Thursday, June 18, 2009
Tuesday, June 16, 2009
Market Direction
In a normal world these two charts would be complementary. As interest rates on the 10-year Treasuries rise one could reasonably expect the Dollar Index to follow. But ever since March18th when the Federal Reserve announced its $300 billion quantitative easing policy, the divergence has been pronounced.—the higher Treasury rates climb the lower the Dollar Index sinks. Has the natural order of the currency markets been upended?
10 Yr Treasury Yield 1 year chart
Dollar Index 1 year chart
In normal economic times the currency market and the bond market respond to the anticipation of higher US rates. The price of Treasuries fall, the yield climbs and the dollar gains. It is the expectation of returning economic growth and inflation that piques the anticipation for a new upward rate cycle from the central bank. If this were a standard recession, with three quarters of negative growth already past, historically low rates, large amounts of additional liquidity, and the first stirrings of recovery, market anticipation would focus on the changeover to a restrictive rate policy.
But these are not normal times. Fed rate policy is constrained by the recession and the residue of the financial crisis. The Fed cannot and will not raise rates until the economy is clear of the threat of deflation and the financial system has restored its ability to lend and supply credit to the economy.
The Fed is in a bind. If it lets consumer interest rates rise it undermines the economic recovery its policy has been trying to foster since last year and risks choking off whatever economic stabilization has been achieved. But if it increases its purchases of Treasury debt to keep rates low then it provokes fears of future inflation; and, what is perhaps more damaging, the suspicion that the US government is willing to monetize its debt.
In the current economic environment, and especially in light of the government’s unprecedented funding needs, extensive Fed purchase of government notes, quantitative easing, will cause as much harm as good. ‘Quantitative easing’ is simply a different term for the monetization of government debt. The Federal Reserve buys debt issued by the Treasury and the Treasury uses the proceeds of the sales to pays its bills, which means distributing the new dollars to the economy.
The inflationary result of quantitative easing is twofold. It contributes directly to present inflation by increasing the money supply and by devaluing the dollar, raising the cost of dollar priced commodities like crude oil. Higher oil prices feed back into consumer price inflation. Last summer’s $4.00 a gallon gasoline was at least partly caused by the historically weak dollar. The cost of gasoline acts as a direct drag on consumer spending, reducing disposable income. The pump price for a gallon has gained more than the dollar in the past two months.
The second effect of quantitative easing is more insidious but in the long run far more damaging to the US dollar. If higher rates for US Treasuries indicate an oversupply of these dollar assets then they pose a danger to the dollar’s status as the world’s reserve currency. One of the basic functions of a reserve currency is as a store of value for liquid assets. If investors look into the future and see only an ever increasing supply of dollar assets for sale, in numbers far beyond the rate of economic growth in the US, issued by Washington to fund its deficits, then the value of those assets will likely to fall..
The financial crisis was a singular event and it prompted an unprecedented flight to quality in the Treasury market. The demand for security was so great that Treasury yields fell far below historical analogues. Two developments particular to the Treasury market and abnormal in the sense of never having occurred before have kept the currency markets from responding in a standard fashion to the rise in Treasury rates.
First, the recent increase in the 10-year yield has taken place in the contest of historically low Treasury rates. The 2.03% yield of last December was an anomaly and the return to more normal yields should not be taken to mean anything but that the most extreme portion of the financial crisis is passed. Higher Treasury yields do not in this case mean a change in Fed policy is near.
10 Year Treasury Yield 20 Year Chart
The second Treasury market development is also brand new and without historical example: the budget plans of the Obama administration.
The Democratic administration isn’t just issuing record debt this year. For the next ten years, in the government’s own projections, deficits never drop below $500 billion in any year. The administration claims that this scale of debt is necessary to help the US avoid the worst effects of the recession. But the costs of the array of new programs that are part of the budget projections dwarf anything that the US government has ever enacted before. Every dollar of this new spending will have to be borrowed.
For the Treasury market the vast supply of issuance threatens to overwhelm demand. This quantity of government debt has never been put for auction to the world’s investors. Their response is unknown. Will the United States government be able to sell its debt and fund its deficit? Yes. The question is at what cost. How much higher will returns have to go to keep buyers purchasing US securities?
In pushing Treasury rates higher, the bond market is responding to the enormous pending supply of government debt and to the historic lows in Treasury yields that resulted from the financial panic. 3.7% yields in the 10-year Treasury are not indicative of a Fed on the verge of a restrictive interest rate policy. .
Because both developments were singular to the Treasury market and do not yet represent a scenario dangerous for the US economy the currency market response was muted. It remains to be seen if currency traders view the projected massive increase in American debt as a positive or negative for the dollar.
Joseph Trevisani
10 Yr Treasury Yield 1 year chart
Dollar Index 1 year chart
In normal economic times the currency market and the bond market respond to the anticipation of higher US rates. The price of Treasuries fall, the yield climbs and the dollar gains. It is the expectation of returning economic growth and inflation that piques the anticipation for a new upward rate cycle from the central bank. If this were a standard recession, with three quarters of negative growth already past, historically low rates, large amounts of additional liquidity, and the first stirrings of recovery, market anticipation would focus on the changeover to a restrictive rate policy.
But these are not normal times. Fed rate policy is constrained by the recession and the residue of the financial crisis. The Fed cannot and will not raise rates until the economy is clear of the threat of deflation and the financial system has restored its ability to lend and supply credit to the economy.
The Fed is in a bind. If it lets consumer interest rates rise it undermines the economic recovery its policy has been trying to foster since last year and risks choking off whatever economic stabilization has been achieved. But if it increases its purchases of Treasury debt to keep rates low then it provokes fears of future inflation; and, what is perhaps more damaging, the suspicion that the US government is willing to monetize its debt.
In the current economic environment, and especially in light of the government’s unprecedented funding needs, extensive Fed purchase of government notes, quantitative easing, will cause as much harm as good. ‘Quantitative easing’ is simply a different term for the monetization of government debt. The Federal Reserve buys debt issued by the Treasury and the Treasury uses the proceeds of the sales to pays its bills, which means distributing the new dollars to the economy.
The inflationary result of quantitative easing is twofold. It contributes directly to present inflation by increasing the money supply and by devaluing the dollar, raising the cost of dollar priced commodities like crude oil. Higher oil prices feed back into consumer price inflation. Last summer’s $4.00 a gallon gasoline was at least partly caused by the historically weak dollar. The cost of gasoline acts as a direct drag on consumer spending, reducing disposable income. The pump price for a gallon has gained more than the dollar in the past two months.
The second effect of quantitative easing is more insidious but in the long run far more damaging to the US dollar. If higher rates for US Treasuries indicate an oversupply of these dollar assets then they pose a danger to the dollar’s status as the world’s reserve currency. One of the basic functions of a reserve currency is as a store of value for liquid assets. If investors look into the future and see only an ever increasing supply of dollar assets for sale, in numbers far beyond the rate of economic growth in the US, issued by Washington to fund its deficits, then the value of those assets will likely to fall..
The financial crisis was a singular event and it prompted an unprecedented flight to quality in the Treasury market. The demand for security was so great that Treasury yields fell far below historical analogues. Two developments particular to the Treasury market and abnormal in the sense of never having occurred before have kept the currency markets from responding in a standard fashion to the rise in Treasury rates.
First, the recent increase in the 10-year yield has taken place in the contest of historically low Treasury rates. The 2.03% yield of last December was an anomaly and the return to more normal yields should not be taken to mean anything but that the most extreme portion of the financial crisis is passed. Higher Treasury yields do not in this case mean a change in Fed policy is near.
10 Year Treasury Yield 20 Year Chart
The second Treasury market development is also brand new and without historical example: the budget plans of the Obama administration.
The Democratic administration isn’t just issuing record debt this year. For the next ten years, in the government’s own projections, deficits never drop below $500 billion in any year. The administration claims that this scale of debt is necessary to help the US avoid the worst effects of the recession. But the costs of the array of new programs that are part of the budget projections dwarf anything that the US government has ever enacted before. Every dollar of this new spending will have to be borrowed.
For the Treasury market the vast supply of issuance threatens to overwhelm demand. This quantity of government debt has never been put for auction to the world’s investors. Their response is unknown. Will the United States government be able to sell its debt and fund its deficit? Yes. The question is at what cost. How much higher will returns have to go to keep buyers purchasing US securities?
In pushing Treasury rates higher, the bond market is responding to the enormous pending supply of government debt and to the historic lows in Treasury yields that resulted from the financial panic. 3.7% yields in the 10-year Treasury are not indicative of a Fed on the verge of a restrictive interest rate policy. .
Because both developments were singular to the Treasury market and do not yet represent a scenario dangerous for the US economy the currency market response was muted. It remains to be seen if currency traders view the projected massive increase in American debt as a positive or negative for the dollar.
Joseph Trevisani
Monday, June 15, 2009
England's Tremandous victory
England kept alive their hopes of reaching the World Twenty20 semi-finals by eliminating holders India in a nail-biting Super Eights encounter.
Kevin Pietersen top-scored with a battling 46 off 27 balls as he and Ravi Bopara put on 71 for the second wicket and helped their side post 153-8.
England then shone in the field as Graeme Swann (2-28) and Ryan Sidebottom (2-31) put their side on course to win.
India were restricted to 150-5 as the hosts claimed a three-run victory.
The result puts England level on points with West Indies in Group E, while it means South Africa have now qualified for the semi-finals.
England play the West Indies at The Oval on Monday and the winner of that game will join the Proteas in qualifying for the last four.
India face South Africa at Trent Bridge on Tuesday but they will be playing for pride alone after seeing their title defence crumble at an electric Lord's, where their supporters were in the majority and the atmosphere was sensational.
They needed 19 off Sidebottom's final over to clinch victory but, although Yusuf Pathan smashed a six and skipper Mahendra Dhoni a four, England held their nerve under immense pressure to triumph.
India would have noted that England's comprehensive defeat by South Africa on Thursday came after they batted first and Dhoni's decision to send the hosts in after winning the toss came as no surprise.
It appeared to be a good call when, after just 1.4 overs, Luke Wright attempted to pull a full-pitched ball from RP Singh but succeeded only in top-edging it to a diving Yusuf Pathan scampering backwards from leg slip.
England were off to a terrible start but the departure of Wright was perhaps a blessing in disguise because it marked the arrival of Pietersen.
The right-hander, nursing a chronic Achilles problem, was quick to signal his intent with a couple of flicked boundaries and he was ably assisted by Bopara, who pulled Ishant Sharma for a massive six to calm any nerves.
Dhoni handed the ball to Yuvraj Singh - a player described by Pietersen as a "pie-thrower" during England's tour to the sub-continent last winter - but he was carted all over the ground before being pulled out of the attack after just two overs.
India would have the last laugh, however, as Harbhajan Singh (3-30) reduced the run-rate with a terrific spell and Ravindra Jadeja (2-26) then sent both men packing.
Bopara's stumps were split after stepping outside leg and missing his shot, while Pietersen was trapped lbw as he tried to slog a second successive ball over midwicket for six.
England promoted Dimitri Mascarenhas up to four and the runs began to flow but unfortunately for the Hampshire player he was losing partners with alarming regularity at a crucial point in the innings.
Harbhajan was the destroyer-in-chief as Owais Shah holed out to Jadeja at deep mid-wicket, James Foster fell caught and bowled and Swann was bowled.
The crowd at Lord's
India supporters were in the majority at an electric Lord's
In between the Shah and Foster wickets captain Paul Collingwood was ousted by Zaheer and, although England took five runs off the penultimate delivery, India would have been the happier of the two sides.
But their reply got off to an unconvincing start in the face of some aggressive bowling by the England seamers.
James Anderson coaxed Gautam Gambhir into miscuing a pull shot that landed safely and Sidebottom came inches away from bowling Rohit Sharma via an inside edge.
Rohit Sharma would not be so fortunate when another inside edge did cannon into his stumps and Sidebottom had his second victim in as many overs when Suresh Raina was snapped up by Wright at deep square leg.
England's disciplined bowling and excellent work in the field kept boundaries to a minimum and ensured India remained some way adrift of the required run-rate.
That began to change when, the ball after Mascarenhas had Gambhir caught at short fine-leg, Yuvraj lofted the same bowler over the top for six.
But the ineffective Jadeja was magnificently caught by Broad just in front of the long-off boundary and then came the killer blow.
Yuvraj famously smashed one Broad over for six maximums during the inaugural World Twenty20 in 2007 and, while still at the crease, he was always going to be dangerous.
But England had clearly done their homework on the left-hander this time round and when Foster showed lightning reactions to whip off the bails after Swann had beaten his outside edge, Yuvraj was gone.
Dhoni and Pathan were India's last genuine hope of salvaging victory and they gave it a good go, but they ran out of time and the day belonged to England.
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