When you talk about a further fall in yields on treasuries, you have to be assuming that the M of F in Tokyo will continue along on its hyperactive path. If they stopped buying our money, our interest rates would skyrocket.
What are risks associated with a hyperactive M of F?
Two come to mind.
1) The obvious: liquidity is piling up in the Japanese economy somewhere. The Bank of Japan creates yen to buy dollars, then sells yen denominated bonds to soak up (i.e. sterilize) the money it has created. Since interest rates in Japan are 1.5 %, this means the cost of soaking up yen is low --- 15 a year to soak up 1000. Good deal. But bonds have to be piling up somewhere. Darfot told us the other day that it was in the Post Office retirement fund. But still, there has to be some kind of market for these sterilization bonds. They can be turned back into yen and those yen can hit the Japanese economy as demand. In other words, I think there has to an incipient inflation problem in Japan, strange as that may sound. If some trigger were to make the incipient become actual and active, then the world would change instantly.
2) The subtle. Markets throw off numbers in the form of ratios, averages, trends, etc etc. People use these numbers to figure out what is going on. When tens of thousands of (more or less independent) people drive a market, the numbers thrown off are probably pretty good. Large numbers of people can’t change quickly and will not respond in the same way in any case.
But when a market is distorted by the actions of a small number of people of disproportionate influence, then the numbers don’t mean as much. There is a big gap between the market of the tens of thousands, and the market of the tens of thousands PLUS the four or five. If the four or five change their minds, or make a mistake, you have a rough transition, and the numbers you were looking at, before the four or five changed their minds, are useless.
This is not an argument for any particular investment strategy, but it is an argument for huge caution.
I am discounting #1 severely because of many things that I have talked about before
1.1) Everyone thinks Japan will stop buying treasuries
1.2) They say they will continue and no one believes them
1.3) They need to be competitive to Europe to continue selling cars and other goods
1.4) The US consumer is still the consumer of choice
1.5) Europe has threatened to interven to stop the rise of the Euro. That would be competition from Japan.
1.6) Japan got pissed at Europe for threatening to do 1.5
1.7) The FED is not even worried that they stop buying the US$. In fact the FED wants them to stop, presumambly for every reason except to buy treasuries with.
1.8) The FED wants a lower US$
1.9) No one else wants a lower US$
As for #2)
2.1) Treasuries and Eurodollars are the most liquid financial instruments on the planet. Bar none. Lots of players.
2.2) It is in no ones best interest to make the system go amuck as that would probably start a depression
2.3) The FED remedy for problems has always been LOWER interest rates. There is still room to cut.
I was 50/50 before on the next move from the FED being a hike. I am now 75/25 that the next move from the FED is a CUT. Not a decison they will arrive at easily as it takes up future bullets. The outcome of the election could change a lot of things as well. Perhaps taking profits on all these eurodollars and preparing to short the spoos or Naz or whatever is the next great play. I will worry about that a few months down the road. The next FED chairman will also shed light on things. If Russ is appointed, I will immediately cash out all my eurodollars right then and there. If Bernanke is appointed, these plays might go on for another year yet. Too many variable to look too far ahead right now, but the jobs trend should work for at least another couple months and probably much more. Odds of a hike now before august are close to zero IMO.
Mish |
