Yield Curve Steepening

[blazespinnaker]

http://quote.bloomberg.com/apps/news?pid=10000006&sid=ajk32K9ivJsQ&refer=home

I wonder, are these bullish economic signals or concern about long term inflationary moves by the fed?

I think it's a combination of both. My pet theory is that we are in a high inflationary environment which has been disguised by globalisation keeping non asset prices down.

The US has expanded the money supply, but then as a response, so did everyone else (maybe why they killed the m3? so other nations couldn't keep in step better?) and this has over stimulated the economy.

Assuming no macroeconomic (hedge funds) or geopolitical shocks, we may find that housing prices do not lower in nominal terms, though wage pressures may increase with baby boomers retiring and general inflation will help return us to a point of affordability.

The question is, assuming for a moment this pet theory is right, what do we know? Gold has already asset inflated, and so has real estate.

One possibility are high growth international equities which will leverage globalisation and not suffer from it and are somewhat protected from wild swings in the commodities market.

Hi growth cheap health, cheap hi tech, cheap education is what I am currently considering for my portfolios. For example, telehealth, generic drugs, open source software, and telelearning.

Those are my current thoughts.

[EJ]

http://quote.bloomberg.com/apps/news?pid=10000006&sid=ajk32K9ivJsQ&refer=home

I wonder, are these bullish economic signals or concern about long term inflationary moves by the fed?

I think it's a combination of both. My pet theory is that we are in a high inflationary environment which has been disguised by globalisation keeping non asset prices down.

The US has expanded the money supply, but then as a response, so did everyone else (maybe why they killed the m3? so other nations couldn't keep in step better?) and this has over stimulated the economy.

Assuming no macroeconomic (hedge funds) or geopolitical shocks, we may find that housing prices do not lower in nominal terms, though wage pressures may increase with baby boomers retiring and general inflation will help return us to a point of affordability.

The question is, assuming for a moment this pet theory is right, what do we know? Gold has already asset inflated, and so has real estate.

One possibility are high growth international equities which will leverage globalisation and not suffer from it and are somewhat protected from wild swings in the commodities market.

Hi growth cheap health, cheap hi tech, cheap education is what I am currently considering for my portfolios. For example, telehealth, generic drugs, open source software, and telelearning.

Those are my current thoughts.



Good thoughts. I agree that precious metals, not only gold, have probably seen their best real (inflation adjusted) appreciation for this cycle, but that doesn't mean they will not see significant nominal appreciation for several years. Unlike real estate, that depends on not only low but declining interst rates in order to grow ahead of inflation, PMs tend to rise inversely to interest rates.

Key: Inflation Inputs and valences: (v downward) (^ upward) (- neutral)

Manufacturing (v) - Downward due cheap imports from low wage rate exporters, enabled by strong dollar and low interest rates, both depend on continued near 80% foreign acquisition of U.S. financial asset issuance

Labor (-) - Was (v) except that labor prices are rising at both the bottom and top income brackets due to tight labor markets at both ends of the range: the U.S. has been drained of highly skilled labor at the top earning quintile and is, in spite of an apparently large influx of immigrant labor, experiencing shortages of unskilled labor

Distribution (v) - Automation and the Internet continues to lower distribution costs

Commodities (^^) - Continued inflationary pressure

The summary inflation component valences that achieved a disinflationary bias is now out of balance due to rising labor costs. Inflationary pressures are continuing to build in labor markets and may produce upward pressures in the coming quarters and move from (-) to (^).

Any event that causes a major shift in dollar demand and U.S. consumption moves Manufacturing to (- neutral) from (v downward) and Commodities from (^^ upward) to strongly upward (^^^ upward).

The valance will go from neutral a year ago, to (^ upward).

[Alfredo Dominguez]

I think it's a combination of both. My pet theory is that we are in a high inflationary environment which has been disguised by globalisation keeping non asset prices down.


Or, if you want to be even more pissed off, think of it in the reverse -- that is, as the Fed inflating away the "price deflation" effects of globalization and the increased productivity brought by technological advances in manufacturing. This is precisely what happened in the 1920s as the Benjamin Strong Fed favored "price stabilization" in the face of "price deflation," the which resulted in a vast expansion of the money supply and the real estate and stock bubbles of that era.

After the Fed popped those bubbles, it failed to reflate as would be done today and actually took an opposite course of money supply restriction, low interest rates notwithstanding. (http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm)
That today's Fed is so dead-set against repeating those errors, the course is clear: massive inflation. In such an unstable environment, I would think that it would be more wise to focus on capital preservation than in speculating on "growth" issues that may or may not appreciate in real terms.

Warren Buffet's aphorism on investing comes to mind:

Rule No. 1: Don’t lose money. Rule No. 2: Don’t forget Rule No. 1

While PMs and other commodities may have already enjoyed the brunt of their real gains, it is hard to think of a safer bet to preserve the purchasing power of one's capital.

[bart]

Good thoughts. I agree that precious metals, not only gold, have probably seen their best real (inflation adjusted) appreciation for this cycle, but that doesn't mean they will not see significant nominal appreciation for several years. Unlike real estate, that depends on not only low but declining interst rates in order to grow ahead of inflation, PMs tend to rise inversely to interest rates.
...
Labor (-) - Was (v) except that labor prices are rising at both the bottom and top income brackets due to tight labor markets at both ends of the range: the U.S. has been drained of highly skilled labor at the top earning quintile and is, in spite of an apparently large influx of immigrant labor, experiencing shortages of unskilled labor

Commodities (^^) - Continued inflationary pressure

The summary inflation component valences that achieved a disinflationary bias is now out of balance due to rising labor costs. Inflationary pressures are continuing to build in labor markets and may produce upward pressures in the coming quarters and move from (-) to (^).

Any event that causes a major shift in dollar demand and U.S. consumption moves Manufacturing to (- neutral) from (v downward) and Commodities from (^^ upward) to strongly upward (^^^ upward).

The valance will go from neutral a year ago, to (^ upward).



Although its unquestionably true about interest rates and gold since '01, the picture in the '70s and up through '01 was exactly the reverse:

http://www.nowandfutures.com/download/gold_10yrBond_trade.png


Labor wise, your points are well taken but at the risk of getting accused of using possibly specious and incomplete BEA data, the hourly rate data doesn't yet support a shortage picture:

http://www.nowandfutures.com/download/avg_houirly_earnings.png




And here are a few pictures of the dollar based on a correlation to Treasury International Capital flows minus the trade and budget deficits - this is the key one to watch in my opinion.

http://www.nowandfutures.com/images/tic_trade_budget_usdx.png


http://www.nowandfutures.com/images/tic_trade_budget_usdx1992-2005.png

[Mauddib]

I think it's a combination of both. My pet theory is that we are in a high inflationary environment which has been disguised by globalisation keeping non asset prices down.


Or, if you want to be even more pissed off, think of it in the reverse -- that is, as the Fed inflating away the "price deflation" effects of globalization and the increased productivity brought by technological advances in manufacturing. This is precisely what happened in the 1920s as the Benjamin Strong Fed favored "price stabilization" in the face of "price deflation," the which resulted in a vast expansion of the money supply and the real estate and stock bubbles of that era.

After the Fed popped those bubbles, it failed to reflate as would be done today and actually took an opposite course of money supply restriction, low interest rates notwithstanding. (http://www.federalreserve.gov/boarddocs/speeches/2004/200403022/default.htm)
That today's Fed is so dead-set against repeating those errors, the course is clear: massive inflation. In such an unstable environment, I would think that it would be more wise to focus on capital preservation than in speculating on "growth" issues that may or may not appreciate in real terms.

Warren Buffet's aphorism on investing comes to mind:

Rule No. 1: Don’t lose money. Rule No. 2: Don’t forget Rule No. 1

While PMs and other commodities may have already enjoyed the brunt of their real gains, it is hard to think of a safer bet to preserve the purchasing power of one's capital.




I tend to agree. I think the Fed is trying to normalize interest rates to around the 7 to 8% range. I think the Fed is just sick of bubbles and is trying to prevent rates from fueling speculation in various assets. We had the stock bubble, then the bond bubble. Truth is there is way too much liquidity out there and the risk is deflation after it is normalized.

Mauddib

[bart]

I tend to agree. I think the Fed is trying to normalize interest rates to around the 7 to 8% range. I think the Fed is just sick of bubbles and is trying to prevent rates from fueling speculation in various assets. We had the stock bubble, then the bond bubble. Truth is there is way too much liquidity out there and the risk is deflation after it is normalized.

Mauddib


I partially agree and think that rates are headed up, but it sure also currently looks a lot like the late '70s global liquidity wise too:

http://www.nowandfutures.com/download/global_liquidity2_bond_gold.png

[Alfredo Dominguez]

Were the repatriated dollars brought in by the Homeland Investment Act counted in TIC?

[Alfredo Dominguez]

And you're seeing gold continuing to rise with interest rates even as liquidity falls?

[EJ]

Good thoughts. I agree that precious metals, not only gold, have probably seen their best real (inflation adjusted) appreciation for this cycle, but that doesn't mean they will not see significant nominal appreciation for several years. Unlike real estate, that depends on not only low but declining interst rates in order to grow ahead of inflation, PMs tend to rise inversely to interest rates.
...
Labor (-) - Was (v) except that labor prices are rising at both the bottom and top income brackets due to tight labor markets at both ends of the range: the U.S. has been drained of highly skilled labor at the top earning quintile and is, in spite of an apparently large influx of immigrant labor, experiencing shortages of unskilled labor

Commodities (^^) - Continued inflationary pressure

The summary inflation component valences that achieved a disinflationary bias is now out of balance due to rising labor costs. Inflationary pressures are continuing to build in labor markets and may produce upward pressures in the coming quarters and move from (-) to (^).

Any event that causes a major shift in dollar demand and U.S. consumption moves Manufacturing to (- neutral) from (v downward) and Commodities from (^^ upward) to strongly upward (^^^ upward).

The valance will go from neutral a year ago, to (^ upward).



Although its unquestionably true about interest rates and gold since '01, the picture in the '70s and up through '01 was exactly the reverse:

http://www.nowandfutures.com/download/gold_10yrBond_trade.png


Labor wise, your points are well taken but at the risk of getting accused of using possibly specious and incomplete BEA data, the hourly rate data doesn't yet support a shortage picture:

http://www.nowandfutures.com/download/avg_houirly_earnings.png




And here are a few pictures of the dollar based on a correlation to Treasury International Capital flows minus the trade and budget deficits - this is the key one to watch in my opinion.

http://www.nowandfutures.com/images/tic_trade_budget_usdx.png


http://www.nowandfutures.com/images/tic_trade_budget_usdx1992-2005.png






Your dollar based on a correlation to Treasury International Capital flows minus the trade and budget deficits... agree that is a key indicator. Leading or trailing?

The relationship between interest rates and gold since '01 has been the reverse, so far, of the 1970s picture. Keep in mind that for 10 years leading up to the closing of the gold window and the opening of the gold market, inflation had already been building to around 5% to 6%. The extreme inflation of 18% that Volcker finally put an end to with huge rate hikes had been building for over 10 years. It did not start to show up in the gold price until the late 1970s. Three years of recssion later, in 1983, rate have been falling ever since. The rise in gold since 2001 is a leading indicator of inflation, and the Fed is as it was in the mid 1970s playing catch-up to inflation pressures that have been building in the economy for many years. The flywheel of inflation does not stop with a couple of rate hikes. Stopping inflation now with the kind of rate hikes that will be needed without causing far worse consequences for the U.S. economy than Volcker's rate hikes will, given the dependence of the economy on asset bubbles, will be no mean feat.

[EJ]

I tend to agree. I think the Fed is trying to normalize interest rates to around the 7 to 8% range. I think the Fed is just sick of bubbles and is trying to prevent rates from fueling speculation in various assets. We had the stock bubble, then the bond bubble. Truth is there is way too much liquidity out there and the risk is deflation after it is normalized.

Mauddib


I partially agree and think that rates are headed up, but it sure also currently looks a lot like the late '70s global liquidity wise too:

http://www.nowandfutures.com/download/global_liquidity2_bond_gold.png



I see a correlatioon beween 10 yr treasury yields and global liqudity but do not see the correlation with gold.

[bart]

Were the repatriated dollars brought in by the Homeland Investment Act counted in TIC?



Best guess, only some of them and probably a minoroty of them.

TIC only includes stocks, bonds, corporates & gov't agency securitires.

[Alfredo Dominguez]

And you're seeing gold continuing to rise with interest rates even as liquidity falls?




Hmm.. that "falls" should be "slows down," of course... (edit function isn't working.)

[bart]

And you're seeing gold continuing to rise with interest rates even as liquidity falls?




Hmm.. that falls should be slows down, of course... (edit function isn't working.)




Pretty much, yes, I'm still long both futures and shares.

The gold price is also driven by fear and sentiment (dot-gold? ;-)), and the two measures of global liquidity I track are still in a pretty high range and above trend. That doesn't mean we won't or can't have a gut wrenching correction, just that on balance it looks to me like we're still in a long term bull.

Amen on the edit function, and the notification function is a bit neurotic too - I've received six emails in the last 10 minutes.

[bart]

I see a correlatioon beween 10 yr treasury yields and global liqudity but do not see the correlation with gold.



There are indeed other factors that affect the gold price.

Imagine a lag of 2+ years when gold is well off the mainstream radar like now and in the late '70s. Also take into account significant above trend gold sales by various central banks per gold,org data in the mid '90s though 2000.

This also may make it a bit clearer:

http://www.nowandfutures.com/images/global_liquidity_gdp_cofer_rates.png

[blazespinnaker]

Someone proposed, (I think it was Alfredo) that the fed might raise rates but continue to pump up the m3.

"Anyone starting to wonder if the hiding of M3 is part of an attempt by the Fed to let the air out of the housing bubble without risking a period of illiquidity? That is, while posturing as "hawkish" with regard to interest rates and having the real effect of putting the brakes on the real estate market, simultaneously opening the floodgates on M3 "

I thought that idea was very intriguing, but I have admit, I'm not sure how that would work exactly by "imultaneously opening the floodgates on M3"

If the fed did it via repos, wouldn't that impact the fed fund rate?

[bart]

Someone proposed, (I think it was Alfredo) that the fed might raise rates but continue to pump up the m3.

Anyone starting to wonder if the hiding of M3 is part of an attempt by the Fed to let the air out of the housing bubble without risking a period of illiquidity? That is, while posturing as hawkish with regard to interest rates and having the real effect of putting the brakes on the real estate market, simultaneously opening the floodgates on M3

I thought that idea was very intriguing, but I have admit, I'm not sure how that would work exactly by imultaneously opening the floodgates on M3

If the fed did it via repos, wouldn't that impact the fed fund rate?



Here's the long term data, what do you think?
Personally, I believe that the only link is what the Fed wants.

http://research.stlouisfed.org/fred2/data/RPNS_Max.png


http://research.stlouisfed.org/fred2/data/DFF_Max.png

[blazespinnaker]

I have to be honest, but I'm not really a huge fan of using visual inspection of graphs for measuring mathematical correlation.

[bart]

I have to be honest, but I'm not really a huge fan of using visual inspection of graphs for measuring mathematical correlation.



I do track both of those stats and was able to whip up a quick chart:

http://www.nowandfutures.com/download/repos_fedfunds.png

[Alfredo Dominguez]

How is your liquidity measurement affected by the absence of an "official" M3? Have you found a source for guesstimating the repo numbers and thrown them in with the other still published data?

[bart]

How is your liquidity measurement affected by the absence of an "official" M3? Have you found a source for guesstimating the repo numbers and thrown them in with the other still published data?



Both ways that I measure global liquidity aren't dependent at all on M3, same with almost all my charts.

I did locate a set of data on the Fed's H41 report just last week that may help with the missing repos, but it requires a huge block of time to extract the years of historical data so that I can test it. I may even be able to back into M3 too, but I sort of doubt it

I just haven't found the big chunk time yet.

[jeffolie]

The liquidity line leads the gold line. The ten year bond is a lagging or coincident indicator.

Both indicate a peak then decline in gold in the near future.