Saturday, June 6, 2009

Six degrees of separation...or less


Epilogue on interest rate paths, possibilities & consequences

So where should rates be? The Fed has Fed funds pinned near zero. The 10-Year note has a one-way ticket to 4%. But pushing term rates up will push mortgage rates up and the housing sector down and, well, there we go again. This is the ‘everything is connected to everything else’ view or the ‘six degrees of separation’ rule of economics. Bonds are close to being oversold. They probably are above ‘true value’ but not far enough to create a backlash. That will happen above 4%.  We are getting there. The debt levels in his economy and mortgage financing needs of this economy simply will not let rates drift much higher and that is the problem for those with inflationist beliefs. Were the Fed to mis-step and were inflation to rise, TERM interest rates would rise (as they are now without the Fed moving) and that would eventually choke-off inflation EVEN IF THE FED DID NOTHING by crashing the economy first. The issue to wrap your mind around here is that the economy’s structure with so much debt and so much financial fragility will not let inflation rise. So many argue the opposite that there is an incentive to inflate debt away. There is that incentive; there always is. But there is no way to do it. The bond market would not stand for it. The economy would crash first.  Because we have a vigilant bond market, inflation is a false worry. Insufficient growth is a real worry. And this analysis is from a guy who thinks the economy is about to grow strongly over the next four quarters or so. The problem is four quarters will not be enough… and if the reality of some strong growth spooks bonds too badly we might not even get four. 

1 comment:

Anonymous said...

Mr Brusca you are quoted in the BCC as refering to the latest labor figures as the "Jolly Green Giant". I am wondering if you have looked at the report in detail as my brief analysis, considering only NFP total employed and average work week indicates that the May figures are worse than April's, which was a blip and also worse than March. In other words the May figures indicate a return to the earlier trend and do not even indicate a flattening of the decrease. The reduced drop in jobloss is more than compensated for by the reduced average working week i.e. companies are reducing the working week rather than laying off people but the overall situation is still getting worse ?