Home > Economy, Liquidity > Lend Us Some Rope!

Lend Us Some Rope!


The market continues to tread water and lose momentum as we wait for the seemingly-inevitable election results and second round of quantitative easing. However, the bond market didn’t get the “treading water” message, and the 10y yield rose to 2.64%, with 10y note futures losing 22.5/32nds in a steady bleed all day. Inflation breakevens rose modestly.

November was once a dangerous month for fixed-income, because many dealers had their fiscal year-ends in that month. As a consequence, market-making liquidity could occasionally seem December-like but investors remained nearly as active as normal. This produced big moves, especially when mortgage convexity was a big deal, and often to higher yields.

Now, though, some of the dealers (Lehman, e.g.) that had year-ends in November have ceased to exist and others (Goldman) enjoy a December year-end as the consequence of creating a 1-month “rump” period in 2008 where losses could be chucked. So November isn’t as chilling a prospect for bond investors as it once was.

On the other hand, general liquidity is lower thanks to various dealer-unfriendly regulatory actions implemented over the last year or so. I bring this up simply because an 8bp selloff on nothing, when other markets were essentially flat, is the sort of move we might have seen in November once upon a time. I wonder if it is a one-off seller in size, or whether bond market investors generally are merely lightening up before the equity investors decide to head for the exits. I suspect the latter.

Economic data today was once again not revelatory. Consumer Confidence came in near expectations, but with “Jobs Hard To Get” edging higher. The FHFA Home Price Index rose month-on-month (versus expectations for a fall), but the S&P/Case Shiller index was softer than expected.

Tomorrow we will continue marking time. Durable Goods Orders (Consensus: +2.0%/+0.5% ex-transportation) is expected to show that Q3 followed the same pattern as the last three quarters: a decline in core durables in the first month of the quarter, followed by a rise in the last two months. Even so, if the consensus estimates obtain then the average over the quarter of core Durables will be the lowest it has been since the first quarter of 2009 (at around 1% annual rate). Indeed, the 6-month rate of change in core Durables will decline to around 1.5% (annual rate) if the consensus obtains, as the chart below shows.

The bounce appears to be over in Durables, too.

In other words, the post-Lehman easy comparisons are now fully past. For some time, it has been clear that this was happening in Initial Claims, where the average for the last year has been almost exactly what it was just prior to Lehman’s demise. The horizontal line in the chart below shows the level of Claims for 9/12/08. I have shown charts of this type before, and readers will be familiar with the message: the “recovery” of early this year, so trumpeted by politicians, equity market shills, financial journalists, and even the NBER, is only a “recovery” because the baseline is taken to be the Lehman/Fannie Mae/Freddie Mac/AIG/etc calamity, and not the recession that was already in place prior to those events. It is as if a man walking along the bottom of the Grand Canyon falls into a hole; when he climbs out of the hole he is relieved to be “back on top” again. Of course, he is still in the Canyon…

Thanks to Lehman, 2009-10 looked like a recovery. It wasn't.

Insert whatever observation you wish to make about the effectiveness of the trillions of dollars that world governments have thrown at the recession. Whatever your observation is will be correct, if you choose your perspective correctly. The trillions “worked” because we were able to climb back out of the hole. The trillions “failed” because we are still in the canyon, and that was our only rope. Fine. All I know is that we’re trying to borrow more rope if anyone will lend it to us.

Also tomorrow, New Home Sales (Consensus: 300k) is expected to show an improvement, and may well exceed the consensus estimates as Existing Home Sales did. Again, your point of perspective matters. Prior to the last four months’ of sales (282k in May, 312k in June, 288k in July and 288k again in August), the lowest tally of New Homes sold ever was the 338k of September, 1981. So contain your enthusiasm.

Actually, containing enthusiasm seems to have been the easiest task for this market for some days now, and for the next few days the most likely occurrence would seem to be continued contained enthusiasm, or even ebbing enthusiasm as we are beginning to see in bonds.

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Categories: Economy, Liquidity
  1. BobJ
    October 27, 2010 at 10:35 pm

    Not exactly related to this, but I often wonder why the Austrians are so negative on TIPS. You talk about TIPS a lot on your blog (I am slowly trying to catch up as I have just recently discovered it). From what I have read, TIPS would seem like an inflation hedge along with other investments like commodities. You mention that it’s possible that they aren’t tracking real inflation and I would assume that CPI could be changed in such a way to underplay inflation, but otherwise what do you attribute to the hostility? That they are a government creation? Ethical concerns?

    • October 27, 2010 at 11:15 pm

      I don’t really know the answer to that but I’ll hazard a guess. I would think that the general hostility of Austrian-school economists to TIPS is related to two things: (1) they are debt, and Austrians hate debt generally, and (2) Austrians tend to think of inflation in the technically-correct sense of an increase in the relative money supply, regardless of the effect on prices, so they probably think TIPS don’t hedge the right thing.

      I’m not worried about CPI being substantially incorrect or being changed, although in extremis we may someday have to worry about all of the promises that the government has made – Medicare, Social Security, national debt – and one way to abrogate the promise with respect to TIPS is to change the definition of inflation. However, it would have to be covert, since the Treasury has stated that if the index is changed in any fundamental way that is adverse to the interests of bondholders, the Secretary would choose an alternative index (see the letter here; search on the page for “index contingencies”). The BLS has also stated that if they make a substantial change in the index, they will continue calculating the old index for the purpose of compensating TIPS investors. They could be lying, but if one assumes that everyone is lying then one will never invest in anything, right?!? 🙂

      Thanks for the query. I wonder if anyone else who reads this blog has an answer to the Austrian question.

  2. BobJ
    October 28, 2010 at 10:49 pm

    Ok. Thanks. I’m still learning about inflation and inflation hedges. I know that Peter Schiff in particular attacks TIPS in his vlogs. Gary North seems to be against them as well. I haven’t heard so much from Marc Faber or others on the subject. Anyway, thanks again and I very much enjoy reading your blog.

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