Long-term rates rose in the last ten days, at their worst the 10-year T-note to 1.83% from 1.65%, and mortgages to 3.50% despite the Fed’s new $40-billion-per- month QE3.
Many fear a general round of rate increases for the usual reasons: Europe back from the brink, an overdone bond-buying panic, a positive turn in the US economy, and the always-popular endgame of central bank money printing. It’s often hard to isolate the cause of market movements, but not this one. Nor is it hard to spot the reversal today, 10s back to 1.77%, stock market hitting a li’l ol’ air pocket.
Europe has been central to this spike, hopes there high for the two-day Brussels summit ending today. Markers: the euro itself rising to $1.31, and yields on Spanish bonds down almost by half. It is hardly an accident that rates here topped yesterday as the summit turned out to be yet another exercise in talking about more talking. Market pressure is down for the moment in the euro-zone, as nobody wants to lash himself to tracks in front of a potential ECB rescue locomotive, no matter how foggy the prospect. As it has seemed for a year, the euro issue will be forced by the social pressure and politics of open-ended depression, and nobody has a model for that groundswell.
Economic data here… all is relative. Those expecting recession have been wrong. The ECRI has forecast recession for a solid year, but its own index has turned up. Lest that thought overwhelm you with optimism, it is “up” into no-man’s-land.
Housing… for reasons best known to stock-pushers, public analysts focus on sales and construction of new homes, which at cyclical peaks account for perhaps 4% of GDP. Yes, one can add the contribution of drapes, furniture, appliances, and landscaping, but the big deal is prices, always and especially during this collapse of household balance sheets. Sales of existing homes influence the value of some 70 million dwellings; new homes now are 1% of that figure. Existing sales are up 11% year-over-year, and the distressed fraction is down from about 35% to maybe 30% — good news but not enough to pull the economy anywhere.
Shifting gears to a subject central to Europe and soon to be here, the IMF this week released some new thinking on the austerity “multiplier.” If a nation cuts its budget deficit by an amount equal to 1% of GDP, how much will it cut GDP? Old thinking had assumed .5%, but actual experience in Europe has led the IMF to a multiplier in the range of .9% to 1.7%. There you have the physics of black holes. The more you try to cut your deficit, whether by tax increases or spending cuts, your economy falls out from under you faster that you can repair your national wallet.
Side note. The austerity multiplier in Europe may be so high for other reasons, namely the insanity of bolting low-productivity economies to the currency of an uber-productive one. Thus the high multiplier there may have no grim implication for the US.
In any event, the Left and most of Center in Europe (and soon, here) howl that austerity is too much too fast, and what we need is stimulus, usually in the form of “investment.” Properly calibrating austerity is serious business, but the stimulus multiplier is in question, too. Prof Michael Pettis writes the best English-language China blog www.mpettis.com , and this month explores the difference between stimulus and pork. Any government spending adds some sugar, but must over time add specific and measurable productivity beyond cost. Every friend returning from China and Europe remarks on the gleaming newness of infrastructure, but are these investments an addition to productivity, or a warmer, dryer place for panhandlers in a meltdown?
Investment has been so overdone in China that its stimulus multiplier may be zero.
The most concerning element in these multipliers: what happens at crossover? When you can no longer afford austerity, but your finances are so poor that you can’t borrow more money for stimulus? You can dream for a while about the magic free-money machine at central banks, but Argentina and Zimbabwe are plain-sight lessons.
What happens? You are going to default. Then you can start over.
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