Markets are taking a much-needed breather during a vacuum of new economic data. The next big report will be February payrolls and wages, but not to be released until Friday, March 9.
The 10-year T-note has held near 2.90%, and mortgages just above 4.50%. Every bond trader and investor on Earth is staring at the 3.00% level, last reached in the fleeting double-top “taper tantrum” at the end of 2013, when Bernanke’s announcement of the end of QE triggered a bond market highchair fit. 10s promptly began a new decline, three years later revisiting the all-time low.
From the perspective of mandatory buyers of long bonds — insurance companies and pension funds must buy to cover future actuarial liabilities — anyone who did not buy at 3.00% in 2013 missed a boat. The previous chance to buy at that fat 3.00%: early 2011. Thus rates have stabilized in part because of buyers determined not to miss this new shot at 3.00%, no matter the Fed on the march and 10s likely to go higher.
The situation is perfect for a period of pretty good chaos. We look back at two of the best performances by any central bank chairs ever, and attendant stability at the Fed and in economic outcome. Everyone likes the new chair, Jay Powell, but he is a rookie and so are several others in leadership.
They are not the only ones. No trader or investor today much under the age of 40 has personal experience with a Fed tightening cycle. The last one began 14 years ago and ended badly 12 years ago. Perhaps most cautionary: the bad ending was not the result of the tightening, but markets gone haywire, in plain sight but in a fashion unprecedented in the preceding 75 years. Nobody has first-hand experience that long.
“Gone haywire” was the creation of a mountain of bad IOUs which exploded in 2007, Krakatoa a firecracker by comparison. Making the ground under today’s rookies even more unstable, especially in markets: the continuing mud flow of fake news about that “haywire” event. On Wednesday the widely read John Mauldin published with favorable comment a fairy tale of government completely at fault, markets innocent and would have quickly self-righted in 2008 if only the Fed had not interfered.
Another consistent mud-flow: those who question the quality or motivation of economic statistics from evil government. Pay no attention to that, please. The stats are approximate, revised, sometimes obsolete, but compiled with the best intentions and methods available.
What to do with the stats is another matter, in two parts. The Fed must decide how to execute monetary policy (not acting is acting, too), but today also feels the need to talk about data and action. In its history the Fed had no compulsion to chat until its February 1994 meeting, when chair Greenspan grudgingly (very) issued a one-sentence post-meeting statement. Before then, and during the rest of Greenspan’s term the Fed worried that the more it blabbed, the more markets would trade based on what it heard from the Fed. But the Fed needs signals from markets — and if markets are corrupted by Fed chatter, then all is circular.
Fed “communication” became extreme with Bernanke, whose faculty-club ways were helpful inside the Fed, but communication has limits. The communicators want not to surprise markets; but communication can be badly mistaken and magnify surprise (see Bernanke’s calming words about subprime mortgages and the overall situation in 2006).
The Fed has said for most of the last decade that it is “data dependent.” Market jackdaws love to ridicule the Fed and confuse investors, and say, “What else would they watch?”
They would watch reliable, forward-looking models. That’s what the Fed’s staff does: build and watch models. Monetary policy acts on the economy with lags anywhere from six to eighteen months, and models are essential for pre-emptive action. Unfortunately — hoo-ee, no foolin’ — the Fed’s models have failed throughout this recovery, in particular badly mistaken about the relationship between falling unemployment and wages and inflation. “Data dependent” means that the Fed has no useful early warning system and will change policy (or not) based on each new datum as it appears.
Yellen had the great courage and wisdom to say that the Fed would be cautious and gradual because it is not clear what is happening. Every day it is harder for the Fed to be either cautious or gradual because its rate hikes are beginning to affect markets, and another group of rookies has done exactly the worst-possible thing, doubling federal deficit spending from $519 billion in 2017 to $1,083 billion next year.
Rookies in markets, both salespeople and investors, a rookie government, and a rookie Fed. What’s to worry?
Three disparate but reassuring items:
1. The Fed’s minutes of its January 30-31 meeting are Jay Powell’s first (a departing chair always defers). Two good things, first the shooting-down of trial balloons from attendees wanting to monkey with the Fed’s 2% target for inflation. No support, there. Second, the Fed staff’s portion of the report says that risks are “balanced,” meaning no leaning toward a faster pace of tightening.
2. The tax bill’s stimulus may be muted, even non-existent. Cisco Systems has repatriated $67 billion in foreign profits; after paying taxes on the money, $44 billion will be spent buying back Cisco stock. No other investments are as compelling. Then, Warren Buffett’s annual Berkshire Hathaway letter will say that he is sitting on $100 billion in cash, and can’t find any worthwhile investment at all.
3. China has just seized Anbang Insurance, an immense operation perhaps 2.5% of China’s GDP, which has been on a foreign-investment binge funded by short-term debt in China. Its chairman Wu Xiaohui has been removed and jailed (US miscreants in the Great Debt Bubble give thanks for American absentmindedness). China is now the world’s great stabilizer. Under the absolute rule of Emperor Xi, thou shalt obey orders to reduce risk or thou shalt never be heard from again. There will be less China funny-money chasing overseas assets, and less chance of economic upset within China.
10-year Treasury in the last two years. Two upward explosions in 18 months, and if it happens, the third may take a while:
The Fed-sensitive 2-year T-note also back two years. Markets have built in two Fed hikes by summer, but not a third, and neither pause nor acceleration:
Inflation data is rarely as tidy as it has been since 2011, thus the market uneasiness from volatile data in the last year. Is inflation rising, or just wobbling in a wider range?
The “shelter” component of CPI — measured as “owner equivalent rent” — is 40% of the index and going nowhere:
Here you go, all in one chart, 30-year Treasurys in blue (note no data before 2008 because we had not sold any for years, the Federal budget in surplus!), and 10s, and Fed funds. The lesson: 10s are converging on 30s from “underneath,” the spread closing by 10s’ yield rising, 30s stuck at 3.20%. Note the last occasion of convergence, and its aftermath. 🙂