Capital Markets Update

By Louis S. Barnes*****************************Friday, February 1st, 2013 The sustained rise in long-term rates in January has stabilized for the moment, and its causes are coming clear. Mortgages have risen from 3.50% or below in the prior five months to roughly 3.75%, and the almighty 10-year T-note from a centerline near1.75% to almost 2.00%. The rise has been puzzling. The Fed committed just last fall to buy $85 billion each month in MBS and long Treasurys, with the expressed purpose of holding rates down until our economy turns sharply better. Which it hasn’t. Today’s employment report had its usual ambiguities. Optimists and the White House are pleased at 157,000 new “non-farm payroll” jobs, and the Nov-Dec upward revision of another 127,000. Markets watch this number, due on the first Friday of each month, more than any other report because jobs are such a tender spot for the Fed and inflation. However, it is one of the least accurate of all data series. The rate of unemployment most civilians seem to have learned is even more unreliable, but rising to 7.9% in January certainly gives the Fed more space to buy bonds, and pushes back the yips that the Fed would tighten policy in 2013. Other than those headline items, payrolls and jobless, the employment details were dim. Year over year, wages have grown 2.1%, barely above core CPI. There is no movement in hours worked, overtime, or participation rate — nor perhaps most telling of all, in unemployment inclusive of “involuntary part-time” stuck at 14.5%. That figure supports the argument that the new jobs being created are inferior to the ones we lost. So, why the rate rise, one nearly always reflecting an improving US economy? In a precursor of our long-term future, rates have risen because forces overseas are larger relative to the US economy than at any time in more than a century. Part of the reason that long-term rates fell so low last year was fear of implosion in Europe, driving global cash to Treasurys and the dollar. The ECB last fall engaged in one of the great bluffs of all time, stopping the run on Club Med bonds by Outright Monetary Transaction — just buy the bonds with invented money. The ECB has yet to execute a single OMT purchase; they are contingent on any nation requesting help also accepting enough austerity to get German permission for the ECB to proceed. That would be suicidal austerity, but the bluff has held. In a world desperate for yield, investors have bought fat yields for exceedingly dubious credits (Spain, Italy) on the theory that the ECB will protect them. Thus cash sloshes out of Treasurys and the dollar and into the euro and silly-bonds. In charts in the on-line edition, you can clearly see the euro and 10-year note yield moving in tandem. Then turn to one of the strangest places on Earth. Japan. In deflation for 20 years, its government a turnstile spinning in and out one ineffective bunch after another, and running out of places to hide new debt annually half of government expenditure… now is trying to do the right thing. Panic. New Prime Minister Abe (also one of the old ones) has instructed the Bank of Japan to print as necessary to turn 1%-2% deflation into 2% inflation. Buy Japanese Government Bonds (JGBs) or foreign bonds, or both. The BOJ is resisting as only it can, but Abe will replace its leaders. Japan is in bluff, too, the BOJ still inactive, but the bluff has had two large effects. First on the yen, in 90 days from 78/dollar to 93 — the weakest in three years. The yen move in the last six months also coincides with higher Treasury yields. A lot of people have been mistakenly worried about inflation for, shoot, twenty years, and especially during the last four years’ QE by the Fed. However, if the Germans let the ECB buy, and the BOJ buys like crazy, inducing inflation on purpose, the world deciding that inflation is better than recession… then sell long Treasurys. That’s the fear, but I don’t think it’s the reality. Neither the Fed nor ECB will tolerate inflation, and Abe’s plan for Krugmanism at the BOJ has all the long-term benefit for Japan of Pearl Harbor. As central-bank inflation bejabbers recede, there’s a pretty good chance to see our rates come back down.