Quiet day on the economic data front. The NFIB Small Business Optimism report came in a 92.2 versus a street consensus of 91.0 and a prior 90.6. At 10:00 AM EDT we have IBD / TIPP Economic Optimism (the street forecast is little change). At 5:00 PM EDT we have ABC Consumer Confidence. The street consensus is for a -43 versus a prior -44. Treasury prices are down this morning ahead of today's 3-year auction, the first of three this week. Tomorrow we have the reopening of the 10-year note and Thursday we have the reopening of the 30-year bond. Demand is expected to be strong, especially for the 10-year note.
The strong demand for treasuries has some asking if their may be a bubble in that market. One could make the case. Even if growth is not "terrific," as stated by Fed Chairman, Bernanke, at 3.19% 10-year appears to be a bit overdone. One could make the same case for prices of preferreds and corporate bonds, especially non-financials. However, where is one to invest? The equity market had climbed too far, too fats and continues to correct. Where is the next opportunity? Opportunities are everywhere if one knows where to look and manages expectations. Absence a new technology or global event that requires the ramping up of production, economic growth will be rather sluggish. With their ability to cut payroll and increase productivity limited going forward, corporate profits will probably level off, or possibly decline. The best description of the U.S. economy may be: It is what it is.
PIMCO's Tony Crescenzi believes that governments are out of stimulus bullets. He stated in an e-mailed investor letter (Keynesian Endpoint): "Time, devaluations, and debt restructurings might be the only way out for many nations." Crescenzi wrote in an e-mailed note titled "Keynesian Endpoint" He went on to say that debt-fueled spending programs designed to put economies on the path to recovery are now "being seen as a magic elixir that has morphed into poison."
I view the situation this way. The economy can be viewed as a very large aircraft. The government has trucked out its most powerful engines and the result is that the craft is airborne, but not flying very high. Unless additional power is added from other sources, the economy will be a low-flying aircraft. Where will that power come from? That is a question being asked by economists around the globe. However, the answers have been few, far between and not very encouraging. Since cheap lending won't do the trick this time, a new technology or industry is needed to provide the jobs needed to fuel a sustained robust economic recovery.
In the "there's no place like home segment" we have the results of a Bloomberg News poll which states that investors are choosing the U.S. not only over Europe, but also over the best Emerging Markets countries, so-called BRIC countries (Brazil, Russia, India and China). This is further evidence that the U.S. is the least dirty shirt, least ugly girl at the dance or whatever other cliché' one can think up. It is this sentiment that may have caused a bubble in bond prices. However as illogical as a 3.20% 10-year may appear, a 10-year note over 5.00% sounds downright ridiculous in this kind of environment. Fed Chairman Ben Bernanke said that the Fed will likely begin raising rates before full employment is achieved, but did not opine as to what he believed full employment would be this time around. It is doubtful he believes that full employment is in the 5.00% - 6.00% unemployment rate range we have experienced during the past two decades. If he is waiting for such low unemployment the Fed could be on the sidelines for a very long time.
Speaking of treasuries, today's three-year auction went well, but you wouldn't know it by the reaction of bond market participants and financial journalists. Critics pointed to the smaller percentage of indirect bidders, which include foreign central banks (46.7% versus an average of 53.9% over the last 10 auctions). However the bid to cover ratio, which gauges demand versus the supply of new bonds (oversubscribed) was 3.23 versus an average of 3.03 for the last 10 auctions. What this means is that while interest among central banks waned a bit, overall demand increased. Judging by the headlines, one wonders if the folks at Bloomberg News realize this. The real test will be tomorrow's 10-year auction. The 10-year is the most popular treasury among foreign central banks and institutions, such as insurance companies for duration and, in the case of insurance companies, actuarial reasons.
We should also keep in mind that this is not a new 10-year not coming to market, but a reopening of the existing 10-year. Demand may not be as strong as it would be for a new 10-year with a new maturity. The reason is that some institutions can only own so many 10-years, but since they must own the most current 10-year, they are bigger buyers of new issues.
The markets also reacted positively to Fed Chairman Ben Bernanke's statement that the economy continues to gain traction. However, he also said the recovery will proceed at a moderate pace and that unemployment is unlikely to fall quickly.
I wouldn't read too much into today's rally as a new trend. The equity markets were to optimistic during the past year (after being too pessimistic the year before). We could be in for a year or so of much volatility, but little real movement in either direction.
Look for the dearth of new corporate bond issue to continue as issuers wait for credit spreads to come in later on, hopefully after calm returns to the markets. However, we probably need strong real job gains and more transparency from Europe regarding the health of the PIIGS and bank exposure to their bonds. Europe's reluctance to come forward with this information has understandably rattled the markets sending the euro marching toward parity with the U.S. dollar.
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