to go ask any corporate management team if inflation is hurting their business....they'll say the same thing.
So once again, the Fed needs to find the balance, because one or the other is going to kill us.
On a side note, the reason it's hard to respect you is just that you're argumentative at the expense of being objective. I'm not always right, and may well be wrong now. My goal is to inspire thought and conversation. Your goal is just to argue.
You're a smart guy (or gal, maybe) with valid points. Thanks for that. But, when you start using arguments that you and I both know are shaky (specifically, the NBER data and the 74/80 'modern history' questions), it just makes me wonder what your agenda is.
You should be writing these articles rather than just picking apart others. (You can do both, I think.) You've only commented though....take a look at your comments - your goal looks destructive rather than productive.
seekingalpha.com/user/...
This is my last post here, as I have to move on to other things.
Rampant Inflation Paints Fed Into a Corner
The November 2001 trough was announced July 17, 2003.
The March 2001 peak was announced November 26, 2001.
The March 1991 trough was announced December 22, 1992.
The July 1990 peak was announced April 25, 1991.
The November 1982 trough was announced July 8, 1983.
The July 1981 peak was announced January 6, 1982.
The July 1980 trough was announced July 8, 1981.
The January 1980 peak was announced June 3, 1980.
Six months to a year late every time. The fact that they haven't said we're in a recession yet means nothing.
Anyway...
One last thing.....you asked for the correlation relationship between long-term (10 year) yields and inflation. I can't show you my math, but I can tell you how to find it and do it for yourself.
Excel has a tool called 'correlation coeffecient', which measures how related or unrelated two data sets are. A 'high' correlation would score in the high 0.90's, while a low correlation would score closer to 0.00.
The correlation cooefficient of the change in 10 year yields and the change in inflation (monthly) is -0.01244....extremely low.
You can find the 10-year yield data here....
finance.yahoo.com/q/hp...
(To do the correlation test yourself, be sure to start them both at the same value - or normalized - and change each one appropriately for each month.)
Or, you could do the easier thing and just look at this chart :)
bigtrends.com/images/0...
BS correctly pointed out the dollar's recent rise should help ease inflation. What he didn't point out was that the dollar is still just slightly above multi-decade lows, and that inflation is still at multi-year highs. The dollar could rise more, and inflation could fall, but we'd still be at almost-unprecedented levels for both. It's a good start, but we need to see about 12 more months of the same before we're healthy again.
On the chart you can also see the correlation between the dollar and the Fed Funds rate.
BS also pointed out that the failure of the bond market to demand higher rates from 10 year bonds meant that they weren't worried about inflation. He may well be right - bond owners may not be worried about inflation. However, what he he failed to point out was that they weren't worried about it in 2006 either, AND THEY WERE WRONG NOT TO HAVE WORRIED ABOUT IT. The 10 year yield didn't even begin to creep higher until after inflation popped above 10 year yields then....right as inflation started to sink - way too late then. (Just because someone does something doesn't mean they're right.)
As for those of you in the 'things aren't that bad' camp....
If you're ok with the fact that inflation is above 10 year yields, and above the Fed Funds rate, for the FIRST TIME EVER IN MODERN HISTORY, well, then we'll have to agree to disagree. I just know when I see things I've never once seen in my lifetime, caution is merited. If you don't think things like that are a problem, then do what you gotta' do.
Rampant Inflation Paints Fed Into a Corner
Of course, you've failed to define 'bad', or establish the various degrees of 'bad'. Until you can do that, I'm unable to compare now to any other recession. You're unable to do the same. Moot.
Yes, things can get worse for the economy and its barometers. They can't get worse for the consumer...even if they get worse for the economy. (Sorry if there was any ambiguity there)
The last half of the 90's, and between 2002 and 2006, spreads were tightening. Yet, the market (stocks) did great then. If you don't believe it, go look at the yield curve chart. Why would narrowing the spread - without inverting the yeild curve - be different this time? As I said, the trick is raising rates enough to temper inflation, without inverting long and short-term yields.
Yes, I said the lending market is on its death bed. Whether you agree or don't is irrelevant for now....if you understand my point, then by default you agree that raising rates isn't going to do any more damage. (If you think the lending market is still breathing, then you disagree with me....and you think rising rates would create more pain.)
With that in mind, I'm back to a previous point....I want to avoid the inverted curve. It has nothing to with lending though....there's nothing that can be done to salvage lending (IMHO). I just don't want the curve to invert for the market's sake. You can't' REALLY' kill anything....something only dies once - like lending.
With all that being said....
Why do you think the dollar is suddenly on the rise? Part of it has to do with weakening currencies overseas. Most of it has to do with the likelihood of rising interest rates (from the Fed) here in the United States. The Fed saw what happened in July, and the market factored in the likely action the Fed would have to take. The effect was seen (for the dollar) before the Fed even needed to take action...adn they might now now. But make no mistake - the dollar is completely linked to domestic interest rates. Like it or not, interest rates here are on the rise one way or another, or will be soon. Which brings me back to the original point....
The Fed needs to raise rates to temper inflation, but not so much that the yeild curve inverts. That's tough - but not impossible - to do.
Rampant Inflation Paints Fed Into a Corner
4) You said....Why would the Fed believe that this current inflation spike is anything more than a run in commodities? Especially now, when commodities prices across the board are already down significantly from recent highs.
I say...all inflation spikes are led by commodity spikes. Even then, inflation has been above 4% for the last three months....July's figure wasn't wildly out of control...just higher than recent levels, which were also significantly high.
Rampant Inflation Paints Fed Into a Corner
Well, you've certainly worked hard to live up to your name. My concern is this....are you trying to highlight BS so much that you'll point out anything that could be argued? Having an opinion is fine. Having a specific bias is dangerous.
If I ever implied or stated this model was iron-clad an inarguable, I apologize. I'm just trying to give investors some perspective they won't have gotten from the media. All of it's up for debate...which is a healthy thing.
I'll try and respond to your points in the same order you voiced them..
1) You said...."Quite a lot, actually, because things are not nearly as bad as you seem to indicate. The economy certainly isn't dead - ailing a bit, perhaps. The lending market certainly isn't dead, but if it were, changing interest rates would have no effect on the economy, would it? The real estate market isn't dead, and by most accounts has some ways to go before recovery begins."
I say...THINGS AREN'T BAD? Seriously? Yeah, they can always get worse. But brother, yes, things are bad. You are correct in that changing rates probably won't heal the lending market. What I don't get is why you're arguing with me....I said the same thing. That's why I said "what have we got to lose"...because changing rates won't matter to lenders. But, slightly higher rates will curb inflation.
You call it 'ailing'; I call it 'bad'. Semantics. It's far from good.
2) You said..."Of course, the fear of an inverted yield curve is clear - the last two inversions did indeed jump-start a bear market."...You really think there's causation here?
I say....actually you make a valid point. I'm not always a fan of economic reasons for the market's performance. So, no, I don't know that the yield curve caused a bear market. I do think it was a symptom of what causes the bear market. Cause or symptom? Doesn't really matter. The CORRELATION is too uncanny to ignore though.
3) You said.....(this is me) "but long-term (10 year) rates thus far have been pretty stagnant at 4%. At the same time, annual inflation is now topping 4% to 5%." Then YOU said....What does this indicate? The market clearly does not believe that inflation is a long-term problem - otherwise the market would demand a higher return on these bonds. Pretty fundamental stuff.
I say....you're reading too much into the absolute levels. The fact that long-term yields and inflation were about the same level is coincidental. I was just suggesting that a Fed Funds rate higher than inflation (whether it was 4% or 14% historically has been healthy). The yield curve inversion could still be a problem whether it happened at 4%, 2%, or 10%.
As for the market not worrying about long-term inflation based on accepting a relatively low yield on long-term bonds, THERE IS NO STATISTICAL CORRELATION BETWEEN INFLATION AND YIELDS, NOR IS THERE A CORRELATION BETWEEN YIELDS AND EXPECTATIONS OF INFLATION. (I can show you my math.) As you asked earlier yourself, you really think there's causation here?
OK, I'm running out of room. I'll continue in another post below.
Note to I.R.S.: How To Make This Rebate Work
My biggest fear is that the rebates will be used to pay off loans and mortgages that would have otherwise been late...the problem you alluded to.
Here's my solution (and I'm not entirely joking)...send the rebate as a gift certificate that expires in sinx months. Stipulate that it can't be 'cashed in', can't be accepted as a bank deposit, and can't be accepted by a credit card company or mortgage company.
A perfect and flawless strategy? Nah - somebody will find a way around the rules. By and large though, the money should indeed be spent on goods and services that may not have been bought otherwise.
If It Looks, Walks and Quacks Like a Recession...
WakeUp, yeah - the unemployment figures may be meaningless and 'tweaked' for optimism. However, that's not new. We just have no feasible way to know just how trumped the historic numbers were as well. That's why I said (though not emphatically enough) the absolute level of unemployment means nothing to me or you. The only thing I have any faith in is the direction of the trend. (e.g. if unemployment rises from 5% to 6%, it's the same effect as rising from 10% to 12%.)
Gordon, I don't know that the GDP is fraudulent, but I do know it's worthless to investors. So, fraudulent or not, I don't even care. As for a BLS investigation, I don't see it happenin'.
Old Style, well said. I still feel a recession will be minimized, as the Fed only seems interested in short-term patches (3 to 12 months). Should the recession last longer? Yes, I think so. A good, long, normal recession would burn off a lot of excess...a much needed does of good medicine. I suspect we'll only get the short-term fix though.
Will Rahal, thanks for the chart. Good stuff.
If It Looks, Walks and Quacks Like a Recession...
Yep, the unemployment analysis is a whole 'nother ball of wax. I didn't touch on it here, but I have observed that there is no 'ideal' unemployment. The only thing that matters (to investors) is the direction of the trend. (e.g. the unemployment rate falling from 18% to 17% is good for stocks, even if still astronomically high by historical measures).
As for the 5% rate now being more of a real burden than say 5% from the 80's, while I never thought about that, I think I agree. Good point. Maybe I'll be able to cross reference unemployment and debt in a future commentary. Thanks for bringing it up.
Hooligan,
I hear that. The more they tinker, the worse it seems to get.