bond market movements and yield curves / strength of dollar issues

Discussion in 'Economics' started by scriabinop23, Jul 11, 2006.

  1. I'm not a bond trader -so let me disclaim myself first off. Also, I've read numerous articles on yield curves and the meaning of bond prices - but I want to discuss this on a macro level with more informed members of the group.

    Here's my personal view and attitude:
    1) for me to invest in long bonds, I'd require a high dividend yield (7 or 8% range), mainly because I see inflation (high energy prices long term expected) and a weakening dollar (from poor US fiscal policy, etc) as a continuing long term force.

    But -- the market doesn't seem to coincide with my personal view:

    1) Bond yields are going down, because the market believes inflation and a weakening US dollar as a long term force are not an issue.

    2) Intuitively, I would conclude if the bond market believes the fed will be done raising overnight lending rates, then yields should adjust downward. So do lukewarm earnings outlooks and a viewed price ceiling (ie oil resistance at 75) to the commodities runup all comprise a view that even another rise in 25 basis points for the fed rate is unlikely?

    This differs from what every analyst you see in the media things. Yet bond prices go up today? I would presume if the market anticipated a .25 bp increase in short term rates, treasuries would at least not go up in price in the interim.

    I'm not sure what to make of any of it.
    So it doesn't make sense to me - despite all of my own bearishness, does the market tell all: they believe long term the US dollar will continue to be at least as strong as it is now, and that inflation will slow down to an acceptable point ?

    Or do long term views not enter into markets, even with products that go 10 or 30 years out ?


    Please cite faults in this (seemingly circular) logic contributing to my long term view:

    1) National debt service issues will not be a problem if inflation or hyperinflation occurs, as increased government tax revenues will cover cost of debt. Thus, high inflation (through high interest rates and/or putting more money into circulation) is required to get us out of a potential bind with our national debt.

    2) If bond markets are bullish, then inflation is not viewed as a long term pressure (since bond yields NEED to outperform inflation pressure).

    3) Typically stock markets suffer in a bullish bond market?? [since bond appreciation will outperform stock from lowering rates]

    4) If future inflation is anticipated low, bonds do not need as high yields to offset risk of holding dollars to foreign investors. So dollar strengthens, and our exports continue to go down, and stock markets suffer. Additionally high commodity costs if remaining (but not growing) add downward pressure to stock markets and economy.

    5) Tax revenues go down to US government from faltering US companies, and government needs to print more money and issue more bonds to prevent from defaulting on debt. INFLATION and US dollar continues to devalue.

    6) Bond rally stops with inflation realized, and yields go up to catch up to rising inflation. Fed comparably raises drop lending rates to stimulate corporate growth. Dollar continues to weaken, but companies do OK.

    7) Devaluing US dollar and poor economic health on the bright side lower our trade deficits with asia, since we can't afford to buy anything with worthless dollars. On the other hand, our exports thrive since strong currency countries can afford to import our products, and equity markets and economy recover.

    So I predict a great stock market boom in tandem with a dollar collapse.

    :) [you see why none of this makes sense to me]
     
  2. I am not sure what you mean by 'dollar collapse' . As far as I can see dollar is already bottom rock cheap.
     
  3. I mean 2 USD to 1 EUR as a collapse. If we need to inflate our way out as a way of dealing with the debt, there's no reason I see it couldn't happen.

    I'm sure the US government will try to stop paying interest on entitlements (3 trillion of the current debt) as a first attempt to deal with this.

    So in summary - my short term view:

    1) bond rally
    2) bear stock market (commodity pressure there as well)
    3) international stock markets do lukewarm from commodity price pressure and interdependance on our faltering economy.
    4) from this global economic slowdown, commodity prices come down.

    then 2-4 years out:

    5) dollar quickly deflates as our poor fiscal policy lashes back at us. So bond market turns bear as yields drift upwards and prices downward.
    6) bear US equities market turns bull as fed lowers rates to stimulate growth even in inflation-dense environment, despite risk of accelerated weakening of dollar. Weakening dollar stimulates economic production and exports, and cheaper commodities does the same.
    7) international equity markets do poorly, since they're currencies are too strong. Other nations do, however, consume our exports however, stimulating us (much like we do to China).
    8) commodities prices return higher and once again start this cycle again.

    If politics change with Bush out in a few years, however, then we have another story. If we have higher taxes and lower government spending from future administrations, then I presume this will stimulate strong dollar policy. It will also probably spell continued trade deficits (which are OK), and a less volatile and dramatic future. Probably still a bearish stock market and a prolonged bull bond market.
     
  4. There are some who think that the bond market is predicting weaker corporate earnings and a weaker economy.
     
  5. You have to take into account the "excessive participation" of hedge funds in the bond market who are engaged in various types of trading that have an overall long-bias. It might take another LTCM-scenario to shake them out and restore a positive slope to the yield curve.
     
  6. ***Ok, let me throw out my two cents. I'm not a professional economist, so I'm allowed to be wrong. :)

    Please cite faults in this (seemingly circular) logic contributing to my long term view:

    1) National debt service issues will not be a problem if inflation or hyperinflation occurs, as increased government tax revenues will cover cost of debt. Thus, high inflation (through high interest rates and/or putting more money into circulation) is required to get us out of a potential bind with our national debt.

    ***Agree on the tax revenues issues, but in general, the ability to print more money any time, in any amount, means that national debt issues will never be a problem, but devaluation of the dollar will be.

    2) If bond markets are bullish, then inflation is not viewed as a long term pressure (since bond yields NEED to outperform inflation pressure).

    ***Depends on what you mean by long term. I view bond purchases like I view 30-year mortgages...the folks who buy them typically don't expect to hold them for the whole duration, so, for example, the time horizon for 10-year bonds may only reflect the next 10 years or so. Also, perception plays such a great role with bonds (i.e., "the Fed has it under control") that the actual future rates are almost unrelated...Remember all the folks that got rich on junkbonds right after interest rates were at 18% and dropping? Prior to that, the issuers of the junk bonds (and the market) really believed that rates would stay that high for years and years.

    3) Typically stock markets suffer in a bullish bond market?? [since bond appreciation will outperform stock from lowering rates]

    ***It depends. I think there is a sweet spot. If bond rates are too high, the cost of money is so high that its hard for businesses to make money. If bond rates are too low, money is cheap, and you may as well invest in your business, but there are less barriers for your competitors to compete against you so you have to run lean. Also, if bond rates are low, it may be because the economy is unhealthy and that may not be a good time for stocks. Basically, it depends on whether the economy is getting sicker or getting stronger, which is a function of lending rates.

    4) If future inflation is anticipated low, bonds do not need as high yields to offset risk of holding dollars to foreign investors. So dollar strengthens, and our exports continue to go down, and stock markets suffer. Additionally high commodity costs if remaining (but not growing) add downward pressure to stock markets and economy.

    ***I agree with your correlation, but it not necessarily the cause and effect. The anticipation of a strengthening dollar would make bonds attractive to foreign investors also. If I thought the yen was going to double in the next 30 days, I'd be OK with holding a bond, payable in yen, with really crappy returns.

    5) Tax revenues go down to US government from faltering US companies, and government needs to print more money and issue more bonds to prevent from defaulting on debt. INFLATION and US dollar continues to devalue.

    ***Indirectly...most companies pay little taxes and lots of tax revenue comes from the middle class. Its more a function of the middle classes ability to earn money and pay taxes. Note that if the middle class is hurting, they don't buy much, so that is bad for businesses. Employment figures play a huge role as they are indirectly, the income that services national debt, and debt drives inflation in a fiat money system.

    6) Bond rally stops with inflation realized, and yields go up to catch up to rising inflation. Fed comparably raises drop lending rates to stimulate corporate growth. Dollar continues to weaken, but companies do OK.

    ***Yes. Another way to look at it is that inflation means there is a lot of dollars out there, and so each individual dollar is worth less.

    7) Devaluing US dollar and poor economic health on the bright side lower our trade deficits with asia, since we can't afford to buy anything with worthless dollars. On the other hand, our exports thrive since strong currency countries can afford to import our products, and equity markets and economy recover.

    ***Agreed. There is a sweet spot for the dollar, and that sweet spot changes over time depending on how other nations do.


    So I predict a great stock market boom in tandem with a dollar collapse.

    *** Dollar will collapse. But I don't know about a stock market boom. You'll have baby boomers retiring in mass numbers in the next decade. They will:

    1. cut their consumption
    2. sell stocks
    3. stop buying stocks

    All of these are bad for the stock market, and my concern is that the market will stagnate for decade. Lots of "tweeners" like me will be expecting their retirement accounts to double one last time and it won't happen. I'm not a doom and gloomer, but I'm trying to buy more foreign stuff and "real" assets.

    SM
     
  7. I did some reading today and saw some things I never realized before:

    1) Japan currently has in excess of $7 trillion (USD equiv) dollars of debt. Their budget deficit is equal to something like 5.6% of gdp. US debt is actually a bit lower (percentage of gdp).

    2) I'm having trouble finding comparable statistics for economies that comprise the EU. But I did find this link as it pertains to Germany (probably the strongest EU member):

    http://www.destatis.de/indicators/e/iwf01.htm#Footnotes

    It indicates some 900b euros (1.2 tril USD) of government debt, and a yearly budget deficit of around 350b euros (similar, but a bit larger than ours), if I've read correctly.

    Any good resources for something that composites all pertinent EU members that affect the EU currency?

    After all, we're not talking about the mark, we're talking about the strength of the Euro.
     
  8. extracting from an infamous Chit Chat thread... take a look at:

    http://www.euractiv.com/en/agenda20.../article-117997 scroll down for the public debt / gdp comparison table... maastricht's treaty 'threshold' is 60% fyi... japan's in the 170% range... at end 2005 Europe's in the 70% range

    http://www.fin.gc.ca/budget06/bp/bpa1e.htm some interesting comparisons - G7, Can vs US - even if not exactly the same aggregates...

    some possible adjustments at the margin... haven't checked for Europe... since its at the margin anyway, otherwise we would already know:
    http://www.cepr.net/publications/real_budget.htm
    http://www.cepr.net/publications/deficit_scare.htm

    also, some good stuff here re pertinence / sustainability of other 'similar' macro-type ratios:

    canada (40%), australia (60%) notably in terms of net int'l debt/gdp ratio... still relevant enough... week-end read: http://www.kc.frb.org/publicat/ECONREV/PDF/1q01holm.pdf and if you can't get enough
    http://www.sedlabanki.is/uploads/files/mb011_4.pdf discusses a couple interesting cases in details

    hope this helps - cheers