The reality of DEFLATION has entered the thoughts of investors
July 9, 2009
Five nights a week at 10pm (Sunday-Thursday) I send an update with my thoughts about markets, the economy and interest rates. Below is the e-mail sent to all daily subscribers last night, if you wish to subscribe the cost is only $1 a day.
The biggest news of the day comes from the $19 billion 10-year T-note auction that sent shorts scrambling to cover after massive losses. I have warned for two weeks that a major short squeeze was coming because the overnight repo rates were causing much pain for those betting on higher long rates. The 3-year repo rate today was MINUS 1.05% and the 10-year was MINUS 2.05%. We should see some relief on Thursday as many of these shorts are gone wondering how they could lose so much is such a short amount of time. The 10-year closed at 3.31% and the inflation component fell 10 basis points to 1.54%. Thursday is the final leg of this week’s auctions and $11 billion of 30-year bonds will need bids at 10am (PST). It’s doubtful the shorts will again wait to cover in the auction and we should see an uptick soon back to at least 3.50% in the 10-year. Today’s auction was truly extraordinary because the 10-year was trading at 3.425% at 10am when bids were due but the auction cleared at 3.365%. Billions of shorts who thought they covered in the auction were left without notes and it was a mad scramble within seconds of the auction results for notes at any price. The bid cover was 3.28 (bids versus winners) and the normal for a 10-year auction is 2.26 which again tells us that most of the shorts missed yet again. We are on our way to 3.00% in the 10-year with more shorts that need to be covered AND because the inflation component has fallen 50 basis points in the last month.
The Fed announced today the dates for their next note and bond purchases with one tomorrow (1-2 yr maturities), two next week and two the following week. The Fed has now bought over 60% of its $300 billion Treasuries and almost 40% of its $1.25 trillion mortgage backed securities. A month ago when the 10-year was at 4.00% everyone believed Fed purchases were inflationary but now these same traders are trying to find places to hide from what is obviously deflation.
The Fed reported consumer credit fell $3.2 billion in May after a revised record decline of $16.5 billion in April. Many experts are declaring an end to the consumer spending contraction but these figures are always revised and banks show no signs of increasing credit to anyone except those that don’t need to use it. Consumer credit has now fallen $62 billion since its peak in July 2008.
Most of the important news on Wednesday showed an acceleration in the DEFLATION that is now affecting new areas of the U.S. economy. A very sharp reader asked about food prices and the Arizona Farm Bureau reported that food prices fell 6.5% in the second quarter of this year.
Southwest Airlines announced one of the biggest fare sales in their history with one-way fares as low as $30 (trips up to 400 miles) and American and other airlines have begun to match as much as possible. Falling air fares in the summer when most people travel on vacation shows how many are not flying and is another example of DEFLATION.
Less flyers means less revenue for airports and many are considering slot machines, corporate sponsorships and other Las Vegas type ideas to bolster their bottom line. http://www.tampabay.com/news/business/airlines/article1016490.ece
According to an analysis from Real Capital $108 billion U.S. commercial properties are now in default, foreclosure or bankruptcy up 100% from earlier this year. At the end of June 5,315 buildings were in financial distress and increase of more than 100% from January.
Last night I wrote about apartment vacancy rates and rents falling and tonight Reis Inc. released rates for both strip and regional malls. Vacancies at U.S. strip malls hit 10% in the second quarter but more importantly effective rents fell 3.2% in the past 12 months. 7.9 million square feet was returned to the market last quarter and there are NO signs of bottoming especially since the consumer can’t obtain credit and is too afraid to spend.
Although the Fed and administration are telling anyone who will listen they want an increase in lending the Fed has quietly been adding personnel to it supervision and regulation group. They are projected to employ 2,876 in 2009 versus 2,674 in 2008. Banks are not only afraid to make loans against collateral that is declining in value but also because they know every loan will be examined more carefully and by more bank examiners than any time in history. This is why the Fed and almost anyone with assets is desperately hoping for a return of inflation. The only winners in a DEFLATIONARY era are those with no assets and a fixed income (minimum wage workers).
Final thought: What if consumers continue to increase savings AND pay down debt instead of spending? Wouldn’t that drive down prices and long-term interest rates to levels not seen in 60+ years? The poor would become rich and the rich would soon become poor. Would anyone in Washington be upset if that happened?
If you missed my last economic forecast/interest rate class or webinar we now have a CD-ROM of the June 17th webinar with all of the material presented for only a $100 donation to Food on Foot.