Minneapolis Fed president Narayana Kocherlakota’s recent speech has unleashed a storm of criticism. The offending remark: “To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.”
Monthly Archives: August 2010
WAITING FOR GODOT…OR BERNANKE
The yield on the 10-year Treasury Note was under 2.5% this morning at one point—the lowest since early 2009 and down sharply from this past April’s 4% range. Not surprisingly, inflation expectations are falling too. The market’s outlook for inflation slipped below 1.5% yesterday for the decade ahead, based on the yield spread between the nominal and inflation-indexed 10-year Notes. The last time this inflation forecast was so low was July 2009.
EXISTING HOME SALES TAKE A DIVE
As widely expected, existing home sales fell sharply last month. The expiration of the federal government’s home buyer tax credit was probably a factor. Whatever the reason, the news is unmistakably bearish for the housing market, with repercussions for the broader economy as well. As the National Association of Realtors (NAR) advised in a press release accompanying today’s update: “Sales are at the lowest level since the total existing-home sales series launched in 1999, and single family sales – accounting for the bulk of transactions – are at the lowest level since May of 1995.”
HOW THE OTHER HALF THINKS ABOUT DEFLATION/INFLATION
The case for worrying about deflation, or at least continued disinflation, is fairly compelling, as we noted yesterday. But is deflation fate? No, at least not yet. Much depends on the Federal Reserve’s actions in the weeks ahead. There’s also the question of how the economy fares. Was the recent slowdown in economic momentum temporary–or the sign of something more ominious for the business cycle?
INFLATION EXPECTATIONS STILL FALLING
The summer is winding down and so too is the market’s outlook for inflation. The 10-year forecast for inflation, based on the yield spread between nominal and inflation-indexed Treasuries, dipped under 1.6% last week—the lowest level in about a year.
A SHORT HOLIDAY…
The Capital Spectator will be MIA for a few days. Back on Monday, August 23.
READING ROUNDUP FOR WEDNESDAY: 8.18.2010
►The Great American Bond Bubble
Jeremy Siegel and Jeremy Schwartz/Wall Street Journal
Ten years ago we experienced the biggest bubble in U.S. stock market history—the Internet and technology mania that saw high-flying tech stocks selling at an excess of 100 times earnings. The aftermath was predictable: Most of these highfliers declined 80% or more, and the Nasdaq today sells at less than half the peak it reached a decade ago. A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds.
► China Reduces Holdings of Treasury Debt in June
Martin Crutsinger/AP
China reduced its holdings of U.S. Treasury debt for a second straight month in June while the holdings of Japan and Britain rose…The debt figures are being closely watched at a time when the U.S. government is running up record annual deficits. A drop in foreign demand would lead to higher interest rates in the United States.
►China Hiding Treasury Purchases
Derek Scissors/Heritage Foundation
China’s reported holdings of U.S. Treasury bonds fell sharply again in June and are now almost $100 billion lower than they were in July 2009. The press reports this as meaningful and important. It isn’t. You may have noticed that American interest rates are not soaring; in fact, they’re at historic lows. One reason they’re not soaring is because, contrary to widespread assertions, American interest rates don’t depend on the PRC. The other reason is, over the same period, reported British holdings of U.S. Treasuries rose $265 billion. Why would the UK increase its holdings 273% in 11 months, when the yield on Treasuries is close to zero? The answer: China’s State Administration for Foreign Exchange (SAFE) has an office in London. When purchases are made through that office, they are initially counted as purchases from Britain, not China. SAFE’s goal is to reduce China’s visible dependence on the United States.
THE ARITHMETIC OF DEFLATION: POSSIBLE BUT NOT PROBABLE?
The president of the Minneapolis Fed, Narayana Kocherlakota, explained in a speech yesterday how deflation is possible but unlikely. Near the end of his talk he provided the setup: “I mentioned earlier that inflation has been near 1 percent recently. These data have led some observers to worry about the possibility of a multiyear period of falling prices—that is, persistent deflation. I don’t see this possibility as likely. It would require the FOMC to make the surprising mistake of ignoring the long run in its desire to fix the short run.”
THE LIQUIDITY FACTOR
In a new interview with Morningstar, Roger Ibbotson explains why liquidity (or the lack thereof, to be precise) should be considered a distinct risk factor in equity investing.
MID-AUGUST PERFORMANCE UPDATE FOR THE MAJOR ASSET CLASSES
Economic anxiety is taking a toll on risky assets so far in August. The mid-month summary for the major asset classes boils down to: bonds are up, stocks, REITs and commodities are down. High-yield fixed income has lost ground on a price basis as well this month through August 16, based on representative ETFs listed in the table below.