Fibonacci

Greenspan Puzzled and Worried About Global Rates: John M. Berry
2005-06-10 00:11 (New York)


(Commentary. John M. Berry is a Bloomberg News columnist.
The opinions expressed are his own.)

By John M. Berry
June 10 (Bloomberg) -- Federal Reserve Chairman Alan
Greenspan continues to be puzzled by and worried about some of
what's happening in the U.S. and the world economy, particularly
why long-term interest rates are so low in the U.S. and many
other countries.
Nevertheless, Greenspan made it plain yesterday that he
wants to keep raising the Fed's target for the overnight lending
rate at a measured pace to keep inflation under control.
That means the target, currently 3 percent, up from 1
percent over the past year, will be raised by another 25 basis
points at the end of this month.
Moreover, the tone of Greenspan's testimony before the Joint
Economic Committee of Congress yesterday suggested that the
target likely would be increased again when Fed officials meet
Aug. 9.
In that testimony, and in a June 7 video conference
appearance before the International Monetary Conference, a
private bankers organization, Greenspan described a situation in
which the free flow of capital among countries has to a
significant degree unhinged the level of long-term interest rates
in the U.S. from the Fed's monetary policy stance.

Yield Curve

With yields on 10-year U.S. Treasury notes about 4 percent,
or even a bit less recently, the slope of the yield curve has
flattened dramatically as the overnight rate target has gone up
by 200 basis points and the 10-year yield has come down about 80
basis points.
``There can be little doubt that exceptionally low interest
rates on 10-year Treasury notes, and hence on home mortgages,
have been a major factor in the recent surge of homebuilding and
home turnover, and especially in the steep climb in home
prices,'' Greenspan told the Joint Economic Committee.
That surge, of course, has greatly lessened the impact on
the economy from the Fed's tightening of monetary policy.
Importantly, that development was completely unexpected by Fed
officials and now makes further increases in the target for the
overnight lending rate a sure thing.
The Fed clearly regards a 3 percent overnight rate target as
still low enough to be stimulating the U.S. economy -- that is,
it remains below the so-called neutral level at which it would be
neither boosting nor restraining economic growth. And there are
enough uncertainties in the outlook for inflation that Greenspan
wants to keep moving the target toward that elusive neutral
point.

Watching Other Signals

In the video conference appearance, Greenspan said the
flattening of the yield curve, or even its possible inversion,
wouldn't necessarily cause the Fed to stop tightening monetary
policy.
Responding to a question, Greenspan said that ``we haven't
seen that phenomenon for quite a while. And it is also certainly
the case that history suggests that that is usually or has been a
forward indicator for softening economic activity.
``I suspect, however, that we have changed the structure of
the flow of funds'' among countries so much ``that I am not sure
what such a configuration, should it occur, would mean,'' he
said. ``I'm reasonably certain we would not automatically assume
that it would mean what it meant in the past.''
In other words, since Fed officials don't know why long-term
rates have come down at the same time overnight rates have gone
up, they can't put a lot of faith in the yield curve's signals.
So Greenspan and other Fed officials are going to watch other
data and do whatever is necessary to achieve non-inflationary
growth.

Unit Labor Costs

In yesterday's testimony, the Fed chairman noted one concern
on that front: Slowing productivity growth has begun to push up
unit labor costs. ``At the same time,'' he said, ``evidence of
increased pricing power can be gleaned from the profit margins of
non-financial businesses, which have continued to press higher
even outside the energy sector. Whether that rise in unit costs
will feed into the core price level or will be absorbed by a fall
in profit margins remains an open question.''
Last year Greenspan and some of his colleagues expressed
confidence that competitive forces would cause companies with
unusually high profit margins to absorb a significant share of
cost increases due to higher prices for petroleum and other
commodities. Now that's an ``open question.''

`Few Signs of Accceleration'

On the other hand, he showed little concern about revised
compensation figures for the fourth quarter of last year that
caused a sudden jump in unit labor costs. He dismissed that jump
as due to ``a large but apparently transitory surge in bonuses
and the proceeds of stock option exercises late last year.''
Excluding those factors, ``overall hourly labor compensation has
exhibited few signs of acceleration,'' he said.
Some analysts had said the high fourth-quarter unit labor
cost figures might cause the Fed to accelerate the pace of its
increases in the overnight rate target. That doesn't seem to be
in the cards though.
Greenspan also gave interesting assessments on some other
troubling issues, including the large and growing U.S. current
account deficit and the Chinese government's peg of its currency
to the dollar.
``Although prices of imports have accelerated, we are, at
best, in only the earliest stages of a stabilization of our
current account deficit -- a deficit that now exceeds 6 percent
of U.S. GDP,'' he said in his testimony.

Currency Peg

As for the currency peg, an item of considerable political
concern both to the Bush administration and Congress, Greenspan
told the International Monetary Conference, that ``the issue of
allowing flexibility in some form in the yuan strikes me as very
much to the advantage of China, and indeed it's something that
I'm certain they will take on reasonably soon.''
Once that happens, the U.S. ``will likely import less goods
from China, but that does not mean that our current account
deficit or our trade deficit will shrink very much, if at all,''
he predicted. That's because as Chinese goods become more
expensive as a result of the revaluation of the yuan, imports of
similar goods from other lower-cost countries will be
substituted.
``It surely is not going to be a major impact on the net
balance of payment structure of the United States,'' Greenspan
said.
The Fed chairman didn't speculate on what might have a major
impact on the current account deficit.

Fibonacci

What If It's a Bond Bubble and Condo Conundrum?: Caroline Baum
2005-06-22 00:04 (New York)


(Commentary. Caroline Baum is a columnist for Bloomberg News.
The opinions expressed are her own.)

By Caroline Baum
June 22 (Bloomberg) -- What makes one overpriced market a
bubble and the other a conundrum?
This question was inspired by a comment from Jim Bianco,
president of Bianco Research in Chicago, in a conference call with
clients last week.
``When technology stocks get to levels we don't understand, we
call it a bubble,'' Bianco said. ``When real estate gets to levels
we don't understand, we call it a bubble. But when bond prices get
to levels we don't understand, we call it a conundrum.''
The implicit assumption, of course, is that bonds are a
perfectly rational, efficient market. The prices make sense. The
problem is the analysis.
If only those persnickety bond strategists would just dig a
little deeper, why, they'd find the answer to why long-term rates
are so low.
For folks who haven't opened a newspaper for the last six
months -- or who were so exhausted by the latest 6,000-word front-
page epistle on the housing bubble they never got to the interest-
rate conundrum story in the business section -- long-term interest
rates are lower now than they were a year ago, when the federal
funds rate was 200 basis points lower.
``If you ask people why interest rates rose from 1946 to 1981,
you'll get a one-word answer: inflation,'' Bianco said. ``Ask
people why interest rates fell from 1981 to 2003, and you'll also
get a one-word answer: disinflation.''

One Word

Not so with the question du jour of why long-term interest
rates have defied the Federal Reserve (which has raised the funds
rate to 3 percent from 1 percent), the economy (which has grown at
an average rate of 4.3 percent the last two years), and record
budget and current-account deficits.
``Ask people why long-term rates are currently so low and
you'll get a lot of reasons,'' Bianco says. ``This is throw-it-on-
the-wall-and-see-what-sticks analysis.''
The persistence of low long-term rates has had a depressing
effect on expectations, which makes you wonder why the exercise is
called forecasting. Six months ago, the 10-year Treasury note yield
was expected to be at 5.1 percent at the end of this year,
according to the median forecast of 59 economists surveyed by
Bloomberg News. In the latest survey, conducted May 31-June 8, the
median forecast was 4.6 percent. The 10-year note has been hovering
near 4 percent.
The Fed offered its own explanation for the conundrum: a glut
of global savings. This view gained wide acceptance because
investors regard the Fed as omniscient when it's merely omnipotent.

Multiple Choice

When Fed Chairman Alan Greenspan said last February that low
long-term rates were a conundrum, bond traders pushed them up. He
must know the appropriate level for 10-year Treasury yields, right?
The increase in rates didn't last long, but it was
breathtaking to behold.
Other candidates to explain the conundrum include a slowdown
in global growth, part real, part forecast; Asian central bank
buying; pension fund buying in order to better match long-term
liabilities with long-term assets; the aging population, with its
demand for fixed-income assets; and a predominance of short
positions on the part of bond investors, who have been forced to
cover as the conundrum failed to resolve itself in their favor.
The fact that there are so many possibilities, offered up at
convenient times and with little conviction, suggests everyone is
shooting in the dark.

Pro and Con

But that fails to answer the initial question. Why are we
searching for something to explain low long-term rates and stating
definitively that housing is a bubble? For all the talk of a
housing bubble, why so little discussion of whether bond prices
represent a bubble?
Yes, the median home price increased 15 percent in the year
ended April, a rate of appreciation that is as ``unsustainable'' as
the current-account deficit, which hit a record 6.4 percent of GDP
in the first quarter. Yet ``the increases in median home prices
have only matched gains in per-capita income over the last two
decades,'' said Steven Wieting, an economist with Citigroup Global
Markets, playing devil's advocate in the debate over whether
housing is or isn't a bubble.
What's more, while median home prices have risen 170 percent
in the last two decades, the principal and interest payments to buy
the home are up only 50 percent, Wieting said.
Finally, a family earning the median income has 122 percent of
the income required to purchase a median priced home, assuming a 20
percent down payment, based on the National Association of
Realtors' housing affordability index.

Relative Value

Wieting cited plenty of reasons to be concerned about recent
trends in housing as well. Confusing speculation with ``the
historically pedestrian decision to acquire shelter'' may produce
``unusual outcomes,'' he said.
To the extent that real estate investors are banking on
history -- the national median home price has never fallen in a
calendar year since the Great Depression -- ``real estate could
become the victim of its own success,'' Wieting said.
Bond bubble discussions are much harder to come by. Why aren't
economists busy deconstructing bond prices in search of signs of a
bubble?
``The reason we call the stock market a bubble is because we
look at stock prices relative to profits,'' said Joe Carson,
director of global economic research at Alliance Bernstein. ``We
look at house prices relative to rents -- incorrectly, I believe,
since the two markets aren't interchangeable. Interest rates are
regarded as absolute.''

No Bond Mamas

Without individual investors, who have never been a force in
the Treasury market, reporters lack the anecdotal ammo to elevate
the conundrum to bubble status. (``Soccer Mom Bets Life Savings on
Bonds Before Employment Report.'')
Probably the single best explanation for why bonds are a
conundrum, not a bubble, is that Greenspan said they are. The Fed
chief framed the debate by assigning a quotable, pithy, Latin-
sounding noun -- conundrum -- to the persistence of low long-term
rates. What if he had said, ``We at the Federal Reserve continue to
be stupefied by low long-term rates in the face of our efforts to
normalize short-term rates?'' Maybe we wouldn't be talking
conundrum today.
Anything Greenspan says or watches has a way of becoming
institutionalized. Bond yields become a conundrum; house prices
show signs of froth, which is a bubble by any other name.
Alas, real estate investors are the equivalent of Wild West
cowboys, staking a claim on a house they have no intention of
making a home, using an interest-only mortgage while they wait for
the capital gains to accrue.
Bond traders are ``pipe-smoking gentlemen in tweeds who talk
about esoteric theories of inflation and fiscal deficits in phrases
most people don't understand -- and always get it right,'' Bianco
said.
Now that's a conundrum Greenspan could put in his pipe and
smoke.

--Editors: Dickson, West.

Story illustration: To graph median home prices, see
{EHSLMP <Index> GP <GO>}. For the housing affordability index, see
{AFFDCMOM <Index> GP <GO>}.

Fibonacci

Gross Sees Brave New World of Low Interest Rates: John Wasik
2005-06-27 00:06 (New York)


(Commentary. John F. Wasik, author of ``The Bear-Proof
Investor,'' is a columnist for Bloomberg News. The opinions
expressed are his own.)

By John F. Wasik
June 27 (Bloomberg) -- In Bill Gross's view, U.S. inflation is
becoming a subdued beast and interest rates will drop.
That's the contrarian forecast of the chief investment
officer of Newport Beach, California-based Pacific Investment
Management Co., the world's largest manager of bonds.
If Gross is right and inflation is declining to the 1 percent
to 1.5 percent range, then the Federal Reserve Board will halt its
policy of raising short-term interest rates this year. That
creates a brave new investment climate for bonds and stocks, and
perhaps a scarier scenario for U.S. real estate.
``Next year, disinflation will ultimately triumph over
reflation,'' Gross said at the Morningstar Mutual Fund conference
in Chicago on June 21. ``That means the 10-year U.S. Treasury note
may yield as low as 3 percent.''
Gross is defying conventional wisdom by predicting the
Federal Reserve will stop its rate-increase policy and start
cutting borrowing costs.
With crude oil hitting $60 a barrel and commodity prices
soaring, though, it's hard to make a convincing argument that
inflation is completely under control.
The Dow Jones/AIG Commodity Total Return Index, for example,
a basket of commodities from oil to metals, is up 12.6 percent
over the past year through June 22, according to Bloomberg data.
That compares with an annual increase of 2.2 percent for the U.S.
core Consumer Price Index, through May 31.

House Prices

The unfettered escalation in U.S home prices also has raised
the cost of living. Over the past five years, residential property
alone has increased in value by almost 50 percent, which
``surpasses any increase in 25 years,'' according to the Federal
Deposit Insurance Corp., the bank insurance agency.
Like many economic savants, Gross is concerned that if his
lower-rate forecast comes to fruition, that will make home
financing even cheaper and encourage more buying and speculation
in already overheated home markets.
``The leverage frightens me,'' Gross candidly said at the
Chicago conference. ``We need the housing market to stay above
water, but 10 percent to 15 percent annual appreciation is not a
good thing.''
The U.S. economy is ``floating because of the housing market
when it should be floating because of productivity,'' Gross said
when asked about the prospect of the home-market bubble inflating
even more if his lower-rate forecast materializes.

Some Wild Cards

Gross isn't known for being on the wrong side of interest-
rate bets, hence his deserved reputation as a bond czar. His
flagship Pimco Total Return Institutional fund, holding about
$82 billion, has beaten 91 percent of peers over the past half-
decade through June 21.
The day after Gross spoke in Chicago, the 10-year U.S.
Treasury note yield dipped below the 4 percent mark. Traders
attributed the decline to concerns of lower global growth, higher
oil prices and a possible rate cut by the Bank of England.
Part of Gross's wisdom, though, hinges on the possibility
that he may be wrong. One wild card includes the chance that
inflation will accelerate -- forcing the Fed to keep raising short-
term rates.
He's also waiting to see if the Chinese and Japanese
governments ease their buying -- and begin selling -- U.S.
Treasury securities. To date, these mega-customers of U.S. debt
have kept rates low in the U.S. and have been cited by economists
as a factor in fueling the American housing boom by providing low-
cost capital for financing.
``If these dollars don't recirculate into Treasuries, we'd
best watch out,'' he added.

The Gross Portfolio

Assuming that Gross is right on a pending decline in interest
and inflation rates, how would you invest? You would want to hold
a generous basket of stocks and bonds. Yet if interest rates
headed north, you wouldn't want to assume too much risk by owning
single bonds or concentrating on long-term maturities.
Two fund suggestions include the iShares Lehman Aggregate
Bond Fund (AGG), an exchange-traded fund, or the Vanguard Total
Bond Market Index Fund (VBMFX). Both low-expense funds represent
broad-based baskets of the U.S. bond market and can be core
holdings for any investor. For non-U.S. bonds, the T. Rowe Price
International Bond Fund (RPIBX) is a good choice.
An even more across-the-board income fund is the Pimco All
Asset Fund (PASDX), a fund of funds that covers a variety of U.S.
and international bonds, commodities and real estate. The fund has
beaten 95 percent of its peers over the past year.
For stocks, which may also benefit from lower rates, consider
the Vanguard Total Stock Market VIPERS (VTI), an exchange-traded
fund that covers most U.S.-listed stocks.

Keep Costs Low

While bonds, stocks and real estate may continue to rally
under Gross's scenario, he doesn't see them or hedge funds
exceeding single-digit returns. That means investment expenses
will play a major role in enhancing total returns.
``In a 4 percent to 5 percent return world, you can't afford
to give away money to fees,'' he said. ``Cut those fees under the
assumption there's not much out there.''
There's always the chance that Gross and other market seers
have foggy crystal balls, and a pronounced economic slowdown is
imminent. In that case, real estate may be hurt the most.
``There is a necessity that the housing market not crash and
do half well,'' he said.
Yet if the economy enters a recession -- a possibility in the
next five years in his estimation -- he notes that the Federal
Reserve may have limited ability to revive it through interest-
rates cuts again.
Then Federal Reserve Chairman Alan ``Greenspan may be out of
rabbits,'' he said.



P.S. - Gross neglects to mention that Alan will be long gone by then....

ViperrepiV

I think you should add cliff notes for each of your posts

Fibonacci

Send PM to GTKrockett


Nutshell:

If you invest and care to see growth on your assets...consider cash this year. It could get ugly.

Fibonacci

Fire!

Bill Gross
07/01/2005


We didn’t start the fire

It was always burning

Since the world’s been turning

Apologia by Fed Governor
Billy Joel





Nero may not be fiddling, but Rome is on fire nonetheless—Rome, Georgia that is: its citizens’ homes appreciating at 10% annually for the past five years; its local newspaper’s stock market quotes recovering smartly since October of 2002; its personal and corporate tax rates down sharply; its country’s deficit running at 4% of GDP. These are but some of the more visible cans of gasoline stoking economic growth across many American towns and cities these days. This new age Rome is conservatively located far from NYC or LA and theoretically unsingeable by speculative flames of finance center investment exuberance—but it is ablaze nonetheless. Still, ablaze is not quite the same as burning, the latter verb being indicative of decay/destruction whereas the former connotes an intensity/excitement hinting that things can get no better than this. Whether or not chemists would validate this distinction is unimportant. Chemistry is a science, but economics is a dismal science at best and I therefore take license with the supposedly immutable laws of nature to make a point: Rome is on fire and not burning, but in future years it may well be.



The origins of this fire can be traced as far back as the mid-1980s when we declared victory over accelerating inflation, and a cascade of lower Reaganesque tax rates and Volker/Greenspanesque interest rate cuts were called upon to stimulate a potentially faltering economy. Our most recent matches were struck, however, during the aftermath of the 9/11 recession when it became apparent to policymakers that a combination of American fear/malaise and accelerating globalization might inhibit a normal economic recovery. It was “decided” that in such an environment, asset appreciation—a recovering stock market, and a thriving, “frothy” housing market being the primaries—would be the vehicle of choice to engineer a recovery until domestic investment and concomitant job growth kicked in. To produce that asset appreciation, policymakers came up with logical gasoline cans or “pumps,” as I’ve referred to them in recent Outlooks, to start the fire. They are displayed collectively below and their timing and stimulative trend are unmistakably correlated to the most recent U.S. recession in 2001.








Readers should not revel in any new magical discovery here, however. These asset pumps have been standard recessionary recovery tools since FDR/Keynesian policy innovations in the 1930s, although direct government spending as opposed to explicit tax cuts were the weapons of choice back then. Still, in prior cycles government policy pumps inevitably led to self-sustaining expansions as investment spending, combined with demographic and policy-induced labor force growth, alleviated the need for additional kerosene. In fact, in every previous cycle, the fuel could eventually be restocked by paying down deficits and raising interest rates so that there would be an ample reservoir the next time around.



This recovery is different because it was spawned and subsequently nurtured on the back of asset appreciation alone. Greenspan and company have high hopes that investment and then employment will ultimately kick in and work their self-sustaining magic one more time, but jobs and investment these days go to Asia at the margin, and domestic animal spirits have been squelched by the looming inevitability of reduced returns on risk capital in a low interest rate world. I’ll leave the Asian story for another day or let you turn on CNN at 11:00pm EST to get your fill of Lou Dobbs—the Dobbsian spectre of foreign competition on the march is undeniably real. My point in this Outlookwill be an extension of the thoughts expressed over the past few months that this recovery is on fragile legs because it is asset-appreciation-based and that future asset appreciation is vulnerable based on the weakening stimulative power of interest rates. Therein lies the potential for a white-hot speculative blaze turning into a destructive recessionary fire. Such an analogy inevitably suggests that in future years, Rome, Georgia, may not be on fire, but burning.



I begin with the blanket assumption, confirmed in recent speeches by Fed Governor Roger Ferguson and others, that when yields (primarily real yields) fall, asset prices rise. “Because they are interest-sensitive,” Ferguson writes, “asset prices are primary components of the channels by which monetary policy is transmitted to the real economy.” This logic confirms what is commonsensically known by most Americans—that if real interest rates decline, housing prices and stocks (bonds too!) go up in price.1 Greenspan’s recent “conundrum” episode is more a reflection of his fear that this process might go too far in housing markets rather than an expression of ignorance as to what’s going on. He knows, I think, why interest rates are down, he just doesn’t want them to be stoking the housing market so furiously—thus all the “conundrum” talk. But I suggest he should be careful here in raising short rates to produce his desired outcome. Raising short yields beyond 3˝% nominal and 1% real risks a recessionary fire. But the fact is that despite raising nominal short rates by 200 basis points, real interest rates are still so low that additional appreciation in houses, stocks, bonds, and other assets may be difficult to engineer. It may be impossible to generate equivalent asset appreciation in future years like we’ve experienced recently, even if yields begin to fall! We may have reached the point in our asset-based economy, in other words, where the burning of Rome, Georgia, is inevitable, although the timing is uncertain.



Such an observation begins with the assumption that the policy “pumps” graphically displayed above are approaching their limits. Corporate and personal tax rates are at their nadir in my opinion and politically incapable of further downward progress. While a declining dollar is the one vehicle that can and probably will be used to attempt to keep assets—especially stocks—on an upward path (the dollar’s decline in 2003 and 2004 added an estimated 10%-15% to S&P 500 corporate profits in each year) the greenback’s strength recently is certainly not a help. Most of all though—and here is where my argument succeeds or fails—interest rates that drive the economy cannot go down much further. Since they cannot, the gasoline that they have pumped onto this economy’s reflationary fire will be exhausted, assets may stop going up at a double-digit pace, the meager inflation and economic growth they have engendered to date may wither and Rome may begin to burn, not blaze.



Why can’t interest rates go down much further? Well, yes there are 300 basis points between current Fed funds and 0, and if the argument depended on that alone then there’d be at least one last pump to use, or one final party for the Fed to hold—a last gasp Bernanke-style infusion of helicopter money. I will admit that another 100 basis-point decline in mortgage rates would certainly prolong the current bonfire for a year or so. But it’s primarily real interest rates that drive asset prices not nominal rates2 and real rates for intermediate and longer dated TIPS have limited room on the downside no matter how large the Fed’s future fleet of helicopters. For explanatory purposes, I again refer you back to the graph above, which features the downward path of a 5-year TIPS—an appropriate proxy for the main driver of housing prices and stock P/Es, and therefore the primary pump that the Fed has utilized to keep our asset-based recovery underway. Not only have these real yields declined by over 200 basis points in the last several years (with only 135 between here and 0, therefore exhausting much of the Fed’s fuel) but there is logic to believe that they can be driven at best back to the 60- to 70-basis point level experienced in March of 2004 during the winter of America’s deflationary fears. That’s not much more gasoline, folks. Seventy-five basis points of future stimulation cannot create an asset blaze like the one we’ve experienced in the last few years.



The following is important, but if your eyes glaze over, skip to the summary.



Why such a meager decline to a 60- to 70-basis point floor? Well any longer dated, inflation adjusted/inflation sensitive security (TIPS,—and yes—stocks, real estate, collectibles, commodities, gold, etc.) has a limit in terms of how far down its real “yield” can be driven. (Stock yields for instance might be “floored” somewhere in the 2% area where they trade now after adding a risk premium to my TIPS floor estimate of 60 basis points. European stock markets, by comparison, reflective of economies closer to deflation than in the U.S., yield 2.5% on average while their 5-year TIPS yield 0.75%. Japanese stocks, however yield 1% with a 60-basis point TIPS yield although their market is more insular and inbred. U.S.houses might be “floored” somewhere in the 30-35 times rents zone or a 3% real yield where they trade in many hot markets today.) Granted real short rates can go negative, but for any 5-year+ inflation-adjusting asset, as its “yield” moves closer and closer to 0, the reduced yield reflects a growing danger that its return will be negative as opposed to positively adjusted if deflation rules the day. If that were to be the case, then the asset’s total return would be guaranteed to be negative—an untenable condition for any investor. Recent issues of Japanese TIPS have averaged 75 basis points and never dropped below 40 for longer than a month.



If you’re not with me here, I apologize, but this is exciting conceptual stuff. Take the 5-year TIPS security for instance. Why would an investor buy this at only a 10-basis point real yield if she felt that deflation might subtract 100 basis points during ensuing years? (Negative inflation or deflation is deducted from almost all outstanding TIPS.) She wouldn’t—she would demand a cushion, a 60-, 70-, 80- or more basis point insurance policy to protect against the even minor possibility of deflation. The same concept applies to stocks and home prices. Deflation subtracts from earnings growth and housing prices just as it does with TIPS returns. Once they have been driven up to values and down to real yields which reflect this 60- to 70-basis point insurance premium plus an add-on for risk, no logical “investor” would pay more unless profit margins expanded substantially in a deflationary “boom.”



Deutsche Bank’s George Cooper in a recent research piece labeled “The Burden of Sisyphus” points to the following chart to explain the price-yield relationship of a perpetual asset of which stocks and houses are close relatives. Theoretically, as yields approach 0% the price of a perpetuity approaches infinity but under such circumstances, deflation would almost assuredly be just around the corner and an investor would cease aggressively buying perpetuities (or stocks, houses, etc.) based on the possibility of deflation reducing future cash flows.






In reality then, we may be not that far away from running out of gasoline with 5-year TIPS at 1.3%, stocks at 2%, and houses at 3% real yields. Japan found that out in the 1990s. As real 5-year yields were driven down towards ˝%, no investor would aggressively buy stocks or real estate because deflation would subtract from their beginning nest egg at par. It was what Keynes labeled a liquidity trap, one in which animal spirits were dampened not just by overcapacity but by the reality of near 0% real yields and their unacceptable consequences for investors in a deflationary environment.



This is important if only to reemphasize that the limited capacity for real yields to decline from this point removes the largest and most potent pump from policymakers’ arsenals. Others such as corporate and personal tax rate reductions seem politically unrealistic. While emotion and irrational exuberance can take asset markets far above “rational” levels of value as NASDAQ 5000 proved, that should not be the odds-on expected outcome for houses or stocks from this point forward.



Summary

Let me summarize my main points:



The current rather mild U.S. recovery has been driven by asset appreciation/consumption and not employment or capex growth.
Future growth is dependent on additional asset appreciation in real estate and stocks if Asia continues to absorb much of our investment and many of our jobs.
Recent asset appreciation has been set ablaze by several fiscal/monetary pumps displayed above with 5-year real rates being the central driver/gasoline can.
Tax cuts are a thing of the past and 5-year TIPS yields can theoretically decline only 60 basis points or so more.
The reason why intermediate/long TIPS have an interest rate floor is that if we approach potential deflation, investors risk losing money on a government guaranteed investment. The same concept applies to homes, stocks, and other inflation-adjusting assets without government guarantees.
The Fed may soon be out of fuel, despite hints of Bernanke-style helicopter money. Stocks and houses are already at low yields and high prices reflective of European economies nearing Japan-style liquidity traps.


If the asset pumps run dry and the kerosene cans empty, the inevitable path of the U.S. economy will reflect slow growth at best, and recession as a realistic alternative. Inflation then would return to low 1% levels in the ensuing years and be pressing the deflationary crossover line. Nominal Treasury paper would enter the 3%-4% zone for 10-year maturities and lower still for shorter intermediates. Such an analysis argues for capturing yield via duration extension now in the face of admittedly artificially low current yields. If Rome burns, long maturity bonds will rule the day and that day may come sooner than many imagine possible.


http://www.allianzinvestors.com/comm...ss07012005.jsp


Nutshell:

We are entering a period where investors should expect to receive lower rate of returns...especially those who've gone crazy loading up on debt to speculate on real estate.

amisconception

It's not July 1st

chef chris

Good stuff.

Fibonacci

China's Bond Buying Causes `Conundrum,' Morici Says (Update3)
2005-07-05 03:14 (New York)


(Updates prices in 10th and 16th paragraphs.)

By Christina Soon
July 5 (Bloomberg) -- China has almost $700 billion of
currency reserves that it can use to buy Treasuries, helping keep
yields on U.S. government debt from rising and fueling what
Federal Reserve Chairman Alan Greenspan called a ``conundrum,''
said Peter Morici, a professor at the University of Maryland.
The People's Bank of China has bought Treasuries with the
dollars it amassed as it has tried to keep the yuan from rising,
Morici said. Dollar purchases by other Asian countries as they
sell their currencies to stay competitive with Chinese exporters
have helped U.S. debt, keeping bond yields low and making it more
difficult for the Fed to curb mortgage lending and consumer
spending with interest-rate increases, Morici said.
``China is the largest part of the problem,'' Morici said in
a phone interview on June 30 from College Park, Maryland, where
the university is based. ``Because China is buying so much foreign
exchange and so many dollars, other countries can't'' allow their
currencies to strengthen ``unless they lose their export market to
China.''
Almost 60 percent of the $1.9 trillion of U.S. Treasuries
held outside the country have been bought by China, Japan, Taiwan,
South Korea, Hong Kong and Singapore, according to U.S. government
figures at the end of April. The purchases have driven Treasury
yields lower, even though the Fed is increasing interest rates.
``At some point, it ceases to be sustainable,'' said Morici,
a former chief economist at the U.S. International Trade
Commission. Morici published his views in a report on June 29
entitled ``Greenspan's Conundrum? It's the China Price.''

`Without Precedent'

The Fed on June 30 raised its rate for overnight loans
between banks for a ninth time to 3.25 percent and restated a plan
to make further increases at a ``measured'' pace.
Greenspan first called the situation a ``conundrum'' on Feb.
16 during an address to Congress. On June 6, in a speech to the
International Monetary Conference in Beijing via satellite, he
said the situation is ``without recent precedent.''
China's holdings of Treasuries at the end of April were $230
billion, up from $163 billion a year ago, according to U.S.
government data.
Yields on benchmark U.S. 10-year notes fell from 4.69 percent
in the past year even as the Fed has boosted rates by 2.25
percentage points during the same period.
Ten-year note yields rose 1 basis point to 4.05 percent as of
4 p.m. in Tokyo, according to bond broker Cantor Fitzgerald LP. A
basis point is 0.01 percentage point. Yields touched 3.8 percent
on June 3, the lowest since March 2004.

Not `Time to Buy'

``Central banks of Asia have bought Treasuries, and that's
the main reason yields are lower than expected,'' said Hiroyuki
Yamada, who helps oversee about $1.3 billion in Tokyo at Daiwa SB
Investments Ltd., a unit of Japan's second-largest brokerage.
Daiwa SB Investments forecasts 10-year yields to be at 4.5
percent by year-end. Yields would be higher than this without
Treasuries purchases by Asian central banks, Yamada said.
``It's not a good time to buy'' Treasuries with longer
maturities, Morici said. ``I'm 56, and I need some money for my
son for college in five, six or seven years. And I'm not buying
five, six or seven-year securities.''
Adjusting the yuan's peg would help reduce the dollars China
needs to buy and keep the mainland from increasing its Treasuries
purchases, said Morici.

Yuan Gain

The yuan is allowed to fluctuate 0.3 percent above or below
its pegged level of 8.3 percent to the dollar, which means that
the Chinese government can buy or sell the U.S. currency to
maintain it at its pegged level.
China's currency would rise to 7.867 against the dollar in a
year if freely traded, forward contracts showed, a gain of 5
percent.
Futures contracts allow investors to bet on the value of a
currency that isn't fully convertible, or hedge investments
denominated in it. Forwards are agreements in which assets are
traded at fixed prices for later delivery. Yuan forwards are non-
deliverable as they are settled in dollars, not local currency.
A yuan revaluation is when China tries ``to find the value
for the currency where they don't have to intervene'' to buy or
sell it, Morici said.

`Make a Difference'

``China may make a small move in the next six months, but I
don't think they'll make a move large enough to make a
difference,'' Morici said. Should the Chinese government not make
a large enough adjustment to its currency peg, ``they'll continue
to have to buy more and more U.S. dollars'' and increase their
demand for Treasuries.
Japan's holdings of U.S. securities rose 70 percent to $685
billion in April from the same month in 2003, according to the
Treasury Department. The Treasuries Taiwan owned almost doubled to
$70.6 billion in the same period, those held by South Korea
increased 51 percent to $56 billion and Singapore's holdings rose
55 percent to $30 billion.
China's foreign-exchange reserves were at $691 billion in
May, according to the State Administration of Foreign Exchange, an
increase of 3 percent from April.

scl23

As I said, I'm glad I'm Korean, so if China begins to take over the world, I'll just learn Chinese. Of course the Mexicans can catch up in a 100 years if they keep the pace.

Fibonacci

Bond Strategists: Cantor Sees Inverted U.S. Curve (Update2)
2005-07-06 07:25 (New York)


(Adds history of inverted curves and recessions in fourth
paragraph.)

By Michael McDonald and Robert Burgess
July 6 (Bloomberg) -- Yields on two-year U.S. Treasuries
will rise and exceed those on 10-year notes as soon as the next
quarter, inverting the so-called yield curve, according to Cantor
Fitzgerald LP, one of the two biggest bond brokers.
Investors will probably send the two-year yield up to 4.25
percent by year-end, from 3.77 percent today, as the Federal
Reserve raises its interest-rate target to 4.25 percent,
according to John Herrmann, director of economic commentary in
New York at Cantor Viewpoint. The 10-year yield will probably
finish 2005 little changed at 4.15 percent.
``I don't see any reason to prevent this thing from
inverting,'' Herrmann said in an interview yesterday. ``The 10-
year will be pinned at around 4 percent while Chairman Greenspan
continues to neutralize the front end of the yield curve,'' he
said, referring to Fed Chairman Alan Greenspan.
An inverted yield curve has preceded each of the past three
U.S. recessions. Greenspan said by satellite to a June 7
conference in Beijing that the Fed ``would not automatically
assume that it would mean what it meant in the past'' should the
yield curve invert again.
The gap, or spread, in yields between the two-year and 10-
year notes has narrowed to 32 basis points, from 193 basis points
a year ago, as investors drove up short-term yields in response
to nine rate increases by the Fed. The central bank lifted the
target to 3.25 percent on June 30.

Last Time

Herrmann is among the first strategists to formally expect
an inversion in the curve, which is a graphic description of a
chart showing yields of bonds of different maturities. Investors
typically demand higher yields on longer-term securities to
compensate for inflation and the risk of default.
The last time the curve was inverted was in 2000, before the
U.S. recession that began in March 2001. Back then, two-year
yields exceeded 10-year yields by as much as 51 basis points. A
basis point is 0.01 percentage point.
Two-year yields were 3.77 percent as of 7:12 a.m. in London,
while 10-year notes yielded 4.08 percent.
By the end of the first quarter, two-year yields will be
4.15 percent, exceeding 10-year yields by 15 basis points,
Herrmann estimates. The gap will shrink to 7 basis points by mid-
2006 as two-year yields fall to 4.02 percent and 10-year yields
declined to 3.95 percent, he said.
Cantor Viewpoint is a unit of Cantor Fitzgerald, which along
with ICAP Plc is one of the world's two largest Treasury brokers.
Before joining Cantor in 2003, Herrmann was chief economist at
IDEAGlobal. He has taught at the University of Pennsylvania,
Columbia Business School and the Stern School of Business at New
York University.

Merrill, CSFB Calls

In December, Herrmann said the yield gap would shrink to 88
basis points by now from 1.23 percentage points at the time.
The Fed last week kept its plan for further interest-rate
increases at a ``measured'' pace, in a statement accompanying the
quarter-point boost to 3.25 percent.
The central bank's rhetoric has more economists and
strategists saying there is a higher chance of an inverted yield
curve. The spread may invert if the Fed pushes its key rate to
3.5 percent, increasing the risk of recession in 2006, Kathleen
Bostjancic, senior economist at Merrill, wrote in a report to
clients last week.
Debt strategists at Credit Suisse First Boston said two
weeks ago the difference in yields between short- and long-term
debt will probably continue to flatten, or even invert.

--Editors: Burgess, Goodman, Anstey.

Story illustration: For a list of U.S. Treasury prices and
yields, {BBT <GO>}. To graph the yield on the 10-year note,
{GT10 <Govt> GY <GO>}. To graph the yield on two-year notes, see
{GT2 <Govt> GY <GO>} To see the gap between the 10-year note's
yield and the two-year, click on
{.USYIELD <Index> GP <GO>}.



Cliff's Notes:

Inverted Yield Curve refers to when long term yields are lower than short term rates. Is a historically accurate predictor of recession.

Silver™

http://money.cnn.com/popups/2005/new...t.exclude.html

Fibonacci

I'm not a pessimist, but a realist. My job is not to run around like chicken little, but to lay the proper path for investors to maximize their returns in the environment which lays before us.

Word to the wise...

Fibonacci

Greenspan's Comments Suggest `Conundrum' Is Conundrum No More
2005-07-21 00:07 (New York)


By Alison Fitzgerald
July 21 (Bloomberg) -- Alan Greenspan's conundrum may be a
mystery no more.
The Federal Reserve chairman yesterday told Congress that
long-term bond yields fell even as short term rates more than
tripled over the past year because global savings are exceeding
investment, inflation expectations are low and the world economy
is stable. Before yesterday, he had rejected several theories
for the so-called flattened yield curve, a situation he termed a
``conundrum'' in February.
``Greenspan has answered his own conundrum,'' Bill Gross,
chief investment officer at Pacific Investment Management Co. in
Newport Beach, California, and manager of the world's biggest
bond fund, said in an interview.
The flattened yield curve ``surely reflects an excess of
intended saving over intended investment,'' Greenspan said in
testimony yesterday before the House Financial Services
Committee. The lower yields also ``can be ascribed to
expectations of lower inflation, a reduced risk premium
resulting from less inflation volatility and a smaller real term
premium that seems due to a moderation of the business cycle.''
Greenspan is scheduled for a second day of testimony today,
this time before the Senate Banking Committee starting at 10
a.m. Washington time.
As the Fed raised the overnight bank lending rate to 3.25
percent from 1 percent at nine consecutive meetings since June
2004, the yield on the 10-year Treasury security has fallen more
than 50 basis points, to 4.16 percent yesterday. The yield fell
as low as 3.89 percent on June 1.

Greenspan's Explanations

Speaking by satellite to a Beijing conference in June,
Greenspan trotted out and then dismissed several potential
explanations. Among those theories was that low long-term bond
yields were signaling economic weakness, or that foreign central
bank purchases were holding down yields.
Greenspan's explanation yesterday ``was as good as any I've
seen,'' said Stephen Stanley, chief economist at RBS Greenwich
Capital in Greenwich, Connecticut. ``His question in February
was, `Why are long-term rates so low?' -- suggesting that
investors have a weak outlook at the same time that risk spreads
are unusually low, which points to a sanguine outlook.''
``He went away from that in June, essentially throwing his
hands in the air and saying, `I don't know why,''' Stanley said.
Pimco's Gross said Greenspan partly accepted the thesis of
former Fed Governor Ben Bernanke that a ``global savings glut''
is lowering long-term yields. Bernanke in March said excessive
savings were flowing into the U.S. and paying for investment and
consumption, aggravating the U.S. current account deficit.

`Secular Phenomena'

``As long as this secular phenomena continues, and it
probably will for years and years, interest rates will be
permanently lower than they ordinarily would have been,'' Gross
said.
Bernanke is now chairman of President George W. Bush's
Council of Economic Advisers and has been mentioned by
economists as a possible successor to Greenspan, 79, whose non-
renewable term as a governor ends Jan. 31.
Greenspan said yesterday that excess savings -- or the high
ratio of savings to investment demand -- are also pushing down
long-term bond yields because there is a greater supply of
savings to demand.
As part of the new theory, he suggested low inflation and
excess saving for investment are longer-term trends that have
pushed down long-term yields for the last decade; the lower risk
premiums demanded by investors account for an acceleration of
the fall in long-term rates in the last year.

Risk-Taking

``Risk-takers have been encouraged by a perceived increase
in economic stability to reach out to more distant time
horizons,'' Greenspan said. ``History cautions that long periods
of relative stability often engender unrealistic expectations of
its permanence and, at times, may lead to financial excess.''
``In other words, low volatility had encouraged excessive
risk taking in the fixed income market,'' said Chris Low, chief
economist at FTN Financial in New York.
Long-term rates are continuing to stimulate the economy, in
part by keeping mortgage borrowing costs low, Greenspan said
earlier this month in a written response to questions from New
Jersey Rep. James Saxton that was released this week.
That has made conducting monetary policy more difficult for
the central bank, which is trying to rein in economic growth and
prevent rising inflation by boosting the overnight bank lending
rate.
``If long term interest rates go down while short-term
interest rates are going up, it means much of the impact of
rising short-term interest rates was blunted,'' said former Fed
Governor Lyle Gramley, now a senior adviser at Stanford
Washington Research Group.
Said William Niskanen, a former member of the Council of
Economic Advisers under President Ronald Reagan who is now
chairman of the Cato Institute, a Washington group that embraces
free markets: ``There doesn't seem to be any particular effect
of the Fed funds rate on longer term market rates, and it's the
longer term market rates that primarily drive borrowing and
savings decisions.''



Cliff's Notes: For those who believe housing will appreciate faster than the long term rate of inflation...think again.

Silver™

Hasn't it throughout history?

In 1970 the average home price was $23K.

With inflation that would be 112K in 2004.

In 2004 the avergae home price was $185K.

GreenMonster

I'm a pessimistic realist

Fibonacci

Apparently you haven't read Irrational Exuberance...as the quote goes, there are lies, damned lies and statistics.


Greenspan Era's Few Downturns Fuel Spending Spree, Less Saving
2005-07-25 00:59 (New York)


By Craig Torres
July 25 (Bloomberg) -- Economic prosperity under Federal
Reserve Chairman Alan Greenspan has changed the way Americans
handle their finances.
Encouraged by rising home and stock prices, they have taken
on more debt and saved less. Managing risks from that legacy may
be one of the toughest tasks for whoever eventually replaces
Greenspan when his term expires Jan. 31 after more than 18 years
at the Fed.
``The American economy is in a very precarious position,''
Joseph Stiglitz, a professor at Columbia University in New York
and winner of the 2001 Nobel Prize in economics, said in an
interview. ``We have a very high legacy of debt. That is what his
successor is going to have to deal with.''
As leader of the world's most influential central bank,
Greenspan presided over the longest expansion in U.S. history,
from 1991 to 2001. Consumers have come to expect long periods of
prosperity and the soaring asset prices that accompany them. The
result of this unbridled optimism ranges from house prices that
have risen 50 percent since 2000 to the lowest savings rate in
more than 70 years.
Fed officials including Greenspan already are stepping up
warnings that households and the markets financing them may have
been lulled into a false belief that asset gains and moderate
business cycles are guaranteed. ``Long periods of relative stability often engender
unrealistic expectations of its permanence,'' Greenspan said in
his written semi-annual testimony before Congress last week. That
can lead to ``financial excess and economic stress.''

Successes

The investor and consumer attitudes that Greenspan frets
about are in some ways the result of his own success.
Fed policies wrenched down inflation, leading companies to
compete on efficiency gains. Incomes rose, unemployment fell and
the central bank's rate cuts kept two recessions to just eight
months each. The government may report July 29 that the economy
expanded at a 3.5 percent annual pace from April through June,
based on the median forecast of 57 economists in a Bloomberg News
survey; that would be the ninth quarter in a row with growth of 3
percent or more. Household wealth boomed as long expansions pushed
stock indexes to records, and the low interest rates of the past
three years accelerated purchases of durable goods.
``The precautionary motive to save has been reduced,'' says
Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey
City, New Jersey.
Consumer spending accounted for more than 70 percent of the
economy every year starting in 2002, the most since the end of
World War II. Household saving fell to just 1.3 percent of income
in 2004, the lowest since 1934, and below the averages of 5.1
percent in the 1990s and 9.5 percent in the 1980s.

An Ever-Larger Burden

Debt is becoming an ever-larger burden. A Fed measure of
estimated payments of mortgage and consumer debt stood at 13.4
percent of household disposable income in the first quarter, the
highest since records began in 1980.
Behind it all are buoyant asset prices that raise perceptions
of wealth. Household net worth, a measure that subtracts debt from
assets including real estate and stock portfolios, averaged 5.57
times personal disposable income for the decade ended 2004
compared with 4.41 times for the 10 years ended 1994.
``People have gotten used to the Greenspan era,'' says Paul
Kasriel, director of economic research at Northern Trust
Securities in Chicago. ``They are going to miss him'' because his
policies spurred gains from investment in stocks, bonds and other
assets.

Marvels

For Greenspan, 79, and Fed governors such as Donald Kohn, 62,
the mortgage and home-equity loan boom was one of the marvels of
an efficient financial system, which translated the Fed's low
interest-rate policies into accessible credit, according to their
speeches in 2003.
Both men have turned cautious this year. ``Capital gains do
not finance capital investment,'' Greenspan said in testimony to
the House Financial Services Committee last week, noting that a
rise in net worth doesn't substitute for saving. ``Clearly, our
savings rate is inadequate and we must address that over the long
run,'' he said.
Greenspan has pointed this year to ``unsustainable'' house
prices and to signs of ``froth'' in some local real-estate
markets.
``A sustained rate of saving of less than 2 percent is too
low for households to accumulate enough wealth to maintain their
standard of living,'' Kohn said in an April 22 speech entirely
devoted to economic imbalances. ``Unless, of course, those
households are lucky enough to receive outsized capital gains on
their homes and other assets.'' Such gains are ``not likely,'' he
added.

`Irrational Exuberance'

Such verbal warnings from the Fed have had little effect on
asset prices in the past. Greenspan's ``irrational exuberance''
comment about the stock market in December 1996 was followed by a
98 percent gain in the Standard and Poor's 500 stock index over
the next three years.
Average U.S. home prices rose 12.5 percent during the first
quarter of 2005 from a year earlier, the fourth consecutive
quarter that gains exceeded 10 percent, according to the Office of
Federal Housing Enterprise Oversight in Washington. Over the past
year, 24 U.S. states recorded home-price gains of more than 10
percent, ranging from 10.5 percent in Montana to 31.2 percent in
Nevada.
Economists say consumers may be acting rationally, using tax-
favored mortgage debt to stock up on property where returns in
most markets exceed stocks, money funds and other assets. What's
worrisome is that the trend is far from balanced and has
implications for economic growth.

Tangible Assets

Starting in 1999, increases in household debt to buy tangible
assets such as homes and cars exceeded purchases of more liquid
financial instruments such as mutual funds, which channel cash to
American corporations and help them grow. That swung what Fed
statisticians call the net financial investment position of
households into negative territory in 1999 for the first time
since 1946. At a minimum, economists say, it raises questions about the
long-term productivity of the U.S. economy because too much
capital is being spent on housing and not enough on research,
development and business investment. ``If it's corporations that weren't saving, I would be more
encouraged because they invest in plants and equipment,'' says
Kasriel. ``As a national economy, we are throwing beer and pizza
parties every afternoon. We are investing in more and bigger
houses, sports utility vehicles, and federal programs.''
The trend is also showing up in the banking system. Home and
commercial property mortgages accounted for 54.4 percent of total
bank loans at the end of the first quarter, a post-World War II
record, according to Fed data.
Large investments in housing ``don't provide more
productivity for anyone,'' says Nouriel Roubini, an economist at
New York University and previously a senior economist for
international affairs at the White House Council of Economic
Advisers from 1998 to 1999. ``There are financial imbalances,''
and Greenspan's successor will face ``a delicate transition.''

--With reporting by Howard Liberman in New York. Editors:
Abruzzese, Miller, Kraus.

Story illustration: To chart changes in house prices using data
from the Office of Federal Housing Enterprise, see
{HPI Levl <Index> GP <GO>}. For more on personal income and
spending, see {PINC <GO>}. To compare the yearly change in
personal income to the change in personal spending, see
{PITLYOY <Index> PCE YOY <Index> HS2 <GO>}. To chart changes in
the household debt-service ratio, see
{DSPBTOTL <Index> GP <GO>}.
To see Federal Reserve data on household debt ratios, click on:
http://www.federalreserve.gov/releas...bt/default.htm



Silver, your relentless bullishness and Dubya optimism is admirable, but misguided.

Silver™

PistonFan, your bearishness and anti-Bush rhetoric is getting old

Sure there could be an economic meltdown, but looking at history as a guide housing has appreciated faster than long term inflation overall...

Unless your dream comes true and we have another Great Depression

Fibonacci

Meh - no wish for depression here...actually I AM an optimist, but the current environment gives me huge pause for concern, and I'm not the only one. If you think growth fueled by massive amounts of new debt is healthy, especially not fixed at historically low rates, I beg to disagree.

As for Dubya, I've stated for the record on multiple occasions that I voted for him twice, but that does NOT mean I engage in hero worship. Our leaders need to be held accountable for their actions.

Silver™

You are the biggest bear since



And no hero worship here either, just don't chose to blame Bush for every problem, unlike some.

Fibonacci

Bearish, perhaps. But I'm pot committed as I presume you are too - 70% of my asset allocation is domestic, so I'd be the first one to put on my pro-dubya cheerleader outfit on if I thought we'd all be better off for it.

Unfortunately, most of the neo-con spin out of the beltway is just that...where's the substance? This Republican Administration and Congress has presided over the biggest expansion in non-military gov't spending in US history - that in my opinion will end up being Dubya's lasting legacy, perhaps even more so than 9/11 and Iraq.

I have no problem with tax cuts, but they need to be paired with spending restraint -- and that has been sorely lacking.

jdone

I was alive and well in 1970 and I can say for a fact that a modern house is actually worth at least $70k more. The average house back then was a lot smaller and almost never came with amenities like central air. Insulation and furnace efficiency were just a joke by modern standards. "They don't make em like that anymore" for a good reason.

Fibonacci

Greenspan Hints at Risk-Free Trade in Treasuries: Mark Gilbert
2005-07-26 19:03 (New York)


(Commentary. Mark Gilbert is a Bloomberg News columnist. The
opinions expressed are his own.)

By Mark Gilbert
July 27 (Bloomberg) -- It's not often Federal Reserve
Chairman Alan Greenspan hints at a risk-free profit opportunity in
the bond market. The central bank chief's remarks last week about
monetary policy, the economy and the yield curve can be
interpreted as signaling the kind of trade that used to be called
a no-brainer when low-hanging fruit seemed easier to pick.
Greenspan said that sustaining growth and keeping inflation
subdued ``will require the Federal Reserve to continue to remove
monetary accommodation.'' With the U.S. central bank driving up
its key lending rate at every meeting, two-year yields look set to
climb in tandem, driving down their prices. At the same time, 10-
year bond values are likely to gain as higher borrowing costs
restrain future consumer-price increases.
That's boosting the likelihood that two-year yields will be
driven higher than those on 10-year bonds, producing what's called
an inverted yield curve in the U.S. bond market.
It's hard to draw any other conclusion from Greenspan's
remarks. He repeated the Fed's mantra that rates may rise ``at a
pace that's likely to be measured,'' suggesting that the nine
consecutive increases since June 2004 that have driven the
overnight lending rate to 3.25 percent are far from being the
last.

Inversion Risk

That prompted David Rosenberg, the chief economist for North
America at Merrill Lynch & Co. in New York, to raise his forecast
for where Fed funds are headed by the end of the year to 4 percent
from 3.5 percent. ``In addition, the risks that the yield curve
flattens/inverts by year-end have risen materially,'' he wrote in
a research note published earlier this week.
The Fed also cut this year's growth forecast to 3.5 percent,
down from its previous range of 3.75 percent to 4 percent. It
raised its forecast for inflation to as high as 2.25 percent for
2005 and 2.5 percent for 2006, after previously seeing a peak of 2
percent.
In years past, central bank chiefs would have been expected
to intervene to prevent an inverted yield curve. When investors
are willing to lend long-dated money at cheaper rates than they
demand on shorter-dated securities, it's typically a signal that
they see recession around the corner.

This Time It's Different

The last time two-year yields climbed above 10-year levels
was in the first half of 2000, with the gap reaching 34 basis
points by mid-year. In the third quarter of that year, the U.S.
economy contracted by 0.5 percent compared with the previous three
months, its worst performance in almost a decade. A fourth-quarter
rally of 2.1 percent was followed by a second contraction of 0.5
percent in the first quarter of 2001.
This time it's different, said Greenspan. ``I think there is
a misconception, relevant not to what we may do, but to the
importance of an inverted yield curve,'' he told the Senate
Banking, Housing, and Urban Affairs Committee on July 21. The
yield curve's ``efficacy as a forecasting tool has diminished very
dramatically.'' That suggests the Fed chairman won't flinch if the
U.S. Treasury curve inverts.
All year, analysts have been forced to capitulate as yields
on 10-year bonds hovered stubbornly below their forecasts. In
January, the 10-year was supposed to end the year at 5.05 percent.
By March, that prediction had dropped to 4.8 percent. In the most
recent Bloomberg News survey, the median forecast of 66 analysts
quizzed June 30 to July 11 was for an end-year yield of 4.7
percent -- still way above the current 4.25 percent.

Sell Twos, Buy Tens

So, back to that risk-free trade. Greenspan shows little sign
of calling a halt to the pace of rate increases, so two-year
yields look poised to extend the climb that's driven them almost
90 basis points higher this year, to about 3.95 percent. Investors
seem disinclined to demand anything more than about 4.25 percent
for lending to the U.S. government for a decade.
By selling the current 3.625 percent note maturing in June
2007 at a yield of 3.95 percent, and buying the 4.125 percent bond
repayable in May 2015 yielding 4.25 percent, you'd make $1,351 on
a $1 million trade if yields are unchanged until the end of the
year, Bloomberg analysis shows.
Your profit climbs to $5,653 if the two-year yield rises to
match the current 10-year rate by Dec. 31. You make more than
$24,000 if the yields match in the opposite direction, with the
two-year unchanged while the 10-year level declines to 3.95
percent. And if the curve inverts by 30 basis points, with the two
yields swapping places, you make almost $29,000.

Risk/Reward Ratio

Of course, it's not really risk-free. You lose more than
$3,000 if the bet goes wrong even by 5 basis points in each
direction, should the two-year yield drop to 3.9 percent while the
10-year climbs to 4.3 percent.
Set against those potential losses is Greenspan. The most
important figure in modern financial history has signed his name
to a picture of rising two-year yields and an inverted yield curve
that he's not worried about. In these days of low yields, low
volatility and skimpy returns everywhere, trade recommendations
don't come much better than that.

Fibonacci

Volatility in GDP Growth Gets Outsourced Abroad: Caroline Baum
2005-08-01 00:06 (New York)


(Commentary. Caroline Baum, author of the forthcoming book,
``Just What I Said,'' is a columnist for Bloomberg News. The
opinions expressed are her own.)

By Caroline Baum
Aug. 1 (Bloomberg) -- The most remarkable aspect of the
current expansion, all the oil-price hysteria and soft-patch
prognostications notwithstanding, is the stability of economic
growth.
Over the last nine quarters, the quarterly annualized change
in real gross domestic product has hovered in a tight 3.3 percent
to 4.3 percent range, with growth in the third quarter of 2003
the outlier at 7.2 percent.
It's almost as if the economy is on automatic pilot.
``I don't remember ever seeing such a high rate of growth in
such a narrow range,'' says Joe Carson, director of economic
research at Alliance Bernstein.
That's not the sense one gets from listening to the
imprudent bears, who keep predicting Armageddon at every bend in
the road; from Democratic politicians, carping about the lack of
job growth; or from protectionists of all persuasions,
complaining that the good jobs are going overseas.
``It's hard to explain the lack of volatility in GDP,''
Carson says. ``Maybe it's due to better information flow and few
surprises on the policy front. But it also shows you that all the
talk about soft patches and slowdowns makes for good press but
poor analysis.''

Offshore Adjustment

Back in the 1980s, which wasn't exactly the Dark Ages, it
was common to see a quarter of 1.6 percent growth sandwiched in
between two quarters of 4 percent growth. Part of the volatility
owed to the fact that the inflation genie had yet to be stuffed
back into his bottle. Most central banks have come around to the
view that the best way to achieve maximum sustainable growth is
through price stability.
``The Federal Reserve's preferred reason (for low economic
volatility) would be that 20 years of anti-inflationary monetary
policy leads to stable economic growth,'' says Neal Soss, chief
economist at Credit Suisse First Boston. ``And they would be
right.''
Secondly, two decades of globalization have produced a more
stable domestic economy.
``We're off-shoring some of the volatility because we import
a lot,'' Soss says.
In the old days, domestic industries would have to slam on
the brakes when final demand ebbed, causing sharp quarter-to-
quarter fluctuations in output.

On Credit's Behalf

Nowadays, when businesses and consumers cut back on their
spending, it translates into reduced imports from abroad.
Countries that export to the U.S. have to do the adjusting. Our
stability is their volatility. (Now there's a good argument for
running a large trade deficit!)
Deregulation is another phenomenon that has forced companies
to become more flexible, Soss says. Otherwise, they won't
survive.
``But the real biggie is the proliferation of credit
innovation,'' he says. ``Credit cards, home equity loans,
mortgage innovations all allow consumers to smooth activity
through time. They aren't constrained by cash in their pocket.''
(No, no one would ever accuse the American consumer of that.)
Economic stability seems to have translated to stability in
long-term interest rates. One component of long-term rates is
inflation expectations. With inflation low and confidence high
the Fed will keep it that way, long-term rates have defied the
Fed's initiative of normalizing overnight rates.
Take the volatility out of growth and inflation, and long
rates have nowhere to go.

Forecasts Raised

Many commentators have remarked on the U.S. economy's
resilience in weathering a series of setbacks, including the
bursting of the stock market bubble, a wrenching cutback in
capital spending, terrorist attacks and corporate accounting
scandals.
Even an old foe like oil has failed to make a dent.
When oil prices rose over $40 a barrel last year, it was
supposed to kill the economy. Then $50 oil became the Maginot
Line. Now oil prices are hovering near $60 a barrel, and
economists are -- guess what? -- raising their forecasts for
third-quarter growth, in some cases to 5 percent.
The optimism came on the heels of Friday's report on real
second-quarter GDP. The headline increase of 3.4 percent failed
to capture strong final demand, or GDP less inventories, which
rose 5.8 percent. The reduction in inventories subtracted 2.3
percentage points from second-quarter growth, the biggest hit in
five years.

Unlikely Trade

Partly offsetting the drag from inventories was trade. Net
exports added 1.6 percentage points to GDP growth last quarter,
the biggest contribution in almost a decade and one that is not
likely to be repeated.
The Commerce Department provided revised GDP estimates for
the last three years as well, showing a less desirable mix of
real growth (lower) and inflation (higher). That combination will
keep the Fed on the defensive.
The decline in the unemployment rate and the rise in
inflation suggest the economy ``is growing above its potential,''
Soss says. ``The Fed is supposed to remove the excess monetary
accommodation.''
Playing defense doesn't mean jamming on the brakes to
produce sub-trend growth. The Index of Leading Economic
Indicators is already pointing to slower growth ahead. On a year-
over-year basis, GDP growth peaked in the first quarter of 2004
at 4.7 percent and has edged down to 3.6 percent in the second
quarter.
In a world where economic growth and inflation are stable,
the central banker's job becomes downright boring.

Fibonacci

Bond Strategists: Merrill Says Yield Curve to Invert (Update1)
2005-08-02 05:17 (New York)


(Updates yields in fifth paragraph.)

By Al Yoon
Aug. 2 (Bloomberg) -- U.S. two-year Treasury note yields
will likely rise above those of 10-year securities next quarter
as the Federal Reserve increases its interest-rate target to cool
the housing market, according to Merrill Lynch & Co.
Two-year yields may rise a half percentage point to 4.50
percent by year-end, as policy makers push up their target rate
to 4 percent from 3.25 percent, Merrill Lynch Chief Economist
David Rosenberg wrote in a research note yesterday. At the same
time, a slowing economy and tame inflation will keep 10-year
yields little changed at 4.25 percent. Yields move inversely to
bond prices.
Rosenberg's forecast assumes shorter-maturity yields, which
are the most sensitive to changes in expectations for monetary
policy, continue to bear the brunt of Fed rate increases. The
difference in yields is about 30 basis points, or 0.30 percentage
point, the narrowest since 2001. The last time the so-called
yield curve was inverted was in December 2000.
``When you take into account that it is now housing that
tops the list (of Fed concerns), whichever way we approach Fed
policy in that context, we now get at least a 4 percent funds
rate and the prospect for an inverted yield curve,'' Rosenberg
said in the report. He didn't return a call for comment.
The two-year note yields 4.05 percent, compared with 2.68
percent when the central bank began raising its target rate for
overnight loans between banks from 1 percent. The 10-year note
yields 4.34 percent, down from 4.58 percent on investor optimism
that the rate increases will temper inflation, which erodes the
purchasing power of fixed-income payments.

Recession Predictor

An inversion of the curve, where short-term yields exceed
long-term yields, has preceded each of the past four U.S.
recessions. The gap between two- and 10-year yields was 248 basis
points at the start of 2004. The looming inversion will last
until the third quarter of 2006, Rosenberg predicted.
Fed Chairman Alan Greenspan as recently as last month said
economic growth remains on ``firm footing.''
Greenspan put a spotlight on the housing market in testimony
to Congress, warning of ``speculative fervor'' and ``froth'' in
some regions. Home prices are rising at a 12.5 percent pace, and
some economists said the Fed is concerned a bursting of the
housing ``bubble'' would damage the economy.
To slow increases in home prices, the Fed would have to
raise its benchmark rate 75 to 100 basis points from 3.25
percent, according to Rosenberg. Merrill, the second-biggest
securities firm, is one of the 22 primary dealers of U.S.
government securities that trade with the Fed.

Housing Market

Annual house-price appreciation of 7 percent to 8 percent
would be more appropriate, based on a Merrill forecasting model
that uses traditional determinants such as interest rates,
income, employment and household information, Rosenberg said.
Rosenberg's yield curve forecast differs from a survey
released last week by the Bond Market Association, which showed
most of its members expect 10-year yields will remain above two-
year yields because of the potential for an expanding economy to
spark faster inflation.
Merrill said growth may begin to slip next year. Rosenberg
reduced his projection for gross domestic product to expand by
2.7 percent, down from a previous estimate 3.2 percent, because
of higher Fed rates and energy costs.
``Concerns over the possible inflationary effect of high oil
prices and the prospect of a slowing productivity profile now
outweigh concerns over the growth outlook,'' Rosenberg said. ``In
addition, the excesses of the housing and mortgage market have
emerged as a major sore spot.''

Contrarian

The economy expanded at a 3.4 percent annual pace from April
through June, for the ninth straight quarter of growth in excess
of 3 percent, the Commerce Department said July 29. Growth hasn't
exceeded 3 percent in as many quarters since a stretch of 16 from
January 1983 through March 1986.
Using an inverted yield curve as sign of an impending
recession is less meaningful than it was a decade ago, Greenspan
said last month.
``There is a misconception, relevant not to what we may do,
but to the importance of an inverted yield curve,'' Greenspan
told the Senate's Banking, Housing, and Urban Affairs Committee
on July 21. ``The quality of that signal has been declining in
the last decade, in fact, quite measurably.''
Investors shouldn't dismiss the meaning, Rosenberg said.
Five of eight series of Fed rate increases since the mid-1970s
have resulted in an inverted yield curve, with each of those five
periods followed by a recession, he said.
``To the view out there that the yield curve is not the
barometer it once was: we are not willing to say that about a
metric with a proven track record of four decades,'' he said.
There are precedents showing inverted yield curves may have
the Fed's desired effect on housing, Rosenberg said. The ``long-
awaited reversal'' in U.K. and Australian housing followed rate
increases that resulted in inverted yield curves in those
countries, he said.

Fibonacci

Why the Federal Reserve must raise interest rates
By Stephen Cecchetti
Published: August 8 2005 03:00 | Last updated: August 8 2005 03:00

When housing markets boom, homeowners get rich. And the rich drive fancy cars, have expensive flat-screen televisions and go on nice holidays. At least that is the way people think it is supposed to work. But we all need somewhere to live so, while the above may be true for some, it cannot work for all of us at the same time. Economy-wide consumption should not respond to changes in property values. That the impact has been large is a problem for everyone, especially for monetary policymakers.


As the Federal Reserve's Open Market Committee (FOMC) meets tomorrow morning, housing should be at the centre of the discussion. Alan Greenspan, the chairman, and his colleagues are in a bind because of the strategy they have followed over the past five years. It now looks as if their overdue reaction to the housing boom will require them to raise interest rates well beyond the 4 per cent or so that most people now expect.

The story starts with the internet boom of the late 1990s. At the time, Fed policymakers concluded that since it was so difficult to identify bubbles as they are inflating, it is best to wait and clean up the mess after the crash. In 2001, that is what they did. The FOMC lowered the short-term interest rate from 6 per cent to 1 per cent.

The predictable result was a housing boom. The value of residential housing in the US is 55 per cent higher today than it was only five years ago. Since household consumption reacts quickly and strongly to increases in property wealth, a recession was nearly averted.

Fed policy replaced the internet bubble with a housing bubble. The problem is that equity and property are very different. When stock prices rise, it signals improved future profitability. Faster growth means higher incomes and more resources to devote to current (and future) consumption.

Housing is different. We all have to live somewhere. When housing prices rise it does not signal any increase in the quantity of economy-wide output. While someone with a bigger house could move into a smaller one, for each person trading down and taking wealth out of their home, someone is trading up and putting wealth in. A rise in property prices means people are consuming more housing, not that they are wealthier. This logic is clear. Even so, when economists look at individuals they see a large effect - an increase in housing wealth has about twice the impact on consumption of an equivalent increase in stock market wealth. For the US economy, the $6,500bn (€5,260bn) increase in housing wealth since 2000 amounts to a $200bn rise in consumption - enough to push GDP up 1.5 per cent and drive the household savings rate to zero.

Much of this added consumption has been financed by increased borrowing. This means that as interest rates rise, an increasing portion of household incomes will have to be devoted to repaying the $4,000bn in additional debt incurred during the first half of this decade. Low interest rates have encouraged borrowing from the future. And the more we borrow, the larger the debt and the bigger the adjustment.

The most troubling aspect of this is the Fed's reaction. The minutes tell us that the FOMC spent a portion of their June meeting discussing housing, concluding that since there is no way to know if there is a housing bubble, there is nothing to be done. These conclusions bear an eerie resemblance to comments made at the height of the internet bubble in the late 1990s.

These statements reveal that policymakers are taking the wrong approach. Consumption should not react to increases in housing wealth. Household spending levels are simply unsustainable and something has to be done. The policy prescription is simple: raise interest rates. Higher interest rates both make borrowing more expensive, reducing household demand, and raise returns on alternative assets for yield-chasing financial institutions.

Hopefully, the Fed can emulate its colleagues at the Reserve Bank of Australia. After three years of nearly 20 per cent annual increases, housing prices have been nearly flat for the past 18 months. A series of interest rate increases, coupled with strong public statements, seems to have done the job. While Australian growth has fallen from 4 per cent to less than 2 per cent, it appears the worst is over.

Following this lead, the FOMC should (1) increase interest rates at the coming meeting; (2) signal that they are far from done; and (3) warn people that the best we can hope for is that housing prices stop rising, but that there is a real risk of collapse.

The writer is professor of international economics and finance, International Business School, Brandeis University

http://news.ft.com/cms/s/e5aeee6a-07...cl=,s01=2.html

Fibonacci

Fed Rate Rises `Not Gaining Traction' in Lifting Borrowing Cost
2005-08-08 00:13 (New York)


By Craig Torres
Aug. 8 (Bloomberg) -- The Federal Reserve's nine straight
interest-rate increases since June 2004 failed to change one
fact: Money is still on sale in America.
It's been at least 32 years since a Fed effort to raise the
benchmark interest rate has had such little effect, a Goldman,
Sachs & Co. index shows. Consumers can still buy washing
machines and computers with zero-interest loans, or homes with
mortgage rates near four-decade lows.
``The Fed is not gaining traction,'' says Lyle Gramley, a
former Fed governor who is now a senior economic adviser to the
Stanford Washington Group in Washington. The central bank has
``to keep tightening monetary policy.''
Chairman Alan Greenspan, who joined the Fed 18 years ago
this week, and other policy makers are likely to extend their
drive to head off faster inflation with the 10th straight
increase in the nation's benchmark rate. They will lift the
overnight lending rate a quarter-point to 3.5 percent tomorrow,
according to the unanimous forecast of 53 economists in a
Bloomberg News survey.
The economy is accelerating, with reports for July showing
the biggest job gains since April, a pickup in manufacturing and
the second-best month ever for automobile sales.
``The Fed is running just to stand still,'' says Jeffrey
Trester, an adviser to the Philadelphia Fed from 2002 to 2004
and founder of price-comparison Web site Pricescan.com. The rate
increases ``haven't substantially raised long-term mortgage
rates, nor have they slowed spending or slowed the economy.''

Rate Forecasts

Wall Street's 22 biggest bond-trading firms are almost
unanimous in predicting the Fed will raise rates at least three
more times this year, according to a separate Bloomberg survey
published today.
``They are going to tighten through the balance of the
year, which will bring the Fed funds rate to 4.25 percent or at
least 4 percent,'' says Michael Darda, chief economist at MKM
Partners LP in Greenwich, Connecticut. ``Monetary policy is
accommodative at current levels.''
Financial conditions haven't been this loose after 13
months of a Fed tightening cycle since at least 1973, according
to the Goldman Sachs Financial Conditions Index. The index
examines data ranging from the trade-weighted value of the
dollar and U.S. stock prices to short-term interest rates.
The index shows that with the Fed's overnight rate at 3.25
percent today, financial conditions are about unchanged from
June 2004, when the rate stood at 1 percent. Typically a 13-
month cycle of increases would have tightened conditions by
about 1 percentage point, the firm says.

Inflation

The Fed's so-called measured pace of rate increase shows
79-year-old Greenspan's preference for moving against risks that
could move the economy away from stable growth and full
employment, says Allan Meltzer, a professor of political
economics at Carnegie Mellon University in Pittsburgh and author
of a history of the Fed.
``He has run the most counter-cyclical policy in history,''
Meltzer says. ``People who criticize him for being too loose too
long would have criticized him for tightening too fast.''
The Fed is trying to head off faster inflation. Its
preferred measure, the personal consumption expenditure index
excluding food and energy, rose at a 1.9 percent rate for the
year that ended in June. That's close to the 2 percent high of
the Fed's forecast range for 2005.
When inflation was a threat in 1994, the central bank
raised interest rates 3 percentage points in 12 months in a
cycle that included three half-point boosts and the only 0.75
percentage point increase of Greenspan's tenure.

Mortgage Rates

Today, with the economy expanding with moderate gains in
employment and inflation, ``the Fed is gradually raising
interest rates,'' Meltzer says. The inflation-adjusted overnight
rate stands at 1.25 percent after 13 months of rate increases.
In early 1995, the so-called real federal funds rate stood at 3
percent after 13 months of increases.
Borrowing costs stayed low in part because yields on 10-
year Treasury notes, the benchmark for many loans, including
mortgages, fell even as the Fed raised its overnight lending
rate. The yield fell to 4.39 percent on Aug. 5 from 4.69 percent
in June 2004 and was below 4 percent less than six weeks ago.
``This is the only postwar tightening cycle when long-term
rates have fallen,'' Joseph LaVorgna, chief fixed-income
strategist for Deutsche Bank Securities LLC in New York, wrote
in an Aug. 4 note to clients. The firm produces a financial-
conditions index that shows the same trend as the Goldman Sachs
index.

Consumers Unleashed

The Fed's go-slow policy unleashed a consumption and
housing boom financed by retailers and banks. Banks are easing
lending standards for both mortgage and commercial borrowers,
the Office of the Comptroller of the Currency said in a report
released July 28.
The low rates are helping companies such as Sears Holdings
Inc. and computer makers Dell Inc. and Hewlett-Packard Co. offer
zero-interest financing on some products. General Motors Corp.,
Ford Motor Co. and DaimlerChrysler AG offered employee-price
discounts to all customers in July and pushed industry sales to
an annual pace of 20.9 million vehicles, second only to October
2001.
Consumers boosted spending by 0.8 percent in June, faster
than the 0.5 percent increase in incomes. Retail sales probably
rose 2 percent in July, the most since May 2004, according to
the median estimate ahead of the Aug. 11 report.
Because paychecks aren't keeping pace with what households
are spending, consumers are taking advantage of low mortgage
rates to tap their real estate equity.

How High?

Cash-out refinancings, where individuals borrow more than
their outstanding mortgage to turn home equity into cash,
amounted to 74 percent of all loans owned by Freddie Mac that
were refinanced in the second quarter. That was the highest
level since the fourth quarter of 2000, the nation's second-
largest mortgage buyer said in a press release last week.
Total cash-out refinancings put an additional $59 billion
in consumers' hands in the second quarter, Freddie Mac
estimated. The long-term mortgage rate averaged 5.82 percent
last week, Freddie Mac said, down from 5.99 percent a year
earlier.
A Credit Suisse index tracking bond financing rates of
investment-grade companies, minus automakers and auto-parts
suppliers, shows financial markets requiring about 8.4 basis
points less yield over corresponding Treasury rates versus last
June. A basis point is 0.01 percentage point.
``When you look at the market what you see is a kind of
indifference to the nine tightenings in place so far, and no
real concerns of credit risk,'' Trester says.
Not even Fed officials know when interest rates will begin
to have a larger impact. Some Wall Street economists say the
overnight rate will have to go a percentage point higher to
tighten financial conditions.
``The market view is that the Fed goes to 4 percent and
then is done,'' says William Dudley, chief U.S. economist at
Goldman Sachs in New York. ``We have them going to 4.5 percent,
and the risks to our forecast is that they go further than
that.''

Fibonacci

US current account deficit puts a cloud over economy
By Christopher Swann
Published: August 10 2005 03:00 | Last updated: August 10 2005 03:00

With the US economyagain seeming in rude good health, it has been tempting toforget about America'sbloated current account deficit.


The US has racked up a deficit of around $2,247bn (€1,821bn, Ł1,260bn) since 2001 without suffering the ill effects predicted by textbooks: chronic currency weakness and surging interest rates.

In fact, the dollar has staged a modest revival over the past six months. More mysteriously, America's debt to the rest of the world has actually declined as a share of national income since 2001.

"It is as if America has been splurging on a credit card without the purchases showing up on the monthly bill," says Bob Sester, an analyst at Roubini Global Economics, a research company. But many economists believe the US has been living in a fools' paradise. Its debt to the rest of the world looks set to rise steeply over coming years. By the end of the year - and for the first time since records began in the 1960s - the US is likely to be paying more to service its debts than it gets in foreign income.

As this happens America will find itself borrowing not just to fund current spending but simply to service previous debts - a position more commonly associated with a developing economy.

So why have the figures looked so good for the US in recent months?

Between 2002 and 2004 the US has run a cumulative current account deficit of $1,188bn. Yet its net foreign liabilities rose by just $87bn and have actually fallen relative to gross domestic product since 2001.

This strange state of affairs is partly the result of currency movements. Since the lion's share of US assets abroad are held in foreign currencies, the decline of the dollar between 2002 and 2004 actually lifted the domestic value of overseas investments.

Meanwhile, because the dollar is a reserve currency, most of America's foreign liabilities are also in dollars - so the value of the liabilities did not increase as the dollar fell. The fall in the US currency has actually boosted wealth and income from overseas investments.

The second reason the US did not suffer from the swelling current account deficit is due to the mix of assets it holds overseas. Americans have tended to invest in riskier assets abroad, while foreigners have been more inclined to opt for safer Treasury bonds. About one-third of US money overseas is in direct investments, one-quarter is in equities, and just 10 per cent is in bonds.

As a reward for taking greater risks, Americans secured a rate of return of more than 7 per cent between 2002 and 2004, compared with 3.4 per cent for overseas investors in the US. So, although US assets overseas are worth about $2,500bn less than foreign assets in the US, Americans still earn more than they pay out.

But neither of these factors will provide long-term safety for the US economy. Americans' preference for direct investment and equities has been helpful during the good times but would become a curse if the world economy slowed.

"If the economy slows, the US would get less money from investments in overseas companies, which could cut their dividends, but would have to continue to pay out interest on their fixed-income obligations," says Stephen King, chief economist at HSBC.

Meanwhile, as US rates rise, so do US payments for overseas investors.

Finally, in order for the currency to offset rising debt as it did last year, the dollar would need to continue to fall. This would increase the chances of overseas investors eventually demanding a risk premium for US assets.

"Either way, the US has a problem," says Nigel Gault, an economist at Global Insight, the consultancy. "It is hard to see a painless solution to this debt problem over the long term."

If the dollar keeps its gains from the past six months, the rise in indebtedness should become much more obvious in the next set of annual figures. With a deficit heading towards $800bn for the year and the currency strengthening, US net external liabilities are expected to rise by about $1,200bn to $3,700bn.

Economists believe that the US may start paying out more than it receives as early as the second or third quarter of this year. The investment income surplus of $36.2bn in 2004 had dwindled to $4bn in the first quarter of 2005.

Mr Sester of Roubini believes that 2005 could see an overall deficit of $75bn. With few signs that the trade deficit is likely to narrow, many economists believe that the current account deficit will reach $950bn in 2006.

"Financial markets may have taken their eye off America's current account but there is absolutely no reason for complacency," says Mr Gault.

http://news.ft.com/cms/s/f21a427c-09...cl=,s01=2.html

Fibonacci

Greenspan Says Fed Paying Attention to Asset Prices (Update3)
2005-08-26 11:01 (New York)


(Adds economist's comment in sixth paragraph.)

By Craig Torres and Alison Fitzgerald
Aug. 26 (Bloomberg) -- The Federal Reserve is paying closer
attention to the rising values of assets such as stocks, bonds
and homes, as low interest rates encourage more risk-taking, Fed
Chairman Alan Greenspan said.
``Global economic activity in recent years has been
influenced importantly by capital gains on various types of
assets, and the liabilities that finance them,'' he said at a
Kansas City Fed symposium in Jackson Hole, Wyoming. ``Our
forecasts and hence policy are becoming increasingly driven by
asset price changes.''
Investors are accepting ever-lower compensation for risk as
economic stability convinces them that their investments are less
risky, he said. While that has helped push up asset prices and
supported consumer and business spending, Greenspan said the
increases ``can readily disappear.'' More caution among investors
could push up interest rates and reduce asset values, posing a
risk for the economy, he said.
``History has not dealt kindly with the aftermath of
protracted periods of low risk premiums,'' Greenspan said. ``Such
an increase in market value is too often viewed by market
participants as structural and permanent.''
His comments come at a time when market interest rates have
fallen even as the Fed is raising the nation's benchmark rate.
The yield on the 10-year note, to which many mortgages and
consumer and business loans are tied, has fallen to 4.16 percent,
almost half a percentage point below where it was when the Fed
began raising rates in June 2004.

`More Balanced'

``Greenspan's remarks appear to be more balanced than in the
past,'' said Stephen Roach, chief global economist at Morgan
Stanley in New York. ``He is moving into closer alignment with
what has become accepted practice in most central banking
circles. Missing, however, is what a central bank should do in
order to avoid the pitfalls of excess dependence on overvalued
assets.''
At the same time, sales of autos and homes have set records,
and the median price of an existing home soared to an all-time
high of $218,000 in July.
``We have a housing valuation issue,'' said Kurt Karl, chief
U.S. economist at Swiss Reinsurance in New York, in an interview.
``The time is now for raising interest rates and defuse these
problems potentially by slowing down the economy a bit and avoid
a big necessary increase later and a consequential recession. The
froth here really raises the risk that he'll continue to raise
rates.''
Kart forecasts the Fed will raise the target rate to 4.5
percent, from the current 3.5 percent, by the middle of 2006
before stopping. ``There is a risk that they will go beyond 4.5
percent,'' he said.

Flexibility

Greenspan said the economy needs to remain flexible,
avoiding movements toward protectionism and larger budget
deficits, to withstand any sudden reduction in asset prices.
``If we can maintain an adequate degree of flexibility, some
of American's economic imbalances, most notably the large current
account deficit and the housing boom, can be rectified by
adjustments in prices, interest rates and exchange rates rather
than through more wrenching changes in output, incomes and
employment,'' he said.
Greenspan's comments come as a growing chorus of economists,
including Roach and David Rosenberg of Merrill Lynch & Co, have
criticized the Fed chairman for remaining sanguine in the face of
what they say is a dangerous bubble in the U.S. housing market.
Paul Kasriel, director of economic research for Northern
Trust Securities in Chicago, said Greenspan has made mistakes.

`Risk Management'

``We have experienced asset bubbles, and we now have an
economy that is more highly leveraged than it ever has been in
the post-World War II period,'' Kasriel said in an interview
before the speech. ``Greenspan has been instrumental in bringing
about this high leverage.''
Greenspan's comment that investors may be overconfident in
the stability of the U.S. economy, thereby bidding up asset
prices, reflects his ``risk management'' approach to monetary
policy.
As he prepares to leave office in January after 18 years at
the helm of the central bank, Greenspan described the philosophy.
Monetary policymakers should look at forecasts produced by
economic models, he said, but they must also consider possible
deviations from those forecasts and the possible consequences.
They then should take action to prevent the most dire
consequences.

Approach on Deflation

As an example, he offered the Fed's discussions about
deflation in 2003. While the possibility was ``very small,''
Greenspan said, ``because the implications were so dire should
that scenario play out we chose to counter it with unusually low
interest rates.''
Greenspan outlined the evolution of monetary policy in the
U.S., from early trade-offs between inflation and employment to
his current approach. He also noted a change in policy
implementation to targeting real, or inflation-adjusted interest
rates as the central bankers learned the importance of limiting
inflation expectations.
The importance of expectations has also played a role in how
slowly the Fed has moved to greater transparency during his
tenure, he said. While the central bank's policy making Open
Market Committee began announcing its policy decisions in 1994,
it wasn't until 1999 that it began regularly offering an
assessment of the economy, and 2003 that it began releasing a
record of its vote.
``We have moved toward greater transparency at a `measured
pace' in part because we were concerned about potential feedback
on the policy process and about being misinterpreted -- as indeed
we were from time to time,'' Greenspan said.

Volcker

Greenspan credited his predecessor Paul Volcker, who chaired
the Fed from 1979 to 1987, with doing the ``very heavy lifting
against inflation,'' which exceeded 10 percent at the start of
Volcker's tenure.
Under Greenspan, the Fed's ``major contribution'' over the
past decade ``was to recognize that the U.S. and global economies
were evolving in profound ways and to calibrate inflation-
containing policies to gain most effectively from those
changes,'' he said.
Greenspan said his concluding remarks tomorrow will deal
with his experience ``living inside'' the Fed, as well as ``some
of the unresolved challenges facing policymakers in the years
ahead.''
Greenspan's comments are an attempt to shape his legacy as
his 18-year tenure at the Fed draws to an end on January 31.
Greenspan presided over the longest economic expansion in U.S.
history and kept inflation in check. He also took a hands-off
approach to a soaring stock market in the 1990s and has done the
same more recently as home prices have outpaced incomes. The
White House hasn't said when it will name a new Fed chairman.

Greenspan Legacy

Greenspan, 79, maneuvered the economy through two stock-
market collapses, in 1987 and 2000, and two recessions in 1991
and in 2001. He cut interest rates to blunt risks from the Sept.
11, 2001, terrorist attacks, the unraveling of the $125 billion
hedge fund Long-Term Capital Management in 1998 and the Asian and
Russian financial crises of the late 1990s.
The economy improved during Greenspan's tenure. Economic
growth averaged 3.3 percent during the last nine years and
consumer prices, excluding food and energy, rose by 2.2 percent.
During the first half of Greenspan's tenure, growth averaged 2.7
percent growth and inflation was 4 percent.
``History will show Alan Greenspan did an outstanding job,''
said Michael Moskow, president of the Fed Bank of Chicago. ``He's
just steeped in economics. He knows the data better than probably
just about anyone else I know.''
The policy making FOMC, led by Greenspan, has spent the last
year reversing interest rate cuts that took its benchmark rate to
the lowest level in 40 years in 2003. The FOMC has raised the
federal funds rate 10 times in the last 13 months, to 3.5 percent
from 1 percent, and said Aug. 9 it may continue to increase rates
``at a pace that is likely to be measured.''

`Conundrum'

The Fed is trying to stave off higher inflation as the
economy accelerates and fuel costs and home prices surge.
Those rate increases haven't slowed the economy much because
long-term bond yields, which usually follow the Fed's short-term
rate moves, instead have fallen. Greenspan called this phenomenon
a ``conundrum'' in February.
In his most recent testimony to lawmakers, Greenspan said
the economic outlook was ``favorable.''
``The U.S. economy has remained on a firm footing, and
inflation continues to be well contained,'' Greenspan told
Congress in July. ``Moreover, the prospects are favorable for a
continuation of those trends.''
Even so, Greenspan warned of risks, such as ``signs of
froth'' in some regional housing markets and the rising price of
oil and natural gas.
Greenspan, who worked as a New York consultant and
Republican economic adviser until then-President Ronald Reagan
nominated him to be Fed chairman in 1987, will probably end up as
the second longest-serving Fed chairman behind William McChesney
Martin, who left the central bank in 1970 after 18 years and 10
months.
The three presidents after Reagan -- Republican George H.W.
Bush, Democrat Bill Clinton and Republican George W. Bush -- each
kept Greenspan as Fed chairman.

Fibonacci

Greenspan Called `Greatest Central Banker' by Blinder (Update2)
2005-08-26 12:13 (New York)


(Updates with Greenspan comment in 10th paragraph.)

By Scott Lanman
Aug. 26 (Bloomberg) -- Federal Reserve Chairman Alan
Greenspan, blamed by some economists for ignoring stock market
and housing bubbles, won a firm endorsement of his 18-year tenure
at the Fed from Princeton University's Alan Blinder, a former
deputy with whom he sometimes clashed.
``He has a legitimate claim to being the greatest central
banker who ever lived,'' Blinder, who spent 19 months as the
Fed's No. 2 in the mid-1990s, wrote in a paper presented today at
a Fed conference in Jackson Hole, Wyoming.
Wall Street economists such as Merrill Lynch & Co.'s David
Rosenberg say Greenspan, 79, has put the economy at risk by not
raising interest rates fast enough to cool the hot U.S. housing
market. Blinder and co-author Ricardo Reis, a Princeton assistant
professor, said Greenspan was right to let the stock-market
bubble of the late 1990s burst and then deal with the
consequences.
Greenspan's ``strategy of mopping up after bubbles rather
than trying to pop them,'' Blinder wrote, is ``a salutary one.''
The Princeton economist, while not discussing the soaring
housing market, said Greenspan's hands-off approach should ``also
work well after other, presumably smaller, bubbles burst.''
Housing prices have risen 50 percent since 2000.
Greenspan, in a speech today at Jackson Hole, said, ``Our
forecasts and hence our policy are becoming increasingly driven
by asset prices changes.''

Assessing Greenspan

Blinder and Reis, while praising Greenspan, don't pull all
of their punches. The authors say Greenspan ran too much of a
``one-man show'' at the Fed, didn't follow a set of clear rules,
and expressed his views on too many issues that did not pertain
to Fed policy.
A 2000 book by journalist Bob Woodward said Blinder was
``profoundly frustrated'' as Fed vice chairman because Greenspan
blocked his efforts to become chairman.
Blinder's 93-page analysis of Greenspan's performance is the
lead paper at the Federal Reserve Bank of Kansas City's annual
symposium, the most prominent gathering of central bankers
outside of Washington. The paper is being discussed today by a
panel of economists at the conference. The theme of the Jackson
Hole event is ``The Greenspan Era: Lessons for the Future.''
Greenspan's term on the Fed ends on January 31.
``It has been a long 18 years,'' Greenspan said at the
symposium's opening dinner yesterday. ``It has been a wonderful
18 years.''

Faster Rate Increases

Economists including Rosenberg and Stephen Roach of Morgan
Stanley are urging the Fed to speed up interest-rate increases to
slow the growth in home sales and prices. New-home sales rose to
a second straight monthly record in July, a government report
this week showed.
``Act now and cut off the pinky, or wait till later and risk
slicing off the entire hand,'' Rosenberg said in an interview
last month. ``Either way it hurts, but you can still type with
nine fingers.''
The policy-making Federal Open Market Committee, which
Greenspan leads, said in June that it wouldn't use interest rates
to address ``possible mispricing'' in home prices, according to
the minutes of the meeting.
``It's not the Fed's job to protect people from making
mistakes,'' said Allan Meltzer, a professor at Carnegie Mellon
University in Pittsburgh and author of a history of the Fed.
Meltzer, who is appearing with Blinder on a panel to discuss the
paper today, spoke in an interview before the event.

Policy Changes

The paper also examines Greenspan's contributions to
monetary policy, such as a focus on ``core inflation'' that
excludes volatile food and energy costs, and the question of
whether Greenspan was ``lucky or good'' in his achievements.
``For years now, U.S. monetary policy has been said to be on
`the Greenspan standard,' meaning that it is whatever Alan
Greenspan thinks it should be,'' the authors wrote.
Blinder, 59, said Greenspan has opted for ``discretion
rather than rules,'' adding, ``when the next leader of the Fed
takes his seat behind the chairman's desk and opens the top
drawer in search of Alan Greenspan's magic formula, he will be
sorely disappointed.''

`Stomped'

Woodward's book, ``Maestro,'' says Blinder was unhappy at
the Fed because Greenspan worked to ``stomp out'' Blinder's
chances of becoming chairman. Blinder resigned in January 1996
without giving Greenspan advance warning of the announcement,
Woodward wrote.
Blinder, appointed by Clinton as a Fed governor in 1994,
left in January 1996 after it became clear that Blinder wouldn't
replace Greenspan as chairman, Woodward wrote.
Meltzer said he wasn't surprised by the mostly positive tone
of Blinder's paper, though he said, ``Alan Blinder, as vice
chairman, probably didn't understand enough about Alan
Greenspan.''
``Alan Greenspan is very much a person who is a leader, but
who really is something of a one-man band,'' Meltzer said.
Blinder reviews Greenspan's performance during the stock-
market crash of 1987, two wars in Iraq, the financial crises in
East Asia and Russia in 1997-98 and the ``deflation scare'' in
2003.
``Greenspan handled most of these challenges with great
aplomb, and with immense benefits to the U.S. economy,'' Blinder
and Reis wrote. ``His stellar record suggests that the only right
answer to the age-old question of whether it is better to be
lucky or good may be: both.''

Trusted

So trusted is Greenspan, one of today's most famous
capitalists, that Blinder likens him to one of history's most
famous communists, the late Chinese leader Mao Zedong, whose
``Little Red Book'' of quotations became required reading for the
country's residents in the 1960s.
``The financial markets now view Chairman Greenspan's
infallibility more or less as the Chinese once viewed Chairman
Mao's,'' Blinder wrote.



It will be very interesting to see who replaces him...

Robert Rubin

Fibonacci

Foreign Demand Reduces 10-Year Treasury Yields, Fed Study Finds2005-09-28 12:33 (New York)


By Deborah Finestone
Sept. 28 (Bloomberg) -- Foreign demand for U.S. government
debt is keeping yields on 10-year Treasuries about 1.50
percentage points lower than they otherwise would be, a bigger
amount than estimated by some Wall Street strategists, according
to a study done for the central bank.
As of the end of July, foreign investors' net holdings of
U.S. treasuries were about $2.03 trillion, or about half of all
marketable Treasury securities outstanding and up from $975.9
billion in July 2001, according to Treasury Department data.
Federal Reserve Chairman Alan Greenspan on Feb. 16 told
Congress that a drop in long-term debt yields since the Fed
started raising interest rates in June 2004 was a ``conundrum''
partly attributable to purchases by foreign governments. The
benchmark 10-year Treasury yield, which moves inversely to the
note's price, was 4.27 percent at 12:24 p.m. in New York,
according to Cantor Fitzgerald LP.
``Long rates are indeed low, but not surprisingly low,''
according to the Fed report dated September 2005 and written by
Francis Warnock and Veronica Warnock, professors at the
University of Virginia in Charlottesville, Virginia.
Francis Warnock is a former Fed senior economist. He didn't
immediately return a call for comment. The 10-year note's yield
is used to help determine consumer and corporate borrowing rates.
``The results in this paper suggest that large foreign
purchases of U.S. bonds have contributed importantly to the low
levels of U.S. interest rates over the past two years,''
according to the study.
Debt strategist at firms including Banc of America
Securities LLC have estimated that overseas demand helped push
yields on 10-year notes about 20 basis points lower than they
otherwise would have been. A basis point is 0.01 percentage
point.

Largest Holders

The yield is down from 4.76 percent in June 2004, when the
Fed started increasing its target rate for overnight loans
between banks. The rate is now 3.75 percent, up from 1 percent.
The largest foreign holder of Treasuries is Japan, at $683
billion, followed by China, with $242.1 billion, according to the
Treasury Department.
China is likely to keep buying U.S. debt based on its steady
need to reinvest growing foreign reserves, Steven Abrahams, a
senior managing director at Bear Stearns & Co. in New York, said
in a research report dated yesterday.
``The good overseas bid means that portfolios waiting for
higher rates in the long end of the U.S. curve may end up
disappointed yet again,'' Abrahams wrote of longer-maturity debt.
Treasury Secretary John Snow said foreign demand for
Treasuries is likely to remain high, in part because of a global
glut of savings.
``Savings around the world are at a high rate,'' Snow said
in an interview with CNBC. ``A lot of that savings is going to
find its way, as it has in the past, into the U.S. Treasuries and
into the U.S. Treasury and into the U.S. capital markets
generally.''

source: bloomberg.com


Cliffs Notes: In other words, next time you hear some clown bashing China or Japan, tell them to go fuzz themselves --- they're the reason you enjoy cheap imports and low mortgage interest rates.

Fibonacci

Fed sets tone of caution

By Sue Kirchhoff, USA TODAY

WASHINGTON — Federal Reserve Chairman Alan Greenspan warned Tuesday that investors should not become too sanguine about prolonged periods of low interest rates and economic stability, saying they are inevitably followed by falling asset prices.
The central bank chief did not specifically mention the current run-up in housing prices in his speech via satellite to the National Association of Business Economics meeting in Chicago. But he said in a speech last month that lower interest rates and higher productivity had helped propel stock, bond and home prices higher — and cautioned that such increases in value were too often seen as permanent.

Greenspan also said Monday that home buyers were putting themselves at risk by taking out exotic mortgages, such as interest-only loans, though he added that most homeowners have enough equity to help them weather a price drop.


Repeating a recent theme, Greenspan said Tuesday that central bankers' success in promoting economic stability has had an unintended side effect: "euphoria" by investors. (Related: Full text of speech.)

"A decline in perceived risk is often self-reinforcing in that it encourages presumptions of prolonged stability," Greenspan said. "History cautions that extended periods of low concern about credit risk have invariably been followed by reversal with an attendant fall in the prices of risky assets."

The Fed is increasingly concerned about the red-hot housing market, which has been setting records for five years. Interest rates on 30-year mortgages have unexpectedly remained under 6% even as the Fed has raised short-term rates 11 times since June 2004 to 3.75%, supporting home sales.

Still, Greenspan reiterated that the Fed should not use interest rate policy to pop possible asset bubbles, saying doing so could cause broad harm. He called economic flexibility the best defense.

Also Tuesday, Janet Yellen, president of the San Francisco Fed, told a London conference that the U.S. growth rate, now at a 3.3% annual pace, would probably decline by half of a percentage point through the end of 2005 due to Hurricane Katrina, then rebound in 2006.

Yellen made it clear that more interest rate increases are in store to head off inflation from higher energy prices and other factors: "One option that is clearly not on the table is allowing an unacceptable rise in inflation. To maintain its credibility, the Federal Reserve must deliver — again and again — on its commitment to price stability."


http://www.usatoday.com/money/econom...reenspan_x.htm

Fibonacci

U.S. 2-Year Note Yields May Exceed 10's on Inflation (Update3)
2005-10-03 07:45 (New York)


(Updates yields in fifth paragraph.)

By Al Yoon and Elizabeth Stanton
Oct. 3 (Bloomberg) -- U.S. bond investors are betting that
two-year Treasuries will yield more than 10-year notes for the
first time in four years as Federal Reserve policy makers
indicate they will keep raising interest rates to tame inflation.
The gap, known as the yield curve, is 0.16 percentage point,
the narrowest since Aug. 30, as two-year note yields rose the
most in three months. Traders, strategists and economists at some
of Wall Street's largest bond-trading firms say yields on two-
year Treasuries will rise faster than those on 10-year securities
as the central bank slows price increases.
Kansas City Fed President Thomas Hoenig was among central
bank officials that last week said they were more concerned about
inflation than a slowing economy after Hurricanes Katrina and
Rita. Such comments are a recipe for even higher two-year yields,
which may invert the yield curve, an event that preceded each of
the past four recessions, including the last one in 2001.
``The curve is going to end up being flatter, or inverted,''
said Alan De Rose, a proprietary trader and Treasury market
strategist in New York at CIBC World Markets Inc., one of the 22
primary dealers of U.S. government debt that trade with the Fed.
``The Fed's been very clear about what they want to do.''
The benchmark two-year note yielded 4.16 percent as of 7:41
a.m. in New York, according to bond broker Cantor Fitzgerald LP.
The 10-year note yielded 4.32 percent. Last week the two-year
yield rose 15 basis points, or 0.15 percentage point, and the 10-
year yield rose 8 basis points. As a result, the yield curve
flattened 7 basis points, the most since the week ended Aug. 12.

`Being Vigilant'

A flatter yield curve ``makes a lot of sense,'' said John
Brynjolfsson, a managing director at Newport Beach, California-
based Pacific Investment Management Co. The Fed ``wants to be
seen as being vigilant against inflation.'' Pimco manages more
than $480 billion, including the world's largest bond fund.
Consumer prices, excluding food and energy, rose 2.1 percent
in August from a year earlier, less than the average increase of
2.3 percent over the past decade. Overall, prices surged 3.6
percent, the most since 2001 and ``high enough to get your
attention,'' Hoenig, who doesn't vote on monetary policy this
year, said on Sept. 26.
Two-year yields, considered more sensitive to changes in
monetary policy than longer-maturity yields, increased 1.35
percentage points since June 2004 as the Fed lifted interest
rates 11 times, to 3.75 percent from 1 percent.
During the same period, traders drove 10-year yields down 36
basis points as the central bank kept inflation tame amid the
economy's expansion, preserving the purchasing power of interest
payments. The difference in yields between the two Treasuries
declined from 197 basis points in mid-2004.

Faded Hopes

``The odds of an inversion look good,'' said Steven
Abrahams, a senior managing director of fixed-income in New York
at Bear Stearns & Co., another primary dealer.
In the weeks after Katrina, the costliest U.S. natural
disaster, speculation rose the Fed would pause in its
``measured'' pace of rate increases.
Consumer confidence as measured by the University of
Michigan tumbled to the lowest since 1992, and interest-rate
futures showed traders reduced expectations that the Fed's
benchmark rate would end the year at 4.25 percent to 13 percent
from more than 90 percent.
Two-year yields on Sept. 21 exceeded the Fed's benchmark
rate by 17 basis points, the slimmest margin since mid-2003, when
the central bank last cut rates. The yield curve widened to 33
basis points on Sept. 19 from 12 basis points on Aug. 29.

`Declare Victory'

``Since the curve has flattened so much, we just decided to
declare victory and not hold out for the last few basis points of
flattening going forward,'' said Robert Truesdell, a fund manager
at Manufacturers & Traders Trust in Buffalo, New York, which has
about $3 billion of fixed-income assets under management.
U.S. personal income unexpectedly fell in August for the
first time since January, dropping 0.1 percent, the Commerce
Department said at the end of last week. Spending fell a greater-
than-expected 0.5 percent, the biggest decline since May 2002.
``It's quite possible the Fed could overshoot,'' said Steven
Roach, chief global economist in New York for Morgan Stanley,
another primary dealer. ``The yield curve is unbelievably flat
here and if the long end continues to confound us and the Fed
stays with its drill, we'll have an inverted yield curve.''
The last time two-year yields exceeded 10-year yields was in
December 2000. The difference is that now none of 60 economists
surveyed by Bloomberg from Aug. 31 to Sept. 8 said the economy
will contract in the coming year, while at the end of 2000, three
of 34 economists called for it to shrink.

`A Misconception'

The International Monetary Fund said last month the U.S.
economy may expand 3.5 percent this year, the fastest among the
Group of Seven nations, and 3.3 percent in 2006.
There is ``a misconception'' as to the yield curve's
importance, Fed Chairman Alan Greenspan told Congress in July.
Its ``efficacy as a forecasting tool has diminished very
dramatically.''
Traders again put on bets that the Fed would successfully
fight inflation without damaging the economy on Sept. 20, after
the central bank lifted its interest-rate target to 3.75 percent
and said the economy faces ``near-term'' setbacks in employment,
spending and production from Katrina.
Futures indicate traders see a 96 percent chance of an
increase to 4 percent on Nov. 1 and a more than 70 percent chance
for a second quarter-point boost on Dec. 13.
Bond investors and traders expect the yield curve to flatten
``with a possible inversion on the not-too-distant horizon,''
said Christopher Sullivan, chief investment officer at the United
Nations Federal Credit Union in New York, which manages $2
billion in debt.


Source: Bloomberg.com

Silver™

I would be a rich man if I had a dollar for every adviser who, over the past 15 months or so, argued that a recession was imminent because the yield curve had become inverted.

I'd be a very poor man if my wealth were dependent on getting a dollar for every one of those advisers who, since late last week, has even acknowledged that the yield curve has become positive again - much less conceded that, by the logic of their previous argument, a recession has become less likely.

It just goes to show how difficult it is to be truly objective in this business.
The yield curve, of course, refers to the relationship between interest rates of different maturities. Normally, longer-term maturities are higher than shorter-term maturities. But, occasionally, this relationship becomes reversed inverted, if you will. Many economists (though not all, by any means) believe that an inverted yield curve is a good leading indicator of economic recessions.

There is no consensus among economists concerning which particular maturities should be focused on when determining whether the yield curve is inverted. One pairing that is widely used, however, is the difference between the yields on two-year and 10-year Treasuries.

The yield curve as thus defined became flat in late 2005, and was inverted during much of 2006. Its maximum inversion in recent months came last November, when the two-year T-Note was yielding 19 basis points more than the 10-year note. As recently as the end of February, the curve was still inverted to the extent of a 14-basis-point difference between the two maturities.

But Wednesday the relationship righted itself. Currently, according to data from the Federal Reserve, 10-year Treasury notes are yielding 4 basis points more than the two-year note.

http://www.marketwatch.com/news/stor...ist=TNMostRead

Silver™

So what did you do with all your cash from 05?

Fibonacci

Like I said before Mr. Precious Metals, you think one step ahead, I think 10 steps ahead. :wink:

You are wrong on the housing bubble.

You are wrong on our invasion of Iraq.

You are wrong on deficits.

You are wrong on global warming.

You are wrong on Peak Oil.

WRONG, WRONG, WRONG, WRONG, WRONG.

And as for net worth, don't worry about me, I'm doing just fine.

Silver™

I see I struck a nerve, perhaps you could elaborate on how I am wrong Mr. Guru.

Still waiting for the housing bubble to pop and the global depression to begin.

Based upon what was known in 2003 I was right about Iraq

What about deficits, the fact that they are declining in recent years.

All that I have said about Global Warming is that we are far from truly understanding our effect upon nature. But I am sure you know the truth about Global Warming, thank you Mr. Gore.

What about "peak oil", the fact that we are still decades from the true peak and new technology and new discoveries will push it back further?





You still haven't told us about what you did with all your cash from 05 that you took out due to the impending recession.

You read some blogs or some pessimistic articles and take it as fact and post it here. A real "guru" would at some point during the last 2 years have given us some real good financial advice that we couldn't also get from reading Bloomberg, you haven't. Which explains why the "guru" is stuck in the deadest city in the country (Detroit)

Fibonacci

Well, since an inverted yield curve has predicted every US recession since 1950, with an exception in 1966, recent history is on my side. :wink:

http://www.bloomberg.com/apps/news?p...d=auWrZNIRpSaI

Silver™

Econ 101:

"Past performance is no indication of future returns."

A real "guru" looks beyond historical trends of one variable and looks at all the variables at that point in time

Fibonacci

You need to take Econ 101 again, Mr. Precious Metals. You are quoting a mutual fund disclaimer, not economic models.

And you need to take your own advice, just because the weather is sunny now doesn't mean it will be tomorrow. Take deficits for example, your sunny disposition neglects the fact that Dubya has conveniently timed his exit to coincide with an exploding deficit dilemma. DO YOUR HOMEWORK!