Long term yields are crtical to everything

[blazespinnaker]

It my opinion that las long term bond yields go... so does everything here. As long as they stay low, people will be lending happy and things will carry on as normal, or at least any recession that occurs will be shallow at best.

When this liquidity heaven cracks, then I can see a lot of pain all around.

But what is keeping long term yields so low?

Here are some ideas which I don't think get enough discussion:

1. Low Japanese inflation. Much like how Carter and Volker punished (or reacted to) the world for selling off US dollars by ramping up interest rates, the Japanese have fone the opposite. To fight off deflation they have lowered interest rates massively and since then long term yields have stayed low.

2. Globalisation is keeping wager pressure low, and thus inflation. We have about 2 Billion new workers coming online in China and India, which means lack of wage pressure as far as the eye can see.

As I mentioned in the other thread, HeliBen has his own pet theories. One of them is about a so called "Global Savings Glut" .. I suppose, but the US economy is a major driver and I don't see a savings glut.

Another is a shift in pension policy as we migrate towards a society that tries to save more. That will no doubt create a lot of demand for long term bonds.

Currency manipulation appears to be a temporary and not a permanent cause of low long term yields. That sounds reasonable, but I am no expert in that area.

Confidence in the Fed is yet another, but I don't believe in that theory at all. Bond traders are a somewhat savvy lot and probably not particularl predisposed towards irrational exuberance in the sameway joe-average day trader might be.

What do you think might cause a significant rise in long term yields?

I think two things: soaring energy costs and high japanese interest rates. Of the two of them. I believe that the latter is the most likely.

Another possibily is unconventional moves by HeliBen .. but until he develops a cult of personality like Alan, I doubt he will be capable of doing this. At the end of the day, the chairman is only one (perhaps two if you include he vice chairman) votes on the board.

[blazespinnaker]

"It my opinion that las long term bond yields go... so does everything here. As long as they stay low, people will be lending happy and things will carry on as normal, or at least any recession that occurs will be shallow at best. "

Should probably be:

"It is my opinion that as long term bond yields go... so does everything here. As long as they stay low, people will be *borrowing* happy and things will carry on as normal, or at least any recession that occurs will be shallow at best. "

[jeffolie]

HOW TO RAISE LONG TERM RATES

Inflation will increase when the Fed stops raising rates (and starts lowering them). The fact that the Fed is tightening monetary conditions and ostensibly keeping inflation in check has doubtless helped to keep the bond market complacent about inflation. When the Fed stops tightening, some of that complacency may disappear. When the Fed starts lowering short term rates, inflation expectations will almost certainly rise, and long term rates may rise along with them. I believe that the Fed is fairly close to completing its tightening cycle, so inflation expectations could increase within a couple months.

Deflating housing will raise interest rates:

In a falling housing market, the mortgage backed bonds will cause higher interest rates to attract investors. A vicious cycle of higher mortgage rates will result in ever increasing foreclosures defaulting MBSs and deflation.

IMPORT AND CURRENCY INFLATION

Oil and other commodities are rising indenpendent of the US's internal demand push inflation. The unpegging of the Chinese currencies will put import price inflation, especially at Wal-Mart.

[blazespinnaker]

Great reply, Jeffolie. I agree on all fronts.

[blazespinnaker]

One thing I find odd though is that you mentioned in another thread that you felt that deflation may occur and holding USD cash is a good idea.

My portfolio is weighted on assets which are not denominated in USD. While some asset deflation may occur, I am not particularly long on the USD because I think heliben will likely over inflate rather than deflate (or even disinflation)

[jeffolie]

US WILL SAVE THE TREASURIES BY HURTING FOREIGNERS AND US BANKS

They will deflate by having the overseas investors taken down while sparing the T-bill market with the "NewBank". In a flight to safety investors will jump on treasuries strengthen the dollar and crashing gold. Searching NewBank, check out
http://www.dailyreckoning.com/Writer.../MG030706.html
Very funny.
The first US bank to go down will be JP Morgan. Over 800 US banks hold derivatives.

Most of the $570 trillion in derivatives are held by overseas investors. These will collapse from the housing bust causing defaults. The default follow like dominos to mortgage backed securities, then collaterized debt obligations and lastly to derivatives.

Controlled deflation will be the Fed's goal so that the dollar will rise. This will help the US government as investor, institutions and countries buy Treasuries as a safe haven. US Treasuries held as reserves will not be sold off avoiding a dollar devaluation. Win -Win for the Feds. Lose-lose for derivatives, MBS (which are explicitly not backed by the US).

Controlled deflation is the Fed best choice among bad choices.

I doubt the deflation can be controlled by lowering Fed rates to zero, but the Fed will try to "mop up".

[blazespinnaker]

I thought HeliBen has all sorts of "unconvential" methods of controlling deflation? For example, paying bills straight from the printing press. It won't take much..

I think it probably will be somewhat controlled by the next president in the office.

HeliBen is probably willing to experiment with creative methods, but might be convinced not to if he doesn't have presidential backing.,

If a clinton is in the white house, we might see some creativity. If a mccain is in the whitehouse... well, mccain fought in vietnam and is a deficit hawk, and believes in sacrifice for the future. I think he'd pressure ben to fight inflation and risk deflation, his presidency be damned .. because it's the Right Thing To Do.

[blazespinnaker]

Also, what about Freddie Mac / Fannie Mae? Aren't they backed by the US Government?

[jeffolie]

GSEs IN DEEP TROUBLE

Freddie Mac's top officer just resigned in disgrace. Freddie Mac is best known for its single-family business, it is a significant source of capital for multifamily housing. As a GSE, Freddie Mac has a Congressional charter and mission to provide a continuous flow of capital for mortgage loans. Freddie Mac accomplishes this mission by buying mortgages and packaging them into securities, and by issuing AAA-rated bonds to raise money to buy pools of mortgage loans. Significant changes to Freddie Mac's pricing, debt rating or financing terms could have a chilling effect on the nation's housing sector - the only segment of the economy still performing well.

The Rudman Commission which was charged with investigating the original charge of account irregularities that has hamstrung Fannie Mae, caused its two top executives to resign, and led to the firing of the Corporations accounting firm, issued its report, finding that Fannie had indeed played fast and loose with GAAS - Generally Accepted Accounting Standards. It also detailed what it called an arrogant corporate culture.

GSEs EXPLICITLY NOT BACKED BY US GOVERNMENT


The whole problem is when the collateral fails through foreclosures and bankruptcy pushing the houses (collateral) into the hands of the GSE's (Freddie and Fannie). This causes the mortgage backed bonds to fail or be seriously impaired. Borrowing against homes added $600 billion to consumers' spending power in 2004, according to research by Federal Reserve Chairman Alan Greenspan.

Banks will fail and cause commercial loans to medium or small businesses to disappear. Credit risk and credit ratings will fall slowing the "velocity" of money and the GDP. The hundred of trillions world wide in derivatives based on mortgaged backed bonds will unwind destroying worldwide liquidity. The feds will step in to salvage and consolidate the surviving banks and thrifts after the collapse as the lender of last resort. The fed will be "pushing on a string", unable to stimulate the world’s economy.

That is the amount of unregulated "credit derivatives" that are known (there may be more) as reported by the WSJ. If the housing bubble bust goes badly (hint - it will go very, very badly), the world goes to hell in a hand basket. Source:

http://prudentbear.com/archive_comm_...tent_idx=51737

http://www.jsmineset.com/

The debt is worldwide not just US. To give you some scale the twin US deficits amount to over $2 trillion. The US GDP is $12 trillion. The derivatives are $570 trillion world wide.

Most of this is overseas. The world is wash in this securitized debt. China, Germany, Europe and Japan all hold this. These are not regulated by the Central Banks including the Fed.

Liquidating the derivatives will collapse the system world wide.