August 20

Monetary Policy and the U.S. Economy. James Bullard, President & CEO, FRBSt.L.

- disinflationary trends have reasserted themselves during 2010
- inflation that is "too low" can be problematic, as the Japanese experience has shown

so, what should the Fed do?

- supplement current policy with additional QE, should inflation move lower
- today... no action is necessary
- should economic developments suggest increased disinflation risk, purchases of Treasury securities in excess of those required to keep the size of the balance sheet constant may be warranted
- purchase size should be in proportion to the size of any deterioration in the outlook

okay, so none of this is news

what is notable by its absence is any indication of what the Fed will be looking for in order to judge whether further QE will be necessary

because, as we all know, the Fed's ability to forecast future developments is just totally awesome; they could never, for instance, miss a housing bubble or think subprime is contained, etc etc; so why should we think they will be on the ball enough to avoid a Japanese-like outcome --- will they really act in a timely-enough fashion to prevent what they fear, but which, at this time, they don't think they have to do anything more about? and why, exactly, do they think they do not yet need to step on the gas pedal anymore? is it because dropping rates to zero and more than doubling the size of their balance sheet was so effective in gaining economic traction?!?

with economic growth having been juiced by inventory rebuilding and temporary fiscal stimulus, what makes them think that the lacklustre sub-potential recovery will gain steam once those impacts fade (and even reverse, with the expiration of tax cuts); do intitial jobless claims mean anything to them? or payrolls ex-census workers and ex-birth/death model? how about the ECRI WLI at -10 or lower for the 5th straight week? M3 steadily trending down? small business optimism still below 90 and small businesses having reduced employment for the 30th consecutive month!? or the fact that the Conference Board LEI has been negative for each of the last 4 months once you strip out the positive contribution made due to a positively-sloped yield curve; manufacturing orders down the last 2 mths and still 12% below their prior peak? housing starts and building permits still under 600k? NAHB tanking? mortgage purchase applications at mid-1990s levels? consumer credit continuing to shrink? consumer confidence at 50? Conference Board intentions to purchase a home or an auto both still trending down? oh wait, but industrial production is up (never mind that it remains 17% below the level it was at pre-recession)

Economic weakness accelerating. Comstock Partners.

the economy is tracing out a trajectory typical of a balance sheet induced recession rather than the garden-variety inventory recessions typical of the period since the end of World War ll. In a balance sheet recession the dire effects of debt deleveraging overwhelm the efforts of the government to stimulate the economy as is happening now, and the economy undergoes a lengthy period of deflation, sub-par recoveries and frequent slowdowns as the U.S. experienced during the 1930s and Japan over the last 20 years.

While the massive stimulative measures undertaken by the Fed, Congress and the White House have succeeded in averting a financial collapse, they are being more than offset by the deleveraging now taking place. The effects of inventory replenishment are winding down without any other major drivers to sustain growth. Typically a new economic expansion is led by inventories, consumer spending, employment, housing and readily available credit. This time only inventories have performed their usual function, meaning that the economy has been acting on only one of five cylinders.

more bond bubble talk, this time from a Tokyo economist, who should therefore know better, via Bloomberg.:

Two-year rates will climb to 0.85 percent by year-end, according to Bloomberg surveys of financial companies. Investors who purchased the securities today would lose 0.4 percent if the projection is correct, according to Bloomberg data. "Buying now is a big risk," said Hiroki Shimazu, an economist in Tokyo at Nikko Cordial Securities Inc

wow, a risk of losing 0.4%.... IF they're right! HUGE risk!

more reaction to the irrational bond bubble claims:
Appeasing the Bond Gods. Paul Krugman, NYT.

So how do austerians deal with the reality of interest rates that are plunging, not soaring? The latest fashion is to declare that there’s a bubble in the bond market: investors aren’t really concerned about economic weakness; they’re just getting carried away.

It’s hard to convey the sheer audacity of this argument: first we were told that we must ignore economic fundamentals and instead obey the dictates of financial markets; now we’re being told to ignore what those markets are actually saying because they’re confused.

also, in his Breakfast with Dave yesterday, Rosie rebut the bond bubble talk, citing the facts that:
- the idea that the U.S. will default is "completely ludicrous"
- growth is weak and there's no inflation pressure; in fact, "we are rapidly running out of disinflation and we are staring deflation in the face"
- if CPI turns negative, today's yields look pretty juicy; we have a 360bp curve from overnight to long bonds, when the norm is about 200bp
- demographics favour more bond buying, as households may be rebalancing their financial balance sheets, which include "a mere 6% in fixed-income securities"
- traders are still net-short long Treasuries
- the powerful appetite for yield remains

as Rosie said,

Everybody is entitled to their opinion but if I had to make the case that bonds were a poor investment — and someday I will, believe me — I surely would not lean on the spurious reasoning provided in yesterday’s [WSJ] column [by Siegel and Schwartz].

The low-interest rate trap. John Rubino.

Pretend for a second that you recently retired with a decent amount of money in the bank, and all you have to do is generate a paltry 5% to live in comfort for the rest of your days. But lately that’s been easier said than done. Your money market fund yields less than 1%. Your bond funds are around 3% and your bank CDs are are down to half the rate of a couple of years ago. Stocks, meanwhile, are down over the past decade and way too volatile in any event. If you don’t find a way to generate that 5% you’ll have to start eating into capital, which screws up your plan, possibly leaving you with more life than money a decade hence.

Now pretend that you’re running a multi-billion dollar pension fund. You’ve promised the trustees a 7% return and they’ve calibrated contributions and payouts accordingly. But nothing in the investment-grade realm gets you anywhere near 7%. If you come up short, the plan’s recipients won’t get paid in a decade or – the ultimate horror – you’ll have to ask the folks paying in to contribute more, which means you’ll probably be scapegoated out of a job.

In either case, what do you do? Apparently you start buying junk bonds.

....

One of the signs that a system headed for a crack-up is deteriorating credit quality. In other words, when low-quality entities are doing most of the borrowing, trouble will ensue....

they really should make a financial history course mandatory for money managers. The fact is that in every bubble, default rates are nice and low when capital is flowing in and then spike when the money stops. Jeeze, it was just a few years ago that housing analysts were using the low default rate on mortgages and credit cards to dismiss the possibility of a housing bust.

Reports of the death of mean reversion are premature. James Montier.

After the Golden Age of Finance. Howard Davies, Project Syndicate.

much of the apparent growth in value added [by the financial sector] has in fact been illusory, based on increased leverage, excess trading, and banks writing deep out-of-the-money options – for example, credit-default swaps (a $60 trillion market in 2007). “What all these strategies had in common,” writes Haldane, “was that they involved banks assuming risk in the hunt for yield – risk that was often disguised because it was parked in the tail of the return distribution.”

Could 62 million homes be foreclosure-proof? Ellen Brown.

Over 62 million mortgages are now held in the name of MERS, an electronic recording system devised by and for the convenience of the mortgage industry. A California bankruptcy court, following landmark cases in other jurisdictions, recently held that this electronic shortcut makes it impossible for banks to establish their ownership of property titles—and therefore to foreclose on mortgaged properties. The logical result could be 62 million homes that are foreclosure-proof.... That means hordes of victims of predatory lending could end up owning their homes free and clear—while the financial industry could end up skewered on its own sword.

Four banks face big losses on repurchases. Reuters.

The four largest U.S. banks could face as much as $42 billion in losses as they repurchase faulty mortgages from housing finance giants Fannie Mae and Freddie Mac

How much debt does the S&P500 have? Bruce Krasting.

Byron Wien admits the economy has been much weaker than he suspected and that the sustainability of corporate earnings is highly suspect. CNBC interview via Pragmatic Capitalism.


next week's bond auctions: $37B in 2yrs, $36B in 5s, $29B in 7s


BP link of the day:
Senior U.S. scientist admits lying. BreakingNews.


other fare:
Many more black eyes for the Blackberry? Reggie Middleton.

Red card: Man United is junk. Independent.

Why the unfolding disaster in Pakistan should concern you. Robert Reich.

Christopher Walken performs Lady Gaga's Poker Face. BBC1 via youtube