US Treasury note and bond yields rose sharply this past week. The Treasury ten-year note yield, for example, reached 3.46% Friday, up from 3.12% a week ago. But this yield rise is not only unlikely to be sustained, it will almost certainly be reversed. That is because its root causes will be, for the most part, inevitably seen as either exaggerated or unwarranted. And if the Fed is not to preside over a significant deepening in the housing sector decline and a reversal of the few feint signs of economic improvement, it will have to not only expand but quicken its pace of Treasury buying. Otherwise, mortgage rates and bond yields will sooner or later rise enough to choke off any hope of an early economic recovery.
The Treasury yield rise this week came despite a deterioration in equity prices from Tuesday through Friday, which might normally be expected to create safe-haven buying of governments. Even after their roughly 30% rise from their March 9 lows, equity prices not only remain below their recent bear-market rally peak, they are still well under their two-hundred day moving average downtrend, suggesting the cyclical decline in equity prices remains intact. However, despite this equity market negative to lean on, the Treasury market was instead focused on its own set of worries, some real some imagined. These include worries over where the buyers for the new Treasury borrowing would come from, a decline in the dollar, fears of an imminent upsurge in inflation amidst a resurgence of economic growth, and anxiety that US Treasury debt might soon be downgraded.
US Treasuries were adversely affected merely through guilt by association this week when Standard & Poors put United Kingdom debt on negative credit watch. That action implied that S&P saw signs of a potential or impending rise in UK debt risk. Attention was focused on a projected multi-year increase in the volume of UK sovereign debt as a percentage of GDP. If this warning goes unheeded, S&P may eventually act, but perhaps not for years. And even then, S&P would almost certainly only downgrade UK debt to AA from its current AAA rating. Virtually every major nation is in roughly the same financially stressed position as it attempts to borrow its way out of the deep recession/depression by both stimulating its economy and forstalling the failure of its key financial institutions. But the prospective debt to GDP percentage of the UK appears higher than the comparable percentage for its principal trading partners, including the US.
The dollar plunged this week. But, that is likely to prove temporary. The economies of Germany, Japan and Mexico, major US trading partners, are all falling at a faster pace than the US. While the GDP of the US declined at a 6.1% annual rate in the first quarter, GDP in germany fell 14.4%, Japan was down at a 15.2% rate and Mexican GDP plunged at an horrendous 21.5% rate.
Optimism on the outlook for the US economy was bolstered by a 1.0% rise in the April Index of leading indicators. This is the first rise after a string of declines. Though it is welcome, forecasters are aware that it takes three consecutive increases in this data series to confirm an impending bottoming out in the economy, typically some six months hence. Thus, a single month's rise should not be the basis for more than hope. The index of coincident indicators confirmed that the economy is still dropping. Similarly. initial claims for unemployment benefits, at 631,000 in the latest week are down only slightly from the prior week and from their highs, but that signifies nothing. The latest initial claims pace remains far from the 400,000 threshold of recovery. Indeed, unemployment is still rising sharply. The Confernce Board's measure of consumer confidence, at 39.2 for April, is up from 26.9 the previous month, but still well below even 62.8 a year earlier. This is far from signaling a recovery in consumer confidence, consumer spending or the economy.
Oil prices were up in recent days. But, that does not signal an imminent resurgence of inflation. Indeed,current prices are still below the probable $75 or so marginal cost of production. Even with speculative and precautionary stockpiling, oil demand is down due to the global recession and it is likely to take years of economic recovery before inflation pressures re-emerge. There is too much excessive capacity of production and labor to sustain any meaningful inflation stepup. on the contrary, deflation remains a threat. The May 22 Jounal of Commerce-ECRI industrial price index,at 78.18, is up slightly from the previous week, but stil down 42% from a year ago.
Safe haven buying of Treasuries will re-emerge as the equity market resumes or extends its price decline. As the dollar resumes its relative strength, the incentive to buy Treasuries will be enhanced. Despite the question of where Treasury buyers will come from repeated in every recession, Treasury yields declined cyclically in almost every recent recession. Treasury yields do rise initially in recovery. But, to the markets repeated surprise, the pace of recent economic recoveries has typically been so disappointing and inflation fears so overblown, that Treasury yields almost invariably reach their cyclical low in that economic recovery period. When the recovery from this recession does eventually emerge, it is likely to be even more feeble and protracted than most, with far less inflation than typical. That is likely to be true even with the Fed's substantial money expansion, because it is credit not money that matters. And the credit deleveraging process still has far to go, curtailing the inflation threat.
Philip Braverman,President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731
Email address: philipbraverman@Gmail.com
This and prior weekly reports can be accessed by going to Internet Explorer and typing the following: philipbraverman.blogspot.com
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