2011 Outlook

Happy Holidays

2011 Outlook

The Holidays are here and 2011 will soon be upon us. With liquidity scare from now through year-end 2011 should be the focus of all fixed income investors. 2011 is going to tell us much. It will tell us if the EU will hold together. It will tell us if the euro can survive as a currency. It will tell us if centralized monetary policy and localized fiscal policies is a feasible model in the long-term. 2011 will also tell us what a non-bubble U.S. expansion looks like.

Europe is going to be interesting. Its problems are not going to be solved with bailout funds and strong language. Troubled countries are either going to cut benefits to its citizens, adopt pro-growth policies or leave the euro and try to devalue their way out of their problems. The list of troubled countries may be expanding. Belgium may join the PIIGS among troubled European countries. I still haven’t come with a new acronym. The bottom line is that Europeans have some difficult choices to make.

One choice which will probably not be available is to continue with their market / welfare state hybrid while being part of a common currency. The ECB can do little to help distressed countries because it can’t ease or engage in QE to help a country like Greece without damaging the economies of countries like Germany. One way to solve this dilemma would be to give the EU the authority to dictate both fiscal and monetary policy for the entire bloc, a United Stated of Europe if you will. However, that would require member countries to give up their sovereignty and adhere to rules set by a central governing body. This will not go over well among the European populace. Although its demise is not certain make no mistake, the euro is in trouble.

Closer to home we will soon see what the economic potential of a non-bubble-fueled U.S. economy looks like. Economic data during the first half of 2011 will be positively affected by the extension of the Bush-era tax cuts and the suspension of the worker portion of the payroll tax. However as with all temporary stimulus measures, the benefits are likely to be short-lived and less affective than anticipated. By the end of 2011, the U.S. economy will have to fly on its own power. Not all stimulus will be removed. It is unlikely that the Fed will engage in QE3, but it is unlikely to raise rates in 2011.

Long-term rates may not have far to rise in 2011. The recent rise of long-term rates is mostly a correction following a smaller than anticipated QE2 program and better growth outlook. Current long-term rates probably have GDP between 3.50% and 4.00% mostly built in. We could see a 4.00% 10-year note by the end of 2011, but maybe not much higher. If the economy cannot gain more traction, long-term rates could languish in the mid-3.00% area. In fact, Philadelphia Fed President Charles Plosser, who has been one of the more hawkish and optimistic Fed officials gave his 2011 estimate today. He forecasts that 2011 will be in the 3.00% to 3.50% area.

Fixed income investing in this environment is not that difficult, if one manages expectations. Ladder your portfolio. Resist swapping into “sexy” products or overweighting on the long end of the curve (or the short end of the curve). Invest new money on the belly of the curve (5-10 years) unless that runs counter to your goals, objectives or risk tolerances. TIPS are rich. The break even between 10-year TIPS and the 10-year treasury is 230 basis points. With inflation likely to be tamer than what the alarmists are predicting us TIPS only as hedging vehicle. Watch out for bubbles in very-low-rated bonds (low B and CCC) and a correction in investment grade industrials. Financials, insurance and, to a lesser extent, telecom offer the best values.

Investors should consider callable agency bonds, including step-ups. I also believe that corporate step-ups offer value, more than do LIBOR-based floaters. CPI corporate floaters may be a better option. Not because inflation is going to run, but because even modest increases in inflation will be greater than what occurs in three-month LIBOR (the typical benchmark for floaters) as it is joined at the hip with Fed Funds and the Fed is not budging in 2011. Not unless housing takes off, removing significant headwinds facing the economy, but that probably will not happen.


Until next year.

Right Said Fed

The November Advance Retail Sales came in better than expected as generous discounts and more optimistic consumers kicked off the holiday shopping season in a big way. Target and Macys were among the retailers reporting strong sales in November, largely due to impressive Thanksgiving sales.



One economist told Bloomberg News:



"Holiday sales are looking pretty good. Consumer spending will steadily improve in coming months. We're seeing a better overall economic outlook."



The street consensus if for improved consumer spending, but considering how poor consumer spending had been, even a big improvement could still leave consumer spending below to what we have become accustomed this far into a recovery. With unemployment expected to remain high and the housing market likely to remain impaired for several more years, consumer spending will likely rise slowly,



A sign that consumer spending is more than holiday driven is the report by Home Depot which indicated that sales of plumbing and electrical supplies rose. Although it is possible that many handy people are going to get what they want for Christmas, Home Depot's results look to be a sign that the pick up in consumer spending is more broadly based. On the down side, electronics retailer Best Buy reported worse-than-expected earnings as discounters such as Amazon and Wal-Mart are providing stiff competition





The headline PPI figure was up .8% versus a prior number of .4% (month-over-month) However, core PPI (MoM) came in at .4%, the smallest increase in five months. Much of the core PPI gain was due to higher energy prices (although egg prices were up a whopping 23%). How much will this influence CPI? Probably not that much. High unemployment, reduced household wealth and a fierce battle for market share are preventing businesses from passing price increases onto consumers. Raising prices is an almost sure way to lose market share in this environment. Instead businesses increase productivity by purchasing more efficient equipment or send jobs to lower-labor regions. This is helping to moderate the employment recovery.





The Fed will announce its rate decision this afternoon, there should be no surprises. The Fed will leave the Fed Funds target rate at between 0.00% and 0.25%. It is likely to reinforce its commitment to QE2, but its statement may very well have a more positive tone as to the strength and pace of the recovery.



The question which is being asked across the industry (across the country, actually), is: Is QE2 working. One could argue is that QE2 has sparked inflation fears in many areas of the economy, but has not helped to boost prices in the sector for which the Fed had hoped to see higher prices, real estate. However, some experts believe that Fed policies are working.



In today's Wall Street Journal, Wharton Professor Jeremy Siegel opines that QE2 is working and the sign that is working is higher treasury yields. Higher yields in among U.S. treasuries have been pointed to as a sign that Fed policy has been a failure based on the belief that QE2 has pushed bond yields and mortgage rates higher due to increased inflation fears because the Fed is causing the government to print money. This is the so-called vigilante theory.



Mr. Siegel argues that the real reason rate have been rising is that the bind market is becoming more optimistic that the economic recovery is strengthening, He states:



"Long-term Treasury rates are influenced positively by economic growth-which encourages consumers to borrow in anticipation of higher incomes and causes firms to seek funds to expand capacity-and by inflationary expectations. Long-term Treasury rates are affected negatively by risk aversion: Seeking a safe haven, investors pile into Treasury bonds, running up their prices and lowering their yields."



Mr. Siegel gets no argument from us, but bond yields are up for a variety of reasons. One reason is certainly due to better growth prospects. However, some of it is due to inflation fears due to the printing of money (we would argue that most of the vigilantism was in response to the tax cut extensions). Seemingly lost in this discussion is that fact that in the months leading up to the launch of QE2, many market participants purchased large amounts of U.S. treasuries on the beliefs that the size of QE2 would be much larger (some thought it would be nearly twice the size of what actually launched) and that the Fed would also target the very long end of the yield curve. Neither scenario played out.



There has been much talk about how the bull market in binds is over. No kidding, When the 10-year treasury note was around 2.50%, did any responsible person really believe it was going much lower (higher in price)? And if so, did any responsible person really believe it would stay there for a long period of time. Look at where long-term U.S. interest rates are, currently. If they rose 50 or even 100 basis points they would still be on the historically low side.

Just because the bull market is over does not mean that the bear market will push rates bank to what were common in the early 1980s. It does not even mean that they will rise to where they were in the early 1990s. All it means is that the probabilities for a double-dip recession of lessened and that the market has readjusted. Of course if one has laddered and diversified one's portfolio, one probably has little angst over where rates are going.

Make Up Your Mind

Just when it you thought it was safe to believe that the economy was gaining some steam, today's data poured water on the fire. Nonfarm payrolls came in with a disappointing 39,000 new jobs in the month of November. Even when one considers the upward revision of 21,000 jobs for the October that only equals a total of 60,000 new jobs. The two-month average of approximately 105,000 new jobs per month, roughly half the number of jobs needed to lower the unemployment rate.

The private payrolls data, considered to be a better measure of unemployment recovery, due to the importance of the private sector in the U.S. economy, was also disappointing reporting only 50,000 new jobs with an upward revision of 1,000 additional jobs to the October data. This is quite a disappointment given last Wednesday’s better-than-expected ADP employment data.

Not surprisingly the markets initially reacted negatively to the data then recovered significantly. The reason for the recovery was said to be the belief that payrolls data for November may be a negative outlier. Supporters of this theory point to the strong ADP number. I cry foul on this. Why do I cry foul? The ADP report (a measure of private payrolls) has undershot the private payrolls component of the establishment survey. Critics have pointed to this and decried the ADP report as being unreliable as it underestimates the employment recovery. Not with the ADP report overshooting today’s private sector data, it is ADP which is being called accurate and the establishment data is now deemed to be unreflective of the job market recovery.

Beware of pundits, market participants and strategists who cherry-pick data for their own needs. Economists put far more value in the Nonfarm Payrolls data and its private sector component for a reason. It is more broad-based and tells a more complete and accurate story. Blind market bulls cannot have it both ways,

As if the Nonfarm Payrolls report wasn’t depressing enough, the Unemployment Rate report offered no comfort. The unemployment rate rose to 9.8% from 9.6%. Often during an economic recovery the unemployment rates will trend higher as discouraged displaced workers become more optimistic and answer the so-called household survey that they are now looking for work. However, that was not the case this time around. The unemployment rate rose due to more Americans being laid off.

I don’t often find much valuable commentary on CNBC. I believe that CNBC really stands for Constantly Naively Bullish Channel. However, today one guest speaker (whose name I did not hear) made a poignant observation. He stated that maybe the impact of technology on productivity is being underestimated and the impetus for large-scale hiring just isn’t there, in spite of the pick up in economic activity. I have heard that before, but I can’t remember where. ;)

Today’s soft jobs data should not come as a complete surprise. Fed Chairman Bernanke has been warning that the economic recovery is sluggish and job growth is impaired. This is why the Fed engaged in QE2 and could very well leave the Fed Funds rate unchanged well into 2012.

Fed policy is causing some inflation concerns. This is not surprising as the Fed as acknowledged it is trying to accomplish just that. However, the benchmark from which to gauge the bond market’s inflation concerns has changed. For almost a decade, the 10-year treasury note was the long-term benchmark for inflation concerns. This was because of the suspension of 30-year government bond issuance in 2001 and because a comparatively small float (amount issued) compared with the 10-year since 30-year auctions resumed a few years ago. Now with Fed making about 1/5th of its purchases in the 10-year area, the 10-year yield, although higher recently, is probably too low to accurately reflect inflation concerns. The long bond has regained its status as the long-term inflation benchmark.

What does the long bond yield tell me? That inflation pressures may increase, but there is no need to buy a wheel barrow to haul grocery money to the store. Sure, we could see 5.00% by 2012, but I doubt we will see inflation strong enough to push long-term rates much higher, not unless we can create another bubble.

There is a debate as to what is and isn’t inflation. There is a stupid YouTube video circulating explaining QE2 and why it makes not sense. The video appears to have been made by an Intellectually-challenged NPR intern using a kiddy V-Tech computer. The video asks why the Fed does not see inflation when food, energy, healthcare and tuition costs are higher.

Obviously this gadfly does not understand demand curves and taxes on consumption from price increases in sectors which have inelastic demand curves. He or she also does not understand that producers cannot pass price increases through to consumers. I don’t know about you, but I am paying less for clothing, vehicles, electronics and various other goods and services.

The area experiencing severe deflation is housing. Not only is the Fed largely responsible for the small amount of inflation pressures we are experiencing, but it is the only thing standing in the way of a collapse in housing prices.

I am not defending the Fed. I am only explaining why it is concerned with deflation and why it has engaged in QE2. If it were up to me I would let home prices reset to levels at which people could afford to purchase them. There are many people who cannot obtain a mortgage for a $500,000 home, but could for a $300,000 home. However, letting prices reset would not only blow up many influential investors in mortgage securities, it could impair the banks, including some large banks. The Fed does not want FC2 (Financial Crisis 2). QE2 is much more palatable. However, it will extend the time needed to turn the economy around, not until the glut of available homes is absorbed by the market will the economy recover.

Happy Holidays

A group of conservative economists have written a scathing rebuke of Ben Bernanke and the Fed. Their general premise is that the Fed’s QE2, the printing of money (which by the way is how regular easing works), is no substitute for pro-growth policies. What these agenda-driven economists either do not realize, or refuse to acknowledge for political reasons (I’m betting on the latter) is that the Fed is not making the claim that QE2 or any of its policies are substitutes for pro-growth policies. Mr. Bernanke is trying to buy time until pro-growth policies are put into place and the glut of homes on the markets (foreclosed or otherwise).

In today’s Wall Street former Fed vice chairman Alan Blinder writes a spirited defense of Ben Bernanke (with which I agree) and of Keynesian policies (with which I do not agree in principle). Mr. Blinder responds to Mr. Bernanke’s critics by stating:

“The Fed's plan is to purchase about $600 billion of additional U.S. government securities over about eight months, creating more bank reserves ("printing money") to do so. This policy is one version of quantitative easing, or "QE" for short. And since the Fed has done QE before, this episode has been branded "QE2."”
“Here's the first Economics 101 question: When central banks seek to stimulate their economies, how do they normally do it? If you answered, "by lowering short-term interest rates," you get half credit. For full credit, you must explain how: They create new bank reserves to purchase short-term government securities (in the U.S., that's mostly Treasury bills). Yes, they print money”.

“But short-term rates are practically zero in the U.S. now, so the Fed wants to push down medium- and long-term interest rates instead. How? You guessed it: by creating new bank reserves to purchase medium- and long-term government securities. “
“That sounds pretty similar to garden-variety monetary policy. Yet critics are branding QE2 a radical departure from past practices and a dangerous experiment.”
“The next charge is that QE2 will be inflationary. Partly true. The Fed actually wants a bit more inflation because, now and for the foreseeable future, inflation is running below its informal 1.5% to 2% target. In fact, there's some concern that inflation will dip below zero—into deflation. The Fed, thank goodness, is determined to stop that. We don't want to be the next Japan now, do we?”
“But might the Fed err and produce too much inflation? Yes, it might, leaving us with, say, 3% inflation instead of 2%. Or it might err in the opposite direction and produce only 1%. Neither outcome is desirable, but each is quite tolerable. To create the fearsome inflation rates envisioned by the more extreme critics, the Fed would have to be incredibly incompetent, which it is not.”
“Finally, there's that old hobgoblin: consistency. Critics tell us that QE2 won't give the U.S. economy much of a boost but will lead to rampant inflation. Both? How does that work? “
“If buying Treasurys is a weak policy tool, a view with which I have some sympathy, then it shouldn't be very inflationary. There is no magic link between growth of the central bank's balance sheet and inflation. People, businesses and banks have to take actions—like spending more, investing more, and lending more—to connect the two. If they don't, we will get neither faster growth nor higher inflation, just more idle bank reserves.”



I agree with Mr. Blinder on all of this, but he loses me with the following:

“Somehow, additional government spending actually reduces employment—even when the economy has huge amounts of spare capacity and unused labor desperate for work; even when the central bank will prevent interest rates from rising to "crowd out" private spending. Really?”


Does Mr. Blinder really believe that there are huge amounts of “spare capacity? I don’t believe that. I believe that much of the spare capacity is really spare capacity. I think it is superfluous, unneeded, at least not given the current structure of the U.S. economy. This is not to be confused with the current state of the U.S. economy. The state of the U.S. economy is not likely to improve much until the structure of the U.S economy changes.

No longer can the U,S. economy rely on high-tech start-ups with no business plan. Nor can it rely on cheap lending irresponsible lending standards to drive housing prices and home building. U.S. leaders are going to have to institute policies which promote business activity, expansion end hiring. Without that, look for the Fed to do whatever it takes to keep the U.S. economy in a semi-alive state. Now matter your political beliefs structural changes need to occur,’’

Americans need to realize two things.

1) There is no going back to the years of the 1990s or early 2000s.

2) There is no need for the U.S. economy to be in its current doldrums. Let home prices reset. Let wages and benefits adjust (unfortunately low, at least initially).

Our trading partners are critical of Fed policy. Not just because it may weaken the U.S. dollar and ruin their exchange rate party, but also because structural changes to the U.S. economy could (if done right) make U.S. consumers less willing to purchase cheap foreign goods.


We will have to wit until next year to see if the new Congress is willing to make the necessary and possibly painful changes to make the economy healthy, long-term. I will be watching and waiting as well, but I will not be doing much writing. I am taking a hiatus for health reasons. Happy Holidays and Happy New Year to everyone.

Out of the Mouths of Governors

Yesterday, Fed Governor Kevin Warsh became a voice of sanity crying in the wilderness. Writing in the Wall Street Journal (and later in the day reiterating in a speech) Mr. Warsh railed against policies which focus on short-term fixes and a return to irresponsible consumer behavior. Mr. Warsh stated:

“The prevailing theory has it that U.S. policy makers should not deny our foregone fate. We should accept smaller improvements in output and employment and productivity. We should resign ourselves to the new normal and conduct policy accordingly. That is the last best hope, they argue, to preserve the remaining vestiges of a golden age that is no more.
I reject this view. I consider this emerging ethos to be dangerous and defeatist and debunked by America's own exceptional economic history. Our citizens are not unwitting victims of some unavoidable fate. The current period of subpar growth and high unemployment is real, but it need not persist. We should not lower our expectations. We should improve our policies.
Broad macroeconomic policies have not changed direction in the past several years. But change they must if we are to prosper. We can no longer afford to tolerate economic policies that are preoccupied with the here and now. Chronic short-termism in the conduct of economic policy has done much to bring us to this parlous point.
Policy makers should be skeptical of the long-term benefits of temporary fixes to do the hard work of resurrecting the world's great economic power. Since early 2008, the fiscal authorities have sought to fill the hole left by the falloff in demand through large, temporary stimulus—checks in the mail to spur consumption, temporary housing rebates to raise demand, one-time cash-for-clunkers to move inventory, and temporary business tax credits to spur investment.
These programs may well have boosted gross domestic product for a quarter or two, but that is scarcely a full accounting of their effects. These stimulus programs did little to put the economy on a stronger, more sustainable trajectory. Sound fiscal policy must do more than reacquaint consumers with old, bad habits.
Policy makers should take notice of the critical importance of the supply side of the economy. The supply side establishes the economy's productive capacity. Recovery after a recession demands that capital and labor be reallocated. But the reallocation of these resources to new sectors and companies has been painfully slow and unnecessarily interrupted. We are feeling the ill effects.
Fiscal authorities should resist the temptation to increase government expenditures continually in order to compensate for shortfalls of private consumption and investment. A strict economic diet of fiscal austerity has greater appeal, a kind of penance owed for the excesses of the past. But root-canal economics also does not constitute optimal economic policy.
The U.S. would be better off with a third way: pro-growth economic policy. The U.S. and world economies urgently need stronger growth, and the adoption of pro-growth economic policies would strengthen incentives to invest in capital and labor over the horizon, paving the way for robust job-creation and higher living standards.
Pro-growth policies include reform of the tax code to make it simpler, more transparent and more conducive to long-term investment. These policies also include real regulatory reform so that firms—financial and otherwise—know the rules, and then succeed or fail. Regulators should be hostile to rent-seeking by the established, and hospitable to the companies whose names we do not know. Finally, the creep of trade protectionism is anathema to pro-growth policies. The U.S. should signal to the world that it is ready to resume leadership on trade.
The deleveraging by our households and businesses is not a pattern to be arrested, but good prudence to be celebrated. Larger, more liquid corporate balance sheets and higher personal saving rates are the reasonable and right responses to massive government dissaving and unpredictable government policies. The steep correction in housing markets, while painful, lays the foundation for recovery, far better than the countless programs that have sought to subsidize and temporize the inevitable repricing. It is these transitions in our market economy—and the adoption of pro-growth fiscal, regulatory and trade policies—that lay the essential groundwork for greater, more sustainable prosperity.
Monetary policy also has an important role to play. However, the Federal Reserve is not a repair shop for broken fiscal, trade or regulatory policies. Given what ails us, additional monetary policy measures are poor substitutes for more powerful pro-growth policies. The Fed can lose its hard-earned credibility—and monetary policy can lose its considerable sway—if its policies overpromise or under deliver.
Last week, my colleagues and I on the Federal Open Market Committee (FOMC) engaged in this debate. The FOMC announced its intent to purchase an additional $75 billion of long-term Treasury securities per month through the second quarter of 2011. The FOMC did not make an unconditional or open-ended commitment. I consider the FOMC's action as necessarily limited, circumscribed and subject to regular review. Policies should be altered if certain objectives are satisfied, purported benefits disappoint, or potential risks threaten to materialize.
Lower risk-free rates and higher equity prices—if sustained—could strengthen household and business balance sheets, and raise confidence in the strength of the economy. But if the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed's price stability objective might no longer be a compelling policy rationale. In such a case—even with the unemployment rate still high—we would have cause to consider the path of policy. This is truer still if inflation expectations increase materially.
The Fed's increased presence in the market for long-term Treasury securities poses nontrivial risks that bear watching. The prices assigned to Treasury securities—the risk-free rate—are the foundation from which the price of virtually every asset in the world is calculated. As the Fed's balance sheet expands, it becomes more of a price maker than a price taker in the Treasury market. If market participants come to doubt these prices—or their reliance on these prices proves fleeting—risk premiums across asset classes and geographies could move unexpectedly.
Overseas—as a consequence of more-expansive U.S. monetary policy and other distortions in the international monetary system—we see an increasing tendency by policy makers to intervene in currency markets, administer unilateral measures, institute ad hoc capital controls, and resort to protectionist policies. Extraordinary measures tend to beget extraordinary countermeasures. Heightened tensions in currency and capital markets could result in a more protracted and difficult global recovery.
Responsible monetary policy in the current environment requires attention not only to near-term macroeconomic conditions, but also to corollary risks with long-term effects. Should these risks threaten to materialize, however one gauges the probabilities, I am confident that the FOMC will have the tools and conviction to adjust policies appropriately. “
Bravo, Mr. Warsh! Some of us have been of similar opinions, but have been marginalized by those who believe that blind optimism and an inflated stock market will heal all wounds. This is not the case. Poor polices and consumer and business irresponsibility got is into this mess. Fundamentally sound polices, a resetting of asset prices (especially home prices) and a reallocation of labor and resources will get us out of this.

Some pundits are viewing Mr. Warsh’s comments as some kind of heresy at the Fed. Come on folks, this is orchestrated Fed jawboning at its best. The Fed knows it can’t fix what ails the economy. It can only keep thing going until better policies are implemented. Imagine the economy as a ship with a breached hull. The Fed is the damage control crew manning the pumps keeping the ship afloat until the repair crew back at the dry dock (Capitol Hill) can make structural repairs. Make no mistake; the economy is still broken,

Is it me or is it ironic that our trading partners who have active policies to maintain favorable exchange rates to promote their exports are angry with the U.S. for managing our currency. I am not advocating a weak dollar policy at all, but the irony here does not escape me.

Speaking of our trading partners they were all over today’s 10-year auction, buying a record 56.5% of the deal. Some believed the auction to be weak because the bid-to-cover was soft, but with foreign central banks willing to buy 10-year treasury notes at yields under 2.60% in an attempt to keep the dollar from weakening further, I would not be worried about a lack of demand in the markets. The treasury has yet to weigh on with its QE2 purchases. Mark my words, this time next year we will be looking at 10-year rates in the low 3.00% area and Fed Funds still effectively 0.00% (up to 0,25%).

Jobs - The Long and Winding Road

Better than expected employment data. No spin here, the numbers were truly better than expected. The Nonfarm Payrolls report indicates a gain of 151,000 jobs. The service industry led the way. There were 28,000 new jobs added to the retailing sector, 46,000 jobs were added to the Professional and Business Services sector. The economy also added 35,000 temporary workers. Manufacturing, information, financial activities, leisure & hospitality and government all reduced the number of workers employed. Pending home sales unexpectedly fell as moratoriums on foreclosures and tighter lending standards are creating headwinds.

In normal times a report of 151,000 new jobs would induce yawns around the street. However, we are not living in normal times (unless this is the new normal). That being said, 151,000 new jobs is lifting the spirits of market participants this morning (to say nothing of those who actually found employment). There is still a long way to go before the jobs lost since the recession began in December 2007 have been replaced. Thus far, over 1,000,000 jobs have been added this year. However, that still leaves the economy down just under 7,000,000 jobs since the recession began.

The real question is: Where are nearly 7,000,000 jobs (accounting for population growth we need to add even more) going to come from without the economic activity provided by an over-stimulated economy? That is the challenge. Critics have pointed fingers at the banks for their reluctance to lend to anyone who does not have excellent credit. These critics correctly point out that many people who can get credit do not need credit at this time. However, what incentives do banks have to lend to higher-risk borrowers when they have difficulty securitizing such loans and cannot simply sit on such loans as they would soon run out of lendable capital and incur huge amounts of risk? There is also no way banks can help borrowers who are upside down on their homes (owe more than the homes worth). Home prices will have to drop further to unfreeze the housing market.


Jobs are the key, people. Without jobs there can be no economic recovery, at least not the kind most people expect or desire. The problem is how to replace millions of jobs which would not have existed previously if not for two asset bubbles (tech then housing). I asked a friend who is a senior strategist at a major investment bank if he had any ideas about how the economy can replace millions of jobs which appear superfluous at this time. Unfortunately he is just as perplexed as the rest of us. He did suggest that NAIRU may come back into vogue.

NAIRU stands for Non-Accelerating Inflation Rate of Unemployment. This is the unemployment rate below which inflation rises. This is a way of determining “full employment.” In may short 22-year career in the fixed income markets, I have was around when full employment was considered to be around 6.00%. I remember when it as believed to be below 5.00%. Where is it now? I wish I knew, but I would not be surprised if it was above 7.00%.


What about this great stock market recovery? Thank Ben and Bernakettes for the soaring stock market. Strength in the equity markets (and the weakening dollar) is directly related to Fed policy. So much so that one pundit stated that he believes that market participants prefer continuous accommodative Fed policy than economic strength. If the Fed decides that it managing inflation is now the top priority, the stock market could be in for a violent correction. Fortunately for equity investors Helicopter Ben is at the controls. The money will be falling like WKRP turkeys at Thanksgiving.

There are critics who, following yesterday’s jobs report, are questioning the Fed’s decision to launch QE2. I am not a fan of QE. I believed from the beginning that if home prices were permitted to fall in early 2008 when, bargain hunters could have still obtained credit, the recession may have been more shallow and shorter-lived. However in the wake of the financial crisis, the Fed was left with little choice but to provide a record level of monetary accommodation. To of you equity bulls who are now criticizing the Fed for being too pessimistic and not understanding the recovery story: The only reason for your soaring stock markets is Fed policies, including QE2.

This is not to say that I am in favor of QE2. I would prefer a bloodletting which changes the business mindset in this country to one which favors long-term strength. However, as long as we live in a CNBC culture and equity wonks are considered experts while experts from other areas of the business are considered worriers, clueless and obstructions to growth, we will continue to live for the short-term boom while our trading partners steal our position of prominence and standard of living sinks into mediocrity.

Pushing on a Slinky

Pushing On a Slinky


As expected the Fed launched QE2. Not quite as expected the Fed announced only $600 billion in U.S. treasury securities purchases between now and June 2011. That works out to about $75 billion per month. The Fed will also reinvest the proceeds from QE1 it will receive during that time to bring the total in the $850 billion to $900 billion range. This is a far cry from the $1 trillion to $2 trillion in new capital many were expecting. Notably nearly absent from QE2 purchases was very long end of the curve (longer than 10 years). Some dealers, such as Goldman Sachs, voiced opinions calling for asset purchases on the extreme long end of the curve. Instead the Fed chose to keep the average duration of the bonds it purchases to the five to six year range spreading purchases nearly evenly from two years to ten years out. The Fed also left the possibility of further easing open.

Aside from keeping rates low, possibly for the next year or two as far as Fed Funds are concerned, and weakening the dollar what has the Fed accomplished? Probably not much, but what it did accomplish will probably keep the economy out of a double dip recession. Some people have described QE2 as pushing on a string (as it would have almost not effect on the recovery). I like it to pushing on a Slinky. When on pushes on a Slinky motion is transferred, but not very efficiently. There is much absorbing of the motion by the spring. The economy will absorb much of this QE because the Fed can keep borrowing rates lower, but it cannot make lenders lend, borrowers borrow or investors invest in mortgage-backed securities.


What about inflation. Sure, the weak dollar could cause food and energy prices to rise, but since the demand curve for such commodities is relative inelastic, they will only hinder consumer spending further. When is housing making a comeback? When home prices fall far enough to where people have enough money saved to make a 10% or 20% down payment. When are jobs coming back? When U.S. labor costs (including taxes and health care) are low enough that businesses can add U.S. workers instead of new equipment or moving jobs overseas. In other words, low rates, high unemployment and sluggish growth will be with us for a very long time.

Stay away from LIBOR-based floaters. Coupons on these bonds and preferreds promise to remain at or near there floors. There will be better times to buy that kind of structure. Most TIPS are rich too. Buy only the 1.25%due 7/15/20 and only in moderation for hedging purposes. Ladder one’s portfolio two-years to 10-years (as I have been saying for a while and how the Fed is doing). Adding some step up bonds for the purpose of increased yield and cushion against rising rates could also be a good idea.

Nonfarm Payrolls on Friday, I can hardly wait.

Touch and Go

The Fed’s Touch and Go.


When a novice pilots are learning how to land an airplane they practice what are known as touch and goes. When pilots practice touch and goes the let the wheels of their aircraft barely make contact with the runway. They never fully land. Instead they pull back on the stick and climb away. For the past 25 years the Fed has been conducting touch and goes with the U.S. economy.


A look back at Fed policy bears this out. In 1981 the Fed began a 25-year policy of easing (lower interest rates), lowering the Fed Funds rate from an inflation busting high of 20% to an eventual affective 0.00% in 2009. One would think that the Fed Funds rate fluctuated much during that time and although that is correct, the chart looks more like a downward stair case than a typical peak and valley formation. The Fed rarely raised the Fed Funds rates back to (or even close to) to rates seen during the prior tightening cycle (in some cases not even to rates seen as neutral.

Let’s look at the history of Fed Funds rates since 1981. We will leave out the punitively-high rates of the early 80s. Let’s begin in the late 1980s when rates were somewhat “normal”.


February 1988 (peak of rate cycle) Fed Funds 9.75%

February 1991 (approximately half way point) 6.25%

September 1992 bottom of rate same rate cycle) 3.00%

Here is the next cycle:

May 2000 (peak of rate cycle) 6.00%.


June 2003 (bottom of cycle (1.00%). Stayed at 1.00% until June 2004.

June 2006 (Peak of rate cycle) 5.25%

December 2008 (bottom of rate cycle) 0.00% to 0.25%)

Can you see the problem? The Fed never landed the economy. It merely conducted a series of touch and goes! This created what we now know to be a dangerous dynamic. Ever lower rates made refinancing and the use of home equity for spending drive growth beyond structural limits and pushed home prices high as more people could afford homes due to lower rates and little in the way of core inflation. We all began to view ever rising home prices, cheap loans and buying whatever we wished to as normal. It wasn’t. The Fed kept the economy in the air for over 20-years, never letting it refuel (correct). Now it is out of fuel.

What is needed to refuel the U.S. economy? Asset price correction, but that sets up another dangerous dynamic, especially when the stigma of walking away from contractual obligations, such as mortgages, is all but gone. Home prices, auto prices and wages in those and related industries rose to levels which are unsustainable. However, asset prices ad incomes must reset to fundamental levels.

The Fed’s solution is to cause inflation and weaken the dollar. In theory this could help. It may have kept us out of a depression thus far, but inflationary and dollar-weakening policies can only have limited benefits when borrowing is constrained, wages cannot rise (cost of leaving raises would make it easier for Americans to pay their mortgages as they are repaying debt created with dollars which are more valuable than the dollars which they are paying), and increased U.S. exports have only a limited benefit due to the relatively small portion of manufacturing in the overall economy (efficient businesses needs few new workers).


Much has been made of the “new normal” of slow growth. Current growth is not the “new normal” no more than the booms of the mid 1980s – 2006 was normal. Once we go through several more years of slow growth and falling home prices growth and employment will level off somewhere between the boom years and today’s bust. What does this mean in numbers? Although no one can say for sure, growth leveling off between 2.00% and 3.00% and unemployment between 7.00% and 8.00% could be where the economy improves to following another several years of pain.

The Fed can slow this correction, but cannot prevent it beaus the Fed has cyclical tools and today’s problems are structural.



Happy Halloween!!!

Borrowed Time

www.mksense.blogspot.com


Bill Gross (rightly) criticizes QE2, Jeremy Grantham (correctly) explains how we got into this economic mess and why structural changes will prevent a return to the economy of the past 20 years and the size a pace of QE2 comes into question and panic grips the market. The prospects of a modest QE2 pushed stocks and commodities lower and the dollar higher. The stronger dollar and the resulting rise of commodity prices is an obvious relationship, but what some investors just don't get is why QE2 drives equity prices.







The knee-jerk response is: The equity market responds positively to QE2 because QE2 will increase growth. Sorry boys and girls, no one except for CNBC anchors believe that (and not even all of them believe it). Another response might be that QE2 will weaken the dollar and increase exports and that will keep balance sheets healthy. That is true, but that isn't the main reason.




The driving factor is leverage. QE2 involves buying treasuries which keeps rates low. This makes leverage cheap. Stocks are being bought with this cheap leverage. Unless this cheap leverage continues or we see a sharp economic recovery the equity market could see a correction. Fortunately for equity investors QE2 is coming to some degree. This will put of the day of reckoning for awhile. However, cheap leverage can't last forever and the economy is structurally incapable of the growth to which we have become accustomed. Beware high yield bonds as well.





I strongly suggest reading Jeremy Grantham's GMO report.






Tell your friends. I am looking for more subscribers.

Mortgaging the Future

When last I published, I discussed mortgage put-backs. I discussed how that could lock up the mortgage market and further hinder a recovery of the housing market. That scenario appears to be playing out. After enduring two weeks of bashig by politicians, investors and the GSEs (yeah, like they are in a position to criticize), banks are beginning to take a stand against there critics. Even Bank of America is going to fight against put-backs.It is easy to point one's finger at the banks, the are not solely culpable.


There is enough blame to go around. Banks slackened their underwriting standards and in the frenzy to write an increasing number of mortgages, banks chose to overwork underwriting departments and may have let a few (or not so few) bad mortgages slip through the cracks. After all, the banks and the credit ratings services had complete and, as we have discovered, misplaced confidence in quantitative models which, as with all models, were backward looking and couldn't account for the unknown unknowns.


However, blame has to be placed on the investors themselves who conveniently did not ask questions regarding the quality of and underwriting accuracy of the underlying mortgages. The banks will have to cough up money, but the large banks have the cash to create reserve funds and can easily raise more capital in this market and raise it cheaply. The demise of large banks is greatly exaggerated, including Bank of America. Regional banks could be a different story.


The end result is likely to be a very modest recovery and soft growth and spending for years to come as the banks find religion and perform proper due diligence. The days of credit for all are over. Any inflation we see (and we could see it) is more likely to be the result of a devalued dollar than growth. We will see a recovery, but it will feel like a prolonged mild inflation. Waiting for unemployment to dip below 8.00%? Good luck!. Getting it below 9.00% will be a challenge.



Investors believe the Fed will succeed in generating inflation as they bought today's TIPS auction with a negative yield to maturity for the first time in history. Inflation, yes. Growth, kind of.

Put Back

The Mortgage Industry has dominated the financial headlines in recent days. At first the financial press and market participants were focused on the mortgage moratorium and the missed revenues (from servicing mortgages), higher operating costs and potential fines which could arise from this debacle. However, my attention was immediately drawn to the possibility that investors may request that banks take back securities backed by trouble mortgages at par due to a lack of due diligence, faulty underwriting procedures, lack of disclosure, etc. After a few days of the so-called “put back” story taking a back seat, it finally popped today.

Put back has a much greater potential for losses for the banks. Estimates from around the street range from about $60 billion to almost $200 billion. This has investors concerned that some large banks will not be long for this world. This should not be the primary concern, at least not for the large money center banks. The large banks should be sufficiently well-capitalized to survive this. The real question is: Can the economy survive this?

Oh, have I frightened you? If I have it is with good reason. The housing market to which we have become accustomed was predicated on high-volume, “efficient underwriting” (speed was paramount) and securitization. If it becomes more difficult to foreclose on properties, if it becomes more expensive for banks to do underwrite and process mortgages (more people instead of robo-signers), if securitization becomes more difficult (investors may want high-quality mortgages, rather than simply having first claim on a pool of dubious assets), the housing market has little chance of a speedy recovery. The same would be true for the broader economy.

The number one question asked since September 2008 is: How to we get back to where we were in 2006 or 2007? The answer is we don’t (or at least we shouldn’t). Cutting corners, packaging mortgages into nearly indecipherable structures and granting credit to anyone who could fog a mirror is not a recipe for success. Those who whish to return to the past are either selfish or hopelessly stupid. Unfortunately, there is no shortage of stupid and / or selfish people. Look for continued policies designed to avoid accepting the reality that home values rose too far, too fast and that lending standards are a good thing. I say, let home prices reset and let people bargain hunt. That is the only way to fix the housing market and economy, structurally.

Who Own The Mortgages? Owns!

Panic has gripped the markets. Apparently, banks have not been observing the proprieties when foreclosing on delinquent home owners. This has cause some banks to halt foreclosure proceedings while proper due diligence is under taken and paperwork is processed in accordance with the stated rules and regulations. This has many investors selling their corporate bond and preferred holdings of large banks, especially Bank of America. Relax folks, although bank bottom lines could be hit due to increased legal expenses and overhead to properly process foreclosures, it is unlikely that the damage will be enough to sink any of the large banks, including Bank of America, worry warts.


Remember back in 2009 when regulators required banks to raise what seemed like an unusually large amounts of capital (especially tangible common equity tier-1 capital)? This was done because government overseers were concerned of what could happen should government stimulus fail to stabilize the housing market and eventually push home prices higher. Currently, the large money center banks should have enough capital to weather another 2008, if necessary. This is one reason (the inability to securitize non-GSE-qualifying mortgages being another) that banks are reluctant to lend. They are hoarding capital. This is not to say that banks will be unaffected, poor earnings could be in their futures (for a variety of reasons), but corporate defaults large banks are an improbability at this time.

Investors in private label MBS, CDOs and SIVs have more to worry about than do corporate bond investors. It is not clear, in some cases, who actually owns a mortgage and who is just a servicer. There are situations in which banks may be foreclosing in propertied when the have no legal right to do so. This could be due to incomplete or incorrect documentation during the securitization process. If this can be proved, banks may have to take back at par the mortgage-backed vehicles currently held by investors. The problem is that many of these vehicles contain mortgages which have taken principal losses and will never be worth par no matter how long they are held. This is the main reason that suspending mark-to-market was not a permanent fix.

Sure, it calmed investors’ fears as banks did not have to recognize unrealized losses, but now losses are being realized and many investors of finding that out the hard way. If one large group of investors can win a judgment versus an issuer, the flood gates could open for more litigation and lock up what is left of the mortgage market. That would practically kill the housing market. However, it is unlikely that these doomsdays scenarios play themselves out. It is more likely that foreclosures continue and many private label MBS issued from late 2005 through early 2008 will experience losses.

Investors in debt (including preferreds) could be impacted by recent developments. If banks are force to absorb losses it is unlikely that they will exercise early capital event clauses afforded by the implementation of the Dodd bill. Instead banks could leave trust preferreds outstanding as long as they can be applied toward tier-1 capital. That means that trust preferreds could remain outstanding until at least 2013, if not longer.

Many investors have become fearful of Countrywide bonds and preferreds. Investors need to understand that Countrywide debt and preferred securities are legal obligations of Bank of America. This is not the case with Merrill debt and trust preferreds. It is unlikely that BAC will default so Countrywide debt and preferreds should be alright, albeit a bit volatile. I would be more concerned about regional banks exposed to Florida and Nevada more than any of the large banks.


Well there you have it. This is my take on the mortgage debacle as I see it at this time. If policymakers would only have permitted home prices to reset early in 2008 when mortgage credit was still available, real estate values probably would not have fallen as far as they have and regulators could have reigned in bad practices. Let’s hope that every one has learned from their mistakes.

Twilight Zone

Today brought us more disappointing Jobless Claims data. Initial Jobless came in at 445,000 versus a street consensus of 455,000. The prior data was revised upward from 453,000 to 456,000. Continuing claims came in at 4,462,000 versus a street consensus of 4,450,000 and a prior revised 4,510,000 (up from 4,457,000). In spite of what some pundits espoused this morning, these are troubling numbers. It is true that initial claims dropped a bit, but claims over 400,000 is troubling. Even more troubling is that fact that continuing jobless claims and the extended benefits roll remain stubbornly high. In fact, the number of Americans on extended benefits increased by 257,000 to 5.14 million. This brings the total number of Americans receiving unemployment benefits to 9,602.000. The fact that businesses are slowing the pace of hiring does not cut it. Some economists believe it could take years to replace the approximately 8 million jobs lost since the recession began. The problem is that at the same time, the U.S. population will increase. This is like a cat chasing a string. Every time we seem to make progress the goal remains seemingly just out of reach.

What does this mean for tomorrow's employment data? It is obvious that recent data has not been encouraging, but it may nit translate directly into the Nonfarm Payrolls and Unemployment Rate data. Such data is subject to various quirks via the way the data is gathered and by their formulas. Remember a few years ago when the Nonfarm Payrolls number undercounted approximately 800,000 jobs over the course of a year or so? The consensus estimate for NFP is 0. However, whether the number comes in -50k or +50k, it matters little as either would be disappointing.

After reading today's Wall Street Journal, I felt as though I was in an episode of the "Twilight Zone". An article on page A8 states that the Fed is considering higher inflation as a way to stimulate spending and growth. The thinking is that if inflation is allowed to run faster than the Fed's alleged target of about 2.00% (let's say to 4.00%), consumers would be further disincentivized to save and would spend more aggressively. What is happening here? Is Bernanke the anti-Volcker? Maybe, maybe not. The problem is that Bernanke realizes just how impaired the U.S. economy is. He, along with other policy makers are trying to avoid a deflationary correction of asset prices, home prices in particular. That could be an exercise in futility.


This morning on CNBC, Pimco's Mohammed El-Ehrian stated that part of the problem is that Americans and policy makers want it all. They want banks to lend, but de-risk. They want consumers to spend, but not severely deleverage while strengthening household balance sheets. It cannot be done. Something has to give. A few years ago it was not uncommon for home values to double in a year or two. Did anyone with a shred of common sense really believe that was sustainable? No, but common sense was eschewed in favor of optimism and models. Reality can be ignored only so long. It is time to pay the piper and he is not cheap.

Former Wall Street Junk Bond "Star" Michael Milken writes in today's Journal his remedies for what ails the U.S. economy. Especially helpful and insightful is his analysis of the housing debacle. He states:


"My early academic research showed that investments in loans against real estate were worse investments than loans to businesses. Collateralized loans to U.S. companies, which create nearly all American jobs, have stood the test of time. Meanwhile, investors have suffered some $1 trillion in losses on supposedly safe mortgage-backed assets. Consider how many more jobs small businesses would have created if they'd enjoyed the same terms we gave homeowners-easy access to 30-year, government-guaranteed loans at near-prime rates with no prepayment penalties. Those terms encouraged larger houses-the average size doubled in a generation to 2,500 square feet, even as family size shrank. This required more land farther from cities, and we bought bigger cars for longer, energy-wasting commutes."



He continues:


"American policy makers got it backwards: In the long run, jobs support housing, not the other way around."


I believe Mr. Milken is spot on. Relying on ever-higher home prices, ever more new construction and ever easier access to credit (and the resulting over-leveraged consumer) is a recipe for disaster, as we have recently seen.

There has been much China bashing emanating form Capitol Hill and from Europe. China is being roundly criticized for undervaluing its currency. China snapped back that letting its currency appreciate by the 20%+ that many of its critics are calling for would result in economic hardship for China. For years we have stated that China will do what is right for China. However, the U.S. will do what is right for the U.S. All Fed Chairman Ben Bernanke is doing is to devalue the dollar. His problem is that he cannot devalue the dollar versus the yuan as China has its currency pegged to the dollar. Japan, South Korea and Brazil have all taken action to halt or moderate the rise of their currencies. There is speculation that the EU and the UK may not be far behind.


Why would Mr. Bernanke risk a currency war which could strain international trade relations? Because he realizes just how bad the economy is. He cares little about foreign economies. He responsibilities lie between the Atlantic and Pacific oceans. Just as Chinese officials will do what the believe to be right for China, Fed officials will do what the believe is right for America.

We are in a race to the bottom in which global economies are trying to grab the largest possible slice of a shrinking pie. V-shaped recovery? We don't see it, at least not for consumers. Since consumers ARE America, a recovery which leaves them behind is no recovery at all.

Welcome to the Bubble (or, Bonds or Bust)

The cries warning us about a so-called bond bubble have been emanating ever more loudly from the street. Sages warn is that there is more upside risk to interest rates than down side reward. No kidding, did theses financial oracles figure this all out on their own? With the Fed funds rates effectively zero and the 10-year not hovering around 2.50% it doesn’t take a rocket scientist or some one with supernatural gifts to draw that conclusion. However, low rates to not a bubble make.

A bubble occurs when investors pile into an asset class, market, etc. irrationally. When calmer heads prevail and profit taking begins the bubble bursts. However, there is nothing irrational about today’s interest rate levels. Inflation is relatively tame. Job growth is lackluster. Banks are disincentivized to lend for both economic and political reasons. Consumers are still over leveraged. What in the world, outside an exodus from the dollar by investors large and small would push rates higher at this time? The answer is nothing, yet.

The truth is that the ability for investors to exit the dollar en masse is limited. Consider this: Gold hits a new high nearly every day. Some foreign central banks are actively, if not desperately, trying to halt the rise of their currencies. Yet long-term U.S. rates remain historically very low. Some of this can be attributed to quantitative easing and the threat of QE2, but it is more the reasons why more QE may be necessary, not the QE itself which is keeping rates low on the long end of the curve.

What are the reasons the Fed believes more QE may be necessary?

1). Consumers are not borrowing. It is true many are simply over leveraged and cannot borrow, but many do have access for credit but see little need to borrow. The Fed hopes to keep rates low (if not push them lower as has happened since the threat of more QE was announced) to entice those who can obtain credit to come off of the sidelines.

2) Businesses benefit from low borrowing costs. U.S. corporations have flooded the market with new debt. Large bond deals have come to market almost every day for the past several months. This cheap source of borrowed funds, which provide debt service expense savings, have contributed to stronger balance sheets and higher profits. If consumers spend less and business activity is modest, the Fed has helped make transactions which do occur more profitable. As evidenced by the Durable Goods. GDP and regional business activity reports, businesses are using this cheap source of funds to buy new, more efficient equipment. However, this does little for hiring.

Some economists have pointed out that increased higher has always followed such spending. This may again be true, but the hiring which does take place may be smaller in scale than in the past, pay lower wages than to what workers have become accustomed and may be created off shore.

3) The third reason is policy-driven economic headwinds. Higher business and personal taxes, unclear effects of new healthcare legislation (apparently HHS secretary, Kathleen Sebelius will have a good amount of discretion to decide which corporate health plans are acceptable and which are not. It is good to be the queen.), concern among banks as to what their capital requirements will be and anti-business rhetoric from the Obama administration are doing much to dampen growth.

Businesses don’t have to hire. Consumers don’t have to spend beyond sustenance levels and banks do not have to lend if the reward of doing so does not justify the risk. No amount of Capitol Hill bluster is going to change that. Many pundits have pointed to one of my aforementioned reasons, but it is truly all three which are responsible for the disappointing recovery.


The upshot of this is that rates will stay low for an extended period of time. Cash is not the place to wait as rates are punitively low. The long and of the curve is not an optimal destination because a 100 basis point rise in long-term rates could result in 10+ point price declines on bonds.

There are ways to soften the blow of rising rates without holding in cash with very little yield. One can ladder. Not all areas of the curve lose value in the same fashion. Like everything in life investing is about balance. While a 30-year bond may lose 12 points worth or principal value for a 100 basis point rise in rates a 10-year bond may lose 7 points, a 5-year bond 3 points and a 2-year bond only one point. By laddering ones bond portfolio, possibly focusing on the so-called belly of the curve (5 to 7 years out), as it is usually the most stable in a changing rate environment, one can obtain decent yields without taking excessive interest rate volatility.

One also should understand that not all bonds react the same way to changing interest rates. Some bonds, such as U.S. treasuries, are interest rate products. Where rates go, they go (the Fed influences the short end while inflation expectations influence the long end). However, some bonds, such as corporate bonds are credit products. Although interest rates an affect their trading levels. Their credit spreads versus treasury benchmarks also play apart. The changing of credit spreads due to balance sheet strength or weakness and investor demand for portfolio diversification can affect credit spreads.

We have seen this in action. In the extreme we saw yields for bank ad finance bonds rise in 2008 and early 2009 even though treasury yields fell. Their credit spreads widened due to balance sheet and viability concerns. Their yields did not follow interest rates. Once it became apparent that the largest banks were not going to fail, their credit spreads narrowed (to a point) and their yields fell more than treasury yields for a period of time. Less volatile sectors such as utilities and companies in the consumer product sectors did not experience such spread widening and flowed treasury yields lower, often out pacing the drop in rates as credit spreads narrowed as investors looking for yield sold their bank bonds and purchased utility or industrial sector bonds hoping to get even a small yield pickup over treasuries.

Rising interest rates may be offset somewhat by purchasing bonds which are trading at credit spreads which remain wider than their historic norms. This leads us back to the banks. Bonds of the large money center banks and large regional banks are still trading wide to treasuries. In some cases 50 to 100 basis points wide. If rates rise due to an economic recovery, these credit spreads could narrow 50 to 100 basis points effectively offsetting the first 50 to 100 basis point rise in long-term rates.

However, the story could be very different for bonds in other sectors. In an effort to earn returns above treasuries, but take on minimal risk, many investors purchased bonds in less volatile sectors and companies. If rates rise due to improving economic conditions, investors may sell their bonds trading at very tight spreads (MSFT, WMT, JNJ, etc.) and buy bonds in sectors or companies that were, until now, a bit to risky for their tastes (BAC, MS, GS, etc.). For this reason the yields of industrial sector bonds could rise even faster and more sharply than treasury yields as their safety is no longer needed.


When investing in fixed income one must understand the mechanics of the various products. By mixing in credit products with interest rate products and spreading ones assets across the curve (only out to10 years or so as one can pick up 75% of the slope of the curve without incurring the volatility of the very log end of the curve). One can earn attractive returns without being blown up by any bursting “bubbles”

I forgot to mention: Preferreds are rich and floater to not necessarily protect you from rising rates. It all depends on how much they float, off of what benchmark they float and off of what benchmark they trade.

Later.

Off To the Races

Off To the Races


The topic of discussion on various financial programs was the futility of Fed quantitative easing and the dangers of devaluing the dollar. Such policies could lead to higher interest rates on the long end the curve, although growth remains subdued. This is the dreaded phenomena known as stagflation. However, other nations are aggressively devaluing their currencies in a veritable race to the bottom.



Today we had the third and final look for second-quarter GDP and although today's 1.7% beat street expectations of 1.6%, the data confirms that the pace of recovery has slowed significantly from a first-quarter pace of 3.7% (and 5.00% for Q4 2009). The winding down of government stimulus and a persistently-high unemployment rate are creating significant headwinds to growth.



JP Morgan chief U.S. economist, Michael Feroli told Bloomberg News:
"We have a slow-growing economy. What we’re getting will do nothing to bring down the unemployment rate. The improvement in the labor market is very slow."
There in lies the problem. The Fed has cyclical tools, but high unemployment and slow growth are the cause of structural changes to the U.S. economy. Today's jobless claims data do little to comfort the markets. Sure, the numbers were down a bit, but the prior numbers were revised somewhat higher. Truthfully, today's drop and last week's higher revision are nothing more than "noise". The street consensus for growth for the balance of the year to remain below 2.00%.

The treasury market has given up earlier gains after fears of even worse jobless data and slower growth were alleviated. However, today's jobless data was poor in real terms. Besides 4,457,000 people counted in the continuing claims data, there are an additional 4.88 million people receiving extended benefits. Although it is true that is an improvement of 293,000, one has to wonder how many people were hired and how many simply ran out of benefits. With few report of large scale hiring, it could be that displaced workers are falling off benefit rolls. Declining jobless claims may not always indicate job growth. In fact, few economists think that is the case. next week's employment data should provide more insight. The street consensus for Non-farm Payrolls is for a gain of 82,000 jobs. Although this would be an improvement from a prior 67,000 jobs, it does not keep pace with the number of people entering the workforce.


Much is being made in the financial media of the Fed using cyclical tools to repair structural problems. That is all the Fed has. Some rocket scientists say that the Fed is devaluing the dollar and that rates cannot stay down at these levels forever. My response is : Duh! Of course rates are going to be much higher than today's levels, eventually. However, that does not mean they will be higher in a month, a year or two years. Look around, other governments are trying to devalue their currencies as well. There is a definite race to the bottom. All the Fed has to do is beat its partners to the punch when tightening.

The danger is that the Fed has lost or will lose its independence and its handlers on Capital Hill will force it to keep rates lower, longer for political purposes. If that happens, the so-called bond vigilantes could sell the heck out of longer-dated treasuries. However, they need a place to go. Yes, commodities provide a destination for some capital, but there are still trillions of dollars which need to be invested in safe,. secure interest paying vehicles. If China does not let its currency and debt be delivered outside of China (and insists on not floating the yuan), China will not be a viable alternative. Europe is even more dysfunctional than ourselves (in spite of what Cramer insists) and other major exporters (Japan, Brazil et al) hare bound and determined to fight currency appreciation. At some point the potential a U.S. interest rate blow-out could be very real, but for now we are probably anchored at today's levels.

More mixed economic data was provided by the better-than-expected Chicago Purchasing Manager's report and the softer-than expected NAPM - Milwaukee report. The strength in the Chicago data was due to businesses ordering more machinery to replace outdated equipment. One pundit on CNBC noted that such increases in equipment spending has "always" resulted in hiring in the past." When in the past have we had this kind of global economy in which we are still dragging our hind quarters in the midst of record stimulus while facing higher taxes and more employment expenses for businesses. It could be that more efficient equipment is being ordered to keep payrolls as lean as possible. We shall soon see.


There has been much discussion in the field regarding whether or not forthcoming economic policies are affecting business and hiring decisions by businesses large and small. I have been of the opinion that concerns regarding forthcoming policies are a major factor. Today's Wall Street Journal reports that McDonalds is considering eliminating its health care plan for store workers. McDonalds offers what is known as a "mini-med" med plan which offers limited coverage for affordable premiums. Under the new health care law, the plan would not satisfy the requirement which states that the insurer must spend 80% to 85% of the premium on medical care. The unintended consequence could be that McDonalds ceases to offer health care. For other business, the result could be a lack of hiring as providing benefits for employees becomes more expensive. I am not commenting on the benefits or lack thereof of the new health care legislation. I am just reporting on how businesses are reacting. You may choose to disagree with either the health care legislation the the response to it by businesses, but it is dangerous to ignore the resulting developments.

No Surprises

No surprises from the Fed. Policy makers saw growth slow, but remain positive. The Fed stated that it is prepared to ease further, if necessary, but declined to engage in another round of quantitative easing.

The Fed is just about out of ammo. Businesses have few structural reasons to hire. It is no secret that many business leaders are not happy with forthcoming health care and tax policies. Could there be a bit of vigilantism going on? It is possible, but there are few reasons to hire at all. What about all the cash on corporate balance sheets? It could be used for mergers and acquisitions. M & A is usually not an engine of job growth.


I will be writing much less going forward, as I have a few other things going on, but I will be back from time to time.

Cheers!

Smash Mouth

Smash Mouth Economy


This week’s economic data was lackluster to say the least. Empire Manufacturing was poor, Philly Fed was negative. Continuing jobless claims only came in lower because the previous week’s data was revised upward to over 4.5 million (the highest in nearly two months.) Even that old interest rate driver, inflation, was tame on both the producer and consumer side. Pundits, politicos and equity bulls were all hard pressed to find positives in the data (though the lovely, but seemingly dim Becky Quick of CNBC sure did try.)

However, the data is not pointing toward a double-dip recession, at least not yet. The data is pointing toward slow forward progress. If one were to compare the economies of the past two decades to the high-flying San Diego Chargers’ offense of the late 1970s / early 1980s, the current economy may be more similar to the offense of the 1990 New York Giants which succeeded with 3.5 yard gain after 3.5 yard gain. This is a “smash mouth economy.

What exactly is a “smash mouth economy?” It is an economy where growth must be hard-fought. Nothing will come easy and bug gains will be few and far between. However, if the defense can hold up, the U.S. economy can succeed. In this case the defense is government policy. Poor decision on that side of the economic ball can doom the recovery because the offense (U.S. consumers and small businesses) do not have ability to reach the goal of success if they are placed in a deep hole.

This flies in the face of those who said that there must be a sharp and robust recovery because the recession was so sudden and. Such views are not well thought out. There are factors which make recoveries robust and sharp after recessions. The main factor is to put cash in the hands of those who are willing and able to spend it. During the past two decades that was done via ever cheaper and easier to access credit. This is not a sustainable economic model. As we have so rudely discovered, rates cannot be set ever lower (zero is finite) and eventually you run out of people who can borrow.

There is a similar flaw in relying on housing to be the driver of U.S. economic growth. Real estate values should be the result of a healthy economy, not the main source of economic growth. After all, we can’t build large numbers of homes forever. Eventually you run out of space and, as the population ages (and possibly shrinks as in Europe and Japan), you run out of qualified home buyers.

A very knowledgeable fixed income strategist whom I know and respect states that he believes rates remain anchored at these levels with the risk of heading lower in the near term. He also believes that the Fed will be on the sidelines until at least mid 2011. I agree with him. Short-term rates remain unchanged for at least a year. Long-term rates will slowly rise over time, but the 10-year stays under 4.00% for at least another year and the economy moves forward three yards at a time with a cloud of dust.

A Little Bit Faster Now

After selling off for much of the past two weeks, prices of long-dated treasuries have rallied the past two days. Recently higher yields and the specter of renewed Fed purchases of U.S. treasuries are responsible for the rally. Even better-than-expected retail sales data couldn't stop the rally. Nor did it spark an equity rally.

The markets have accepted reality. The reality is that although a double-dip recession is not the most likely scenario, neither is a v-shaped broad economic recovery. Welcome to a world of consumer deleveraging and repenting for the sins of past excesses. I think David Semmens of Standard Chartered Bank said it the best today when he stated:


"This will see them (consumers) emerge from the recession in significantly better shape than they entered it but the pain in the meantime still needs to be borne."

There you have it. A return to traditional growth and consumption. A developed economy cannot experience emerging market type growth without consequences. We are experiencing those consequences now.

A Mismatch Made in Heaven

A Mismatch Made in Heaven (or not)


When last I posted we were awaiting the August employment data and although the economy bled jobs over all (and added a below replacement rate number of private sector jobs) the data was not as bad as many on the street had feared. However, the good news may end there.

Today’s Fed Beige Book report indicates that although the economy is growing it is experiencing “widespread deceleration.” Adding to the unemployment woes are what the report termed “a mismatch between job requirements and applicant skills.” Minneapolis Fed President, Narayana Kocherlakota, speaking today in Missoula Montana stated: The mismatch problems in the labor market do not strike me as readily amenable to the kinds of monetary policy tools currently available to the Fed.” The problem lies on where businesses are seeing demand. Much of the demand for goods and services is coming from abroad. This is also were most lower-skilled jobs are being created. Here at home, businesses are looking for workers with specialized skills to aid in the research, development and distribution of products and services. Workers looking for jobs in manufacturing, construction, retail or real estate services are being left on the sidelines without the necessary skills to fill job vacancies.

Another problem is that there are not enough jobs at the top of the economic food chain to provide jobs for large numbers of displaced workers even if they acquired the desired skills. A comparison between the jobs market and the food chain is warranted. As with the food chain, a smaller number of highly developed life forms are necessary to keep the chain functioning. A company may need 50m R&D professionals to develop products which will be built and purchased in Asia. The result is that many workers remain unemployed.

The current dynamic is one in which corporate profits could remain high, but so does unemployment. Some economists are forecasting an unemployment rate over 10% in the coming months. There is little evidence that businesses are poised to begin hiring en masse. Tax and health care policies which are viewed in a negative light by many business owners and executives are not helping the employment situation.

Persistently-high unemployment may be part of the “new normal” frequently mentioned by Pimco’s Mohammed El-Ehrian. In a recent presentation at a major bank Mr. El-Ehrian mentioned that policymakers are using cyclical tools to try to fix structural problems. What he is saying is that the economy is structured differently than it was just a few years ago. Investors and prognosticators, especially in the equity markets, are waiting for a reversion to the economic mean. What they fail to understand is that the mean changes. It is a moving target. The best hope for America may be to increasingly focus on developing small business and fostering more entrepreneurism. However, such an economy runs counter to the ideology of many Americans. Like it or not, behaving like an ostrich does not do any good.

Meanwhile, in spite of all of our problems, the U.S. remains the world’s safe haven and the dollar the world’s reserve currency. This was evidenced by today’s very strong 10-year auction. Today’s auction saw the strongest indirect bidding in a year. Indirect bidders include foreign central banks. The yield of the auction came in a basis point below the WI trading level. If not for Portugal’s successful bond auction allaying fears of a European debt crisis, prices of long-dated treasuries may have recovered. However, markets are looking for any positive signs, no matter how thin, so treasuries ended the day in negative territory.

I am not sure if I will be continuing this blog. Those of you who know me in my professional life remember that, until two years ago, I published a widely-read market commentary piece at my place of employment. That publication has returned. The fact that I am writing professionally again and that some readers at work have mentioned this blog in e-mails makes me uncomfortable. I have not yet made my decision and will keep my readers posted.

Serf City Here We Come

Serf City Here We Come

Today’s rally in the equity markets and selloff in the fixed income markets were impressive. The DJIA was up more than 2.00% and the S&P 500 was up nearly 3.00%. This was due to stronger-than-expected economic data from China and Australia and better-than-expected manufacturing data via the ISM report. The markets paid little attention to the ADP Payrolls report which indicated a contraction of private sector jobs to the tune of -10,000. What many pundits and investors seemingly fail to grasp is that it comes down to domestic jobs. One CNBC pundit proclaimed this morning that due to profits, corporations have the wherewithal to hire. The wherewithal maybe, but there is little desire and even less need to add workers.

Some have pointed to the renewed strength in the manufacturing sector. Manufacturing makes up less than 10% of the U.S. economy. Even there most blue collar jobs have either been automated or sent overseas. For example: Caterpillar’s CEO said the company could add up to 9,000 jobs in the coming month… worldwide. Chances are that most actual manufacturing jobs will be created close to end users where labor is less expensive and logistics make local production more cost-effective.

Meanwhile politicians debate how much more temporary stimulus may be needed to re-spark the economy. Auto sales came in much softer than a year ago during the “cash for clunkers program.” There is a growing contingent of government officials who would like to implement more temporary incentives to spend and borrow. To think that we the people cannot see temporary stimuli for what they are is insulting. The American people are being treated like medieval peasants who can be placated by throwing us a few baubles or treats.

The American people deserve more credit than that. We know that the economy is going through a structural change, not a cyclical correction (sorry Ms. Romer). We want to see changes to policies which make it easier and more advantageous to start or expand businesses. That is how jobs will be created. That is how the economy will recover. Temporary credits and rebates will yield temporary benefits.

It appears that the political and intellectual elite believe they are living in serfdom. The American people cannot be soothed to behave like trained lackeys to spend and borrow (irresponsibly if necessary) to drive the economy forward. Growth will be slow and the recovery shallow until consumer deleveraging is finished and the glut of homes on the market is absorbed by a growing population and no about of optimistic rhetoric, cash for clunkers or other government programs are going to change that.


Bring on Nonfarm Payrolls.

The Life of Ben

GDP was revised sharply lower, but not as much as the street had feared. I can't say that it is good news that GDP was revised lower from 2.4% to 1.6%, but it at least shows that the U.S. economy is not in free fall. Personal consumption was better than anticipated, but the primary driver were higher natural gas and electricity purchases during the early stages of the heat wave which began affecting the eastern half of the country in June. Long dated treasuries are selling off as weaker data had been baked into treasury levels. The price of the 10-year treasury note is down 17/32s to yield 2.54% and the price of the 30-year government bond is down 26/32s to yield 3.56%. Such a selloff is expected given today's data versus expectations. Yesterday's seven-year auction was very well bid for and priced at an all-time low yield for the seven-year auction. All eyes and ears will now turn to Fed Chairman Ben Bernanke when he speaks later today at the Fed conference in Jackson Hole Wyoming.


I have long been an advocate of paying close attention to not only what the Fed does, but also to what it says. However, I believe the market is expecting the Fed to be a miracle worker rather than a central bank. An increasing number of people have been calling on the Fed to find new ways to increase consumer demand and economic growth. The truth is that the Fed cannot create demand. It can only bring demand forward by enticing consumers to borrow at low rates and spend. As an increasing number of articles in the financial press have been stating the Fed is nearly out of ammunition. The Fed has very little ability to bring more demand forward.

Let me explain bringing demand forward. Be providing incentives to spend and borrow, many consumers make purchases that they would have normally made at a later date. At some point that artificial demand has to wane. However, for the past 25 years, every time that correction was set to take place (and the economic began to slow), the Fed would ease and bring more demand forward. Wall Street augmented the phenomenon by making it possible for more consumers to borrow and spend, but with rates as low as they can go (without becoming Japan) and investors now knowledgeable about what kinds of loans make up the securities necessary to facilitate such lending, demand cannot be brought forward further. Now consumers will have to pay off debts and deleverage to the point they can spend responsibly. Unfortunately that probably means growth rates far below to what we have become accustomed. It also means job creation will be poor for a number of years. It probably does not mean a double-dip recession unless consumers become more depressed and hold back spending. This morning's University of Michigan confidence reports indicates that consumers are becoming less optimistic. The danger of a self-fulfilling prophecy continues to loom. Thanks to Fed policy, Wall Street securitization and irrational exuberance by consumers (sorry Mr. Greenspan.) the country has become accustomed to growth rates usually seen in developing countries even though the U.S. economy is quite developed.

A paradigm shift is likely to occur where the U.S. consumer begins to live more within his or her means (don't worry, Americans will still borrow, just not as much). The result will be several years of sub-par growth and high unemployment until natural demand takes over as consumers need to replace durable goods which wear out and a growing population and gradually improving consumer finances eat thorough the housing surplus. Relying on housing to drive the economy in the manner it has during the past two decades is unreasonable and probably unfeasible. Patience is a virtue and will likely be rewarded.


The markets’ response to Mr. Bernanke’s speech at the Fed conference in Jackson Hole, Wyoming was reminiscent of Monty Python: The life of Brian. In the film, Brian desires to join the Peoples’ Front of Judea. He is asked by the group’s leader, Reg: “How much do you hate the Romans?” To which Brian’s response is: “A lot.” Reg tells Brian: “Alright you’re in.”


This is not much different than what happened in Jackson Hole. The markets have been asking Mr. Bernanke: “What are you going to do to stimulate the economy?” Last Friday Mr. Bernanke answered: “A lot.” The market said: “Alright, busy stocks and sell bonds.” In my opinion the stock markets rally and the bond market’s fall was a so-called dead cat bounce, or at least it should be. The Fed is mostly out of ammo. The guns have been fired. Now the economy must advance under its own power. The advance will be slow and there may be some set backs, but it will advance, unless of course, the leadership in Washington, insists on poor strategy.

Fear of the forthcoming policy and tax changes, along with an undeniable trend toward consumer deleveraging will slow the economic recovery. This is to be expected. As a country we spent like drunken sailors and we now have to become more responsible. The question is: Without bubble-like conditions can unemployment fall below 7.00%? I am not a trained economist, but I find it hard to imagine unemployment that low. Our best hope is for entrepreneurs looking to maintain or better their lifestyles to drive the economy forward and thus create jobs. Unfortunately, many of those in power are not pro-business, not even pro-small-business. They believe that to be pro-business is to be anti-worker. Shortsightedness will be the death of this nation.





Buy high-quality bank bonds 7-10 (15 years if a step up), callable agencies and (if one is an equity buyer) high-quality dividend-paying stocks. Many investors have been buying junk bonds even though they may be outside of their risk tolerances. Investors are better off taking duration risk to pick up yield rather than going down in credit quality. The problem is that the ability of lower-rated companies to issue debt may merely be putting off eventual defaults.

The Gorge of Eternal Peril

Jobless came in better (or not as bad) as expected. Make no mistake, 473,000 new claims is troubling and the prior week's upward revision is also not good news, but the street was fearing worse. Continuing claims fell to 4,456,000, but the prior number rose to 4,518,000. Not accounted for in the continuing claims number are displaced workers receiving extended benefits. The number of displaced workers receiving extended benefits rose by 302,000 for a total of 5.84 million more people receiving unemployment benefits than indicated by the continuing claims data. Do the math. That would be over 10 million people receiving some kind of unemployment benefits. It is going to be a long time before we see unemployment drop below 9.00% never mind the sub 8.00% rate predicted by government economic officials last year. The Fed has viewed full employment as being between 5.00% and 6.00%. Good luck seeing that any time soon. Most economists see unemployment above 9.00% through 2011.

Relatively good news from the mortgage sector. Foreclosures and delinquencies fell on a percentage basis. However, the trend with in the quarter indicates that new delinquencies and foreclosures were beginning to rise. Mortgages more than one month overdue increased. This indicates renewed distress among home owners. Experts believe that such an increase suggests than a slowing economy may push foreclosures higher as borrowers lose their jobs. One street economist told Bloomberg News:


"As we work through the bucket of troubled loans, we’re seeing an increase in a new crop of troubled loans." "It’s primarily driven by the jobs market. It still takes a paycheck to make a mortgage payment."
It will be a long way back, but we will come back, as long as consumers to no become too discouraged and businesses are incentivized to create jobs. When you figure out the last part, let me know.


Durable Goods data missed expectations by a wide margin, so wide that the upward revisions of the priors month's data hardly matter. Durable Goods less the volatile transportation sector came in at a -3.8%. That is a horrendous number.


There were some disturbing signs within the durable goods data. For instance, there were gains in the purchase of business equipment, but the equipment is being used to replace less efficient equipment rather than for expansion purposes. By most accounts there is excess capacity in the economy and there is little reason to add more. Manufacturing continues to be the strongest sector, but there are signs it too is beginning to slow. Manufacturing makes up such a relatively small portion of the economy that reliance on it for growth is not a prudent strategy.

New home sales, like existing homes sales, were terrible. The month-over-month change was -12.4%. The prior month's data was also revised lower. A lack of home buyer incentives and a poor jobs market are hindering homes sales. In fact, foreclosures continue to rise as walking away from homes in which one is underwater is now considered to be a prudent financial decision. REITs are doing the same with commercial properties and are being applauded for doing so by traders and strategists. Values? We don't need no stinking values.\

Folks, we may be caught in a negative feedback loop. This is where economic data misses expectations causing consumers and businesses to retrench a bit. That causes the next round of numbers to be worsen and consumers and businesses retrench some more. This is the opposite of the optimism-driven recoveries we to which we have become accustomed. Usually consumer spending breaks the trend, but the consumer is strapped. Productivity only helps to keep consumer prices in check. If consumers have little with which to spend, productivity's benefits are muted.

Some readers have asked me if it is time to sell long-dated assets to realize gains. It is hard to time this. I have been cautiously optimistic on the economy at best. What scares me here is the potential for a negative feedback loop. If you asked me last month if we would see 10-year at 2.45% I would have said: "no way" as such a yield would be pricing in a double-dip recession but the data do not bear that out. Now the data are falling in line, but it is a chicken and egg situation. Are the data driving consumer and business sentiment or is sentiment driving the data?

I think it is more of the latter. Fundamentals were indicating a slow recovery. Consumers and investors were counting on a robust recovery (without knowing where the growth was going to come from). When that did not materialize negativity set in. I can't see rates going much lower short of another severe recession or worse and would be inclined to sell the long and now, but as long as we are caught in this loop, it may not be a bad idea to ride it for a while longer. Our only hope may be a repeal of Obama-care and an extension of the Bush tax cuts. The fears of businesses and consumers must be alleviated. The last thing they need is less money in their pockets.



I was once told by a wise person: "never ignore what the market is telling you.” Please keep that in mind when considering letting ideology affect your investment strategy


Tomorrow we have GDP. We shall watch and pray.

No Denying It

Today's existing home data was ugly. It was coyote ugly. It was so bad that forecasters would probably be willing to chew off a foot to be able to get out from under their predictions. Today's data indicated that the pace of existing home sales, a seasonally adjusted annual rate of 3.83 million. Many expected the pace of home sales to decline now that the home buyer stimulus programs have expired, but the decline reported today indicates the real estate market is severely impaired. A glut of homes, more restrictive lending standards and a poor job market are conspiring to keep the housing market in an impaired state. The following appeared in the Wall Street Journal:

"I'm in no rush," said Steve Hamilton, who sold his Carlsbad, Calif., home two years ago and has been on the sidelines since. He said he was happy to continue renting a home that costs half of what the monthly mortgage payments were just a few years ago. "The tide is still going out," said the 41-year-old commercial-real-estate investor. "When I see a steady increase in local jobs, that's when we'll step back into the market."


This is another blow to those who say that consumers are not needed to lead us back. The problem is that the economy has become overly reliant on an ever stronger housing market. While increased productivity helped keep prices down, it also helped keep wage growth down. Consumers became more dependent on using home equity to fuel spending. That unsustainable part has ended. The recovery has basically stalled. I am still not in the double dip camp, but there is no denying the fact that a v-shaped recovery is not in the card. We may be lucky to see 2.00% growth and that is not enough to be of much help to the job market.

Inflation should not be a problem, but treasury yields may be over done, unless a second deep recession does occur. Some people are of the opinion that we could see stagflation and higher rates as confidence in the dollar wanes. Although that is possible, there is another piece of the equation which must be considered.

There has to be a destination for the displaced investment capital. Where is the capital going to go? To Europe? Not likely as its problems may be worse than those of the U.S. China? See what happens when you want to move the renminbi out of China. Nope, capital will stay in the dollar for now and slowly we will move forward, but a double dip is a distinct possibility.