May 5, 2005
RETHINKING THE 10,950-DAY MATURITY FOR TREASURIES
Last month, the U.S. Treasury announced that Savings Bonds would no longer pay a variable rate. Now we hear that the defunct 30-year Treasury Bond (which was scratched several years ago when the everyone thought the government would run a budget surplus) may be making a timely (or should we say untimely?) return.
Maybe we're a bit sensitive, but this seems like one more signal to sell bonds. Indeed, the Treasury doesn't make such decisions without a reason. The only question: what's the reason?
In weighing the potential contenders we keep coming back to the subject of inflation. Indeed, why would the government suddenly want to sell you longer-term maturities debt instruments? Or take away the variable-rate option on savings bonds, for that matter? Because it thinks that inflation and interest rates are going down? If you believe that, you're on the short list to buy swampland in Arizona.
Then again, that's the Capital Spectator's take on the credit markets in the here and now, and that's a take that doesn't necessarily reflect the bond market proper. In fact, ours seems to be a view that's in direct contrast with fixed-income traders, to judge by today's action in the benchmark 10-year Treasury Note.
If you thought that today's news that 30-year Treasuries may be making a comeback would frighten the bond market into selling, you thought wrong. The yield on the 10-year slipped a bit today, which is to say that traders were buying the 10-year. With a current yield of roughly 4.15%, a 10-year Treasury, while not exactly priced for perfection, is still very much trading on the expectation that the future holds favorable news on the inflation front. Namely, inflation will remain "contained," to quote the Federal Reserve, and so fixed Treasury payouts will more or less hold their value in coming years.
Further isolating ourselves from the herd, we duly note that junk bond yields slipped a bit today as well, settling at 7.62% on the day, according to the KDP High Yield Daily Index.
No doubt the optimism on the fixed-income horizon was boosted a bit by today's nonfarm productivity release, which revealed that U.S. output per hour in the nonfarm business sector rose by 2.6% in the first quarter, up from 2.1% previously, according to the Labor Department. That's still a long way from the extraordinary 8.7% logged in the third quarter of 2003, although the rise in productivity generally gives aid and comfort to the notion that labor trends won't stoke the fires of inflation.
Or so goes this view of productivity, which is tied to the belief that greater output per worker helps keep a lid on inflation. Why? If Acme Widget can increase output without hiring another employee, that lessens inflationary pressures, at least if you subscribe to the once-dominant school of thought that falling unemployment boosts pricing power.
All which works back to the delight of bond investors because higher productivity at this juncture suggests slower growth in employment, which implies the economy's slowing and so interest rates won't rise as fast, if at all. In fact, unit labor costs inched higher in the first quarter over the fourth quarter, which arguably inspires companies to pull back on hiring. That's just what may be unfolding if one takes today's initial jobless claims report to heart: new fillings for jobless benefits rose last week to their highest in four weeks.
But one long-time pessimist on the U.S. economy and inflation isn't inclined to change his views based on today's numbers. Indeed, Peter Schiff of Euro Pacific Capital remains as bearish as ever when it comes to prospect for paper assets issued by the government. What's more, today's news on 30-year bonds only strengthens his distrust of the Treasury's motives, ulterior or otherwise.
"While it makes perfect sense for the government to borrow for 30 years," Schiff writes today on Euro Pacific's web site, "I would question the intelligence of any one foolish enough to lend," i.e., buy Treasuries.
By that assumption, there are more than a few fools around. No matter, Schiff is sticking to his analysis. "With short term rates now at 3%," he continues,
and the yield on 30 year bonds at about 4.5%, the savings between borrowing short and borrowing long are not nearly as great as when short rates were only 1%. As a result, the Treasury apparently realizes that it no longer makes sense to keep the maturity of its debts so short.
Arguably, the expected renaissance of the 30-year Treasury Bond must pass muster with the foreigners, a group that's been more than accommodating in buyer lesser-maturity instruments in recent years and thereby financing America's trade and fiscal deficits. Whether you agree or disagree with Schiff's pessimism on America's capacity to dig itself out of its red-ink hole, he makes a warning flag about the kindness of foreign investors, or the lack thereof, going forward:
In the end, not only will the federal government be confronted with far bigger budget deficits, but it will also need to finance them at considerably higher interest rates. The Treasury had better hope that Asian savers are willing to step up to the plate, for if they balk, default or hyper-inflation will be the only alternatives. Holders of U.S. Treasuries, or any U.S. dollar-denominated assets, be warned.
Posted by jp at May 5, 2005 6:47 PM
Actually the release from the FOMC meeting states inflation "expectations" remain well contained, which by the reaction of the bond market appears to be true. Since the pundits parse every word from the Fed and Greespan, it is curious that most conclude that this infers soley to price inflation as measurd by the CPI.
Who can deny housing inflation, oil inflation, gasoline inflation? It appears the biggest inflated asset is US bonds.
While working in the Las Vegas casinos during the late 70s, you could not unmistakably see the monetary inflation in all the newly, printed cash in circulation that passed through our hands. Although no longer living in Nevada, I have not experienced, to the extend that I encounter money since plastic rules, this characteristic as of yet in my every day dealings. It appears that all the freshly minted dollars are sitting in foreign central banks or being recycled into Treasuries.
Posted by: vince at May 6, 2005 12:54 AM