November 4, 2005
With less than three months to retirement, America’s monetary demigod yesterday warned that deficits do matter after all. Alan Greenspan scolded that the red ink on the government's budget ledger is a ticking time bomb. "Unless the situation is reversed, at some point, these budget trends will cause serious economic disruptions," the Fed chief said yesterday in Congressional testimony, according to AP via BusinessWeek. He want on to remark, "I find it utterly inconceivable, frankly" that ongoing budget deficits in the long run "will not have a significant impact on long-term interest rates."
It's anyone's guess whether the budget deficit will persist, or if the red ink will push up yields higher than they otherwise would be. History is a bit mushy in that regard, with deficits sometime accompanying rising yields and sometimes not. The bond market, however, seemed in no mood to take any chances yesterday, with the yield on the benchmark 10-year Treasury Note ascending to a 16-month high on an intraday basis when it reached 4.649% at before pulling back a bit to close at 4.644%.
The allure of higher long rates in the U.S. didn't go unnoticed elsewhere around the world, including among that species of speculator who toils in the land of forex. The U.S. Dollar Index shrugged off its recent lethargy yesterday to close near its recent highs set back in the summer. Suddenly, the notion of a dollar rally is alive and kicking. If and when long rates in the U.S. move higher still, the dollar will almost certainly post further gains at the expense of the euro, yen and other currencies. If so, the rally will be no small triumph for a currency whose economy is the target of reprimands from the nation's top central banker.
Investors the world over are many things, but stupid isn't one of them. When faced with the choice of higher yields in government bonds vs. lower yields in comparable securities even a half-asleep investor will pick the former. As such, a 10-year Treasury that offers a 118-basis-point yield premium over its German equivalent, for instance, according to Bloomberg, is too inviting to ignore. The same is true, and then some, for the Treasury's 300-plus-basis-point edge over a 10-year Japanese government bond at the moment.
Back in the U.S., the newly emboldened rise of long yields is in serious of danger of being no fluke. Rather, one could argue that the fixed-income set is simply looking at the data that puts a current yield into proper perspective. That includes an inflation rate (measured by the latest consumer prices report) that shows prices advancing at 4.7% annual rate through September. That's still a bit higher than the 10-year's yield. The argument that the core inflation rate (less food and energy) is significantly lower doesn't seem to hold much sway at the moment.
The debate over whether the core vs. headline inflation rate was always destined to be settled by the market. Is the market now dispensing a verdict?
A definitive answer is still forthcoming, and that of course will be determined by what economic data drips out. On that note, there's a mixed message in today's release of October's employment report. On the one hand, job growth was less than expected, although hourly earnings growth surprised many economists with a relatively high 0.5% advance last month.
Like the choice between the lower core and headline rates of inflation, there are two ways to read today's employment report. Indeed, there is any number of trends these days to fit every lifestyle and bias. Absolute truths are a slippery concept in the dismal science, but perspective as defined by the crowd is often everything, and perspective looks set for a retread in the coming weeks and months. Even Mr. Greenspan seems compelled to speak bluntly these days, no doubt because his tenure is nearly up. But clear speaking is intoxicating, if sometimes awkward. Perhaps the fixed-income will take the hint in the pricing of risk. Stranger things have happened.
Posted by jp at November 4, 2005 10:32 AM
Cleveland Feds time new report on the obvious: Oil price increases seem to coincide with every recession since 1971.
Posted by: E at November 6, 2005 9:37 PM
Higher rates mean higher risk. If else we would not need rating agencies who have been sitting on their hands in the case of the US far too long.
Show me another debtor whose oustanding debt has ballooned that much without being downgraded.
US rating 1980 (zero foreign debt): AAA.
2005 ($8 trillion public debt, most of it picked up by foreigners): AAA.
This does not work out properly for me.
Posted by: The Prudent Investor at November 5, 2005 10:27 AM
...I think most of us who come here believe that everything can come undone; the chatter seems to me to be about how long to hang out in prospects waiting for the "inevitable". Certainly much is new in the world, which creates great challenges and therefore opportunities. I have never meant ill will in any of my postings here; perhaps it's time to return to observer status.....
Posted by: lotek at November 4, 2005 10:43 PM