January 31, 2005

The long end of the bond market reminds me of that watch commercial: “it keeps on taking a licking but keeps on ticking” The 30 yr. US treasury yield is now at 4.59% DOWN exactly 1% or 100 basis points in less than a year while the Fed Funds rate has risen 125 basis points from 1.00% to the current 2.25%. The FOMC meeting begins tomorrow and ends on Wednesday with the announcement at 11:15am of another rate increase to 2.5%.

The amazing part of this is that the economic news for the past week or so has been anything but bond friendly AND yet the bond market is rallying into this Friday’s jobs number that should show the biggest jump in new jobs in years. The seasonal adjustment factor the BLS uses for its January number is a -3MM (yes that’s right, a loss of 3 million jobs in one month) so how can the number be anything but a big jump????

Although housing prices appear to be going flat in the US (or is it just the rate of advance that is slowing??) lumber prices hit a 15 month high at $388 per 1000 board feet. Is this demand from the US or China????

In a few hours the Bank of England will announce its mortgage lending data for December with the last few months showing a slowdown in refinancing activity. In the US the Fed announced that real estate loans FELL last week by $3.5 billion and home equity loan growth slowed to a $.7 pick up. It’s only one week BUT if this statistic ever turns around consumer spending is sure to suffer for many months if not years.

On the corporate side of the ledger commercial and industrial loans rose again last week and the last two weeks show a $11.3 billion gain. Non-financial commercial paper borrowings have risen over $20 billion in January. Somebody is borrowing but no one seems to care…..Normally this would push the Fed into a tightening mode but they are already there and long term interest rates keep falling. There seems to be a consensus that foreign $$$ is entering the US and being used to buy US treasury bonds, notes, bills, etc. and that is what is causing long term interest rates to fall and fall and fall….maybe….but I doubt it….

Long term interest rates over time have and continue to be a function of inflationary expectations. The 30 yr. treasury rate has declined because investors all over the world are convinced that the FED is SERIOUS and will raise short term rates to the necessary level that will extinguish inflation for many years…I do believe the yield curve will go negative this year but that will be with declining long term rates meeting rising short term rates somewhere in the 3-4% range.

Bill Gates announced on Saturday that he has joined with Warren Buffett and is “short” the dollar believing that this is a sure-fire way to make money in 2005. We now have the two richest men in the US telling everyone their “secret” positions. This just doesn’t happen unless you need some help in turning a losing position into a winning one…..I still believe that the dollar has hit bottom and last year’s big story will be this year’s massacre for hedge funds…..

Lots of economic stats the past few days but some are not exactly as we see them…..this morning personal income rose in December 3.7% BUT excluding a $32 BILLION dividend from Microsoft it rose only 0.6%. Personal spending rose 0.8% so the savings rate rose because of Microsoft but fell without it…somewhat confusing….

The core PCE (Personal consumption deflator) which is Mr. Greenspan’s favorite inflation indicator is still increasing at only a 1.5% yearly rate. No inflation anywhere except in the Fed Chairman’s head…..Oh well, you know one of my other favorite expressions: “never fight the Fed”

Every day I read a dozen articles about economic growth in China but do realize that India just revised its growth for last year to 8.5% the fastest growth since 1951! If it weren’t for China India would be the hottest country in the world.

Friday’s announcement that GDP grew at only a 3.1% rate was met with bond buyers sending long term interest rates lower and yet when Canada Stats announced today that they had made a BIG error in their compilation of US/Canada trade figures and that this error would add 0.4% to the US GDP # it was met by more buying in the long end of the US bond market. There’s a message in all of this and it is the following: Sometimes the market’s don’t pay close attention to economic fundamentals and that can last for a few weeks or a couple of months, BUT the markets are like rubber bands and eventually they do snap back and hard….so although I believe the next few weeks will see signs of unusual strength in the US economy it will NOT change the long term trend of interest rates which is still DOWN!!!!

Last thought for the day: This morning it was announced that the inventory of UNSOLD homes in the US is now 4.8 months the highest since June 2000. There were 432,000 homes for sale on 12/31/04 and this is the highest since August 1973. 260,000 of the 432,000 homes for sale are still under construction the highest number since 1979. Maybe the builders know something that we don’t……….I doubt it!!!!

January 27, 2005

A few thoughts about a world economy where “complacency” appears to be the word for 2005.

Did you know that “junk bonds” now yield just less than 2% above US treasury bonds??? They were 9.25% higher just two years ago…..16% of all corporate bonds issued in the last 12 months have a Caa rating or lower and many are issued with the following comment in their prospectus: “their are doubts that we will be able to pay the first interest coupon”…..Complacency or insanity for investors as they reach for yield while taking very high risk that they will NOT be repaid at maturity……From junk bonds that were issued in 1996 – 40% defaulted in the first three years and an incredible 74% have defaulted in just 8 years….

According to the US census bureau state and local property tax collections were $204.5 billion in the first nine months of 2004 which is 30% higher than 2000. With rising home values the local governments don’t have to raise tax rates they just have to keep reassessing homes as quickly as they are sold. What happens when prices stop rising???? Probably nothing according to many Americans, a University of Michigan survey found that over 22% of home buyers now believe that house prices will continue to rise even if interest rates rise and the economy slows down, so it’s better to buy now than wait…..does anybody remember the 80’s or early 90’s….i guess everyone loses their memory when they are making so much money buying and refinancing and then buying some more, etc. etc., etc…..

The price of oil is trading just under $50 as China announced that it’s oil imports were up 35% in 2004. And guess who is now Japan’s top trading partner??? Not the US…but China who accounted for over 20% of overall Japanese trade.

The 10 yr. Us Treasury note is currently yielding 4.21% which is in the middle of its recent trading range. I have a strong feeling that it is about to test the outside band of this range to the UPSIDE…We have 4th quarter GDP tomorrow morning and the important price deflator. Next Friday (2-04) the jobs news may bring some surprising news with jobs increasing more than expected, thus I expect the 30 yr. interest rate to rise over the next few weeks….I do NOT expect the sleepy start of 2005 to continue…there’s a economic land mine out there and it will be touched off sooner than later……..

January 25, 2005

When something becomes easy in the markets it’s usually time to give it a rest and the yield curve flattening trades of the past few months fit this category. Every bond trader in the world is long the 30 yr. and short the 2 yr. because it has become obvious that the Fed will tighten until short rates rise to levels above long rates. They may be right but the path to instant profits is never easy and I see a few warning signs on the horizon….

Today’s new of a six month high in consumer confidence caused the long and short end to sell off with rates rising 8 basis points in the long end. The 10 yr. Treasury is back to the 4.20 level which is the middle of its recent trading range but I smell something going sour for the next few weeks in the interest rate arena….Friday February 4th is the next jobs report and although the street consensus is for an increase of the “usual” 175,000 jobs we may be looking at something much higher and that would drive long rates significantly higher for at least the next month or so…..

Inside today’s confidence number we find that the jobs plentiful index rose to 20.7% from 19.4% which is the highest since 2002 and the jobs hard to get category fell to 24.7% for 26.4% again the lowest since 2002. There is no question that the Fed’s tightening of the last 6 months has had almost no effect on public psychology and the fact that long rates are much lower only adds another layer of complacency to the overall picture. I’m not sure what is coming but I would batten down the hatches for a few weeks and take cover….

The above comments do NOT reflect a change in my opinion that long term interest rates are headed much lower, but since nothing happens in a straight line it appears we have hit a temporary bump in the road….

January 17, 2005

I have been watching interest rates on a hourly, daily, weekly, monthly, yearly basis since 1968 and I really don’t remember a period of time where the interest rate market was a quiet as it is this month. Everyone has finally come to the conclusion that the Fed will continue to raise short term interest rates (Fed Funds) until they yield curve goes flat or inverted and with long term rates DECLINING every time the Fed tightens that surely will happen sooner than later…. The reaction of the bond market to almost all news is a little bit up and then a little bit down….The 10 Yr. US treasury continues to trade in a tight range of 4.00% on the downside and 4.40% on the upside. Everything in between is just noise…Daily Fed speakers just repeat different parts of the recently released December Fed minutes with almost no one paying attention to the part concerning a housing bubble…everyone has heard this for so long that no one believes housing prices can ever fall except for a couple of months. A recent poll of home buyers showed over 80% EXPECT that prices will double in the next 10 years. And if they don’t??? why worry there is no downside…right??? remember we only see ahead what we have experienced in the past…has anyone lost any $$$ buying and then selling a house in the past 10 years???especially in Southern California….meanwhile 37% of banks assets are in the form of real estate loans with banks eager to keep piling on more real estate loans…it doesn’t really create more jobs but why worry when you can tap that unrealized equity thru more borrowing…..

Something different is going on but it’s too early to say what part of the dam will break first….it does remind me of the kids game where they stop the music and remove a chair and someone is unable to sit down…..if that someone is a big lending institution that has real estate loans it will be the Fed again that has to step in a make a big enough chair so the game can continue……

The one market that looks to be strong for 2005 is the one that no one expects…the dollar…yes that awful dollar that everyone hates….if the Fed keeps raising short term rates the interest rate differential between the US and its trading partners will widen and more money will flee these countries and be invested in US treasury bonds….

Inflation is low…the economy is medium strength….our trade deficit is growing and growing…but long term interest rates are sending a message that everything is NOT the way the Fed believes……

January 10, 2005

If at first you don’t succeed keep on trying until you get it right….

From weekend newspapers:

1/08 – Financial Times of London – The US rate puzzle – ” In the longer term, (more than one day to many traders) higher yields look inescapable as part of the required rebalancing of the US economy.”

1/08 – Financial Times of London – The only way for US rates is up – Two articles in one day, maybe the writers are all short the US bond market??

1/09 – Japan – All Markets were closed for observance of the “Respect for the Aged Day” – we should have that in the United States….I have been around so long watching interest rates that I now qualify as “AGED”

1/10 – Financial Times of London – US treasuries column – ” Despite the pain endured last year, investors should not shy away from placing bets on yields rising in 2005 – The only investors who suffered pain last year were those that bet on higher US interest rates.

1/10 – Financial Times of London – Foreign exchange column – ” Analysts (economists) are rarely held accountable for their
forecasts or strategies. Experience teaches that responsibility WITHOUT accountability leads to less than optimal results.” – Didn’t I write that last week??? Maybe someone from the FT is reading my e-mails…….

Atlanta’s Fed President Guynn in a speech this afternoon said that short term rates are still NOT in neutral territory and that he couldn’t promise that the Fed’s future increases will be gradual…WHOA!!!! If the Fed speeds up its tightening we will have sub 5% 30 yr. mortgage rates and maybe even 4% sooner than even I imagined…..Remember that since June 30,2004 the Fed has INCREASED short term rates from 1.00% to 2.25% while the 30 yr. US treasury rate has DECREASED from 5.87% to 4.81%….

The Fed and all other central banks seem afraid of impending inflation….The UK announced today that wholesale inflation fell (0.4%) last month and was the biggest drop since November 2001 and core PPI fell (0.3%) the most since July 1999. That’s DE-flation not inflation.

This past Friday afternoon the Fed reported that consumers paid DOWN consumer debt by $2.1 billion in November which was the first decline since January 2003. Could this be the start of a trend towards more consumer savings and less spending????

One of my favorite economic forecasting models comes from the folks at ECRI (http://www.businesscycle.com) and last week they reported that they show the economy now growing at only a 0.7% rate and inflation at just 2.1%. They tend to be as accurate as anyone, have no biases, and are generally six months AHEAD of most other economic indicators.

Almost forgot to mention the jobs number last Friday was a non-event and interest rates ended the day just about at the same place they started with the 10 yr. at 4.27%. Oh well, maybe next month (February 4th)….

FINAL THOUGHT: If you want to see long term (10 years++++) interest rates drop further keep rooting for the Fed to raise short term interest rates and you will get your wish… The higher short rates go the lower long rates will FALL……

January 6, 2005

We are just a few hours away from the BIG jobs report so interest rates were virtually unchanged today even though oil rose almost 5% to $45.50 a barrel. Remember from the FOMC minutes released earlier this week that the Fed believes lower oil prices are good for the economy due to consumers having more $$$ to spend so the Fed needs to raise short term rates….and the Fed believes that higher oil prices are inflationary so the Fed needs to raise short term rates……they have it covered both ways…they just want to tighten no matter what happens so tomorrows jobs report may NOT have the market impact normally seen after the release of the number.

Tonight in Tokyo Japanese Finance Minister Tanagaki announced that it appears that Japan will have inflation in 2005 with a 0.1% rise for the year in consumer prices after five consecutive years of deflation. He added that he does not expect to see a change in monetary policy due to this outbreak of inflation. 0.1% would be deflationary every country in the world except Japan where they are ecstatic to have inflation (0.1%) come roaring back……Interest rates are unchanged tonight in Japan and the one year treasury bill continues to yield 0.1% just like the 2005 inflation rate…..

I rarely touch on the stock market but I found it interesting that in this weeks poll from Investors Intelligence they show the highest bullish reading (62.9%) from advisors since 1987…..That was Mr. Greenspan’s first year as Fed Chairman and he managed to raise short term interest rates to try and save the dollar, instead it created a stock market crash in October. I wonder if history will repeat itself????

It’s Greenspan time around the world and in this mornings’s Scotland newspaper the article entitled “Greenspan will prove a hard act to follow” makes interesting reading: http://business.scotsman.com/index.cfm?id=13092005

I’ll have more tomorrow after the jobs number and the Fed weekly loan stats…..

January 5, 2005

We are just two days away from the jobs report (Friday at 5:30am) and yet the bond market is focused on the Fed and 2005 monetary policy. Usually the Fed pays close attention to the economy but the FOMC minutes released on Tuesday seem to show that Mr. Greenspan is only paying attention to his own crystal ball. It is his sandbox and we are just spectators BUT there are other events he needs to view and the sooner the better…..

This morning it was reported that mortgage applications for purchases fell last week by 13.7% while refi’s dropped 5.7%. This may not be significant because the end of the year is NOT usually a good predictor of future activity BUT we should pay close attention to the first couple of weeks of January for more clues….

Mortgage approvals in the UK fell to a 9 year low in November and it appears that the air is slowly coming out of the housing bubble in England. This should prevent the Bank of England from increasing their overnight rate in 2005.

The Fed says it is afraid of inflation and yet according to an article in today’s NY Times Wal Mart had to cut prices to jump start sales between Thanksgiving and Christmas. That’s not inflation….

Delta has announced price cuts of up to 50% on certain flights in the US. That’s not inflation…..

The Association of Foreign Investors in Real Estate that represents 17 countries found that 60% of its members found it “very difficult” to find attractive real estate investments in the US. It also found that foreign investors plan on REDUCING their holdings in the US from 71% to 55% of their holdings. This is NOT good news for those who believe that real estate prices will rise again this year.

In today’s Wall Street Journal one of their forecasters leads his 2005 predictions with: “Never in the course of human events have so many predicted something (higher interest rates) for so long and been so wrong.” He goes on to predict again higher rates for 2005.

Auto sales in December were a record 18,4 million which on the surface is good news, BUT it is really just more deflationary news as prices plummeted to create the sales. In the 1980’s increased sales were usually accompanied by higher inflation due to capacity utilization’s numbers that were at record highs. In 2005 increased sales with excess capacity and lower prices does NOT convert to inflation.

The only good news is that if the Fed keeps it’s current policy intact for a few more months they will create a once in a lifetime opportunity for nimble investors to make more $$$ than they thought ever possible………..

January 4, 2005

It’s time to strap on your seat belt nice and tight because according to the minutes of the December FOMC meeting released this morning the Fed really is afraid of the BIG BAD wolf named inflation. This truly is a MUST READ for everyone that has a vested interest in future Fed policy (isn’t that everyone in the world??), so run don’t walk to http://www.federalreserve.gov/fomc/minutes/20041214.htm and read and re-read this most important document. It appears that Mr. Greenspan and his posse have interpreted every economic statistic in a way in which inflation is the result no matter which way the US economy turns…..very strange and very dangerous. The minutes quote a Fed Governor as stating that an upturn in merger and acquisition activity is a sure sign of future inflation…..it probably is a better sign of FEAR from corporations that are so unsure of the future that they would rather spend their cash on stock buy backs, increased dividends, or mergers because the normal course for investing $$$ is capital expenditures to increase their bottom line….

But the scariest line in the minutes is “the current level of the real (nominal less inflation) fed funds rate target remained below the level it most likely would need to reach to keep inflation stable.” So the Fed is telling us that short rates need to rise much higher to make sure that inflation does NOT rise further????? The truth is inflation continues at a 1.5% annual rate and has shown NO signs of increasing and yet the Fed sees a storm coming when there are no clouds in the sky….IF and it’s a big if the Fed continues to raise the funds rate each FOMC meeting and reaches a level that many predict of 3.5-4.0% we will have record LOW long term interest rates in the next 12 months. The good news is that the Fed is often (more than 50%) wrong in its economic and inflation predictions and can and will change monetary policy quickly upon this realization. The good news for investors/borrowers/lenders is that it presents an incredible (once a decade) opportunity to make $$$ by going against the crowd of interest rate pessimists.

In today’s news the German unemployment rate at 10.8% rose to a 7 yr. high. Somehow inflation rising to 2.3% from 2.2% received more attention from European economists…..Did you know that the estimate of economic damage from the tsunami is approx. $10 billion but the damage from the 2004 hurricanes was over $22 billion. Unfortunately the low amount of reconstruction $$$ won’t help recover the 150,000 lives that were lost…..

Friday’s estimate of the jobs number of 175,000 should be taken lightly as the average “miss” by the experts in 2004 was 108,000. It would be easier to throw darts and maybe more accurate. My guess is an increase of under 100,000 based on the lower jobs component of the recently released ISM surveys.

BTW, the tsunami has had no effect on world interest rates and really should not be anything more than a small blip for the countries impacted except for a brief slowdown on tourism….much like SARS in Asia the world tourist is a tough traveler and will still travel to places where they can get the biggest travel bargains.

I know I am repeating myself every night but it’s lonely predicting something that no one thinks is possible…the BIG surprise in 2005 will be that long term interest rates do NOT rise…..

January 3, 2005

Happy New Year to everyone and it looks like 2005 is starting out the same way we ended 2004, everyone continues to believe that long term interest rates will rise…..The most hated asset for the new year continues to be the long term (10 years ++) US Treasury bond and yet the yield ended the year at the same exact point it started the year….4.25% for the 10 yr. note. If someone had told you a year ago that 2004 would see a Fed increasing the Fed Funds rate by 125 basis points, oil rising to over $50 a barrel, the dollar depreciating 10%+++, the current account and budget deficits spin out of control, the US savings rate at 0.3%, etc., etc. BUT long term interest rates would be unchanged at 4.25% you would have written the prediction off as a wild long shot or a typographical error. YET, interest rates did stay down the entire year of 2004. Just like the blackjack player in Las Vegas who doubles down after each losing hand the world’s best (???) economists have again predicted that long term interest rates will rise in 2005. They have been predicting higher rates for the last three years and it appears they will keep the same prediction every year until they are correct or they lose their jobs (do economists ever get fired for poor predictions??) In this mornings Wall Street Journal 56 economists were polled on their predictions for June 2005 (six months) and all but one (Merrill Lynch) believe that the 10 yr. Treasury rate will rise from current levels with the average forecast of 4.79 which is a rise of 57 basis points from today’s level. Last June these same economists predicted the 12-31 rate would be 5.14 so they only missed by 89 basis points and not ONE economist was even close to the actual 4.25% level. It’s the one occupation where pay is high and results are low……..

In the last 12 months foreign buying of US securities totaled over $850 billion with a current account deficit of just over $600 billion so the US actually raised more $$$ than it needed to cover the deficit. If the Fed continues to tighten the dollar should strengthen and pull more $$$ into US bonds. When will the Fed stop raising short term rates??? In the last 25 years the Fed has not stopped until the spread between the 2 yr. and the 10 yr. was around 20 basis points, today it is just over 115 basis points. Does this mean the Fed has another 100 basis points to increase the Funds rate??? Hopefully not BUT remember this is not your ordinary Fed tightening the long end of the bond market has already discounted more short term interest rate increases than will occur in 2005 so the ONLY direction for long term rates is DOWN!!!!!!

Tidbits from around the world: France announced its unemployment rate rose to 9.9% the highest since February 2000. In the UK the Nationwide Building Society reported that housing prices FELL 0.2% in December. Tokyo’s CPI fell 0.4% in December as DEFLATION continues in Japan. Last month in Japan 150,000 lost their jobs AND 450,000 people dropped out of the labor pool because they felt finding a job was too difficult. On Thursday (12/31) quotas on the import of clothes from China EXPIRED……this is NOT inflationary and will result in LOWER prices for many goods in 2005.

Tuesday the Fed releases the minutes from it’s December FOMC meeting and on Friday (1/07) we have the monthly roller coaster ride called non-farm payrolls (jobs) and the experts (???) are predicting an increase of 175,000.

It’s the same old song……the Fed and everyone else sees the ghost of inflation past and as a result are predicting HIGHER long term rates and yet the bond market like a tough boxer just keeps on taking the hits but keeps on fighting back with LOWER rates. Remember on June 29th the day BEFORE the Fed’s first interest rate increase the ten year treasury interest rates was higher than today. The BIG surprise for 2005 will be that long term rates do NOT rise………….