It's Probably Time CR To Work Up A Model of How Interest Rates
will move through the stages of the next recession. My view is that rates move down during the initial phase--(which may be upon us now)--as market participants adhere to Econ. 101, and make a familiar, traditional move into Treasuries.
As awareness and recognition of the Recession develops, the above trend likely extends itself to yet another top (prices) in Treasuries. But that top (prices) in Treasuries begins to intersect with what will likely be another leg down in the USD. If the movement to that top in Treasuries is dramatic enough, it may for a time neutralize the currency losses for foreign holders. But eventually, the Dollar losses begins to overtake the price gains for those foreign holders.
That's when the next phase begins. The rally in Treasuries, which may have been quite ferocious, is then seen as even more vulnerable to not only a currency-driven pullback, but a counter-trend selloff. IMO, there is already not enough capital domestically to support the current state of the Treasury Market. Domestic capital shifts however will have provided some support to Treasuries in the initial phase. But the yawning gap we see already, between domestic and foreign ownership of treasuries will express itself anew, in the second phase. That's when market participants both move into cash, and, begin to use capital to pay off debt, or merely survive. A tremendous amount of the currently available capital in the US will have to be used to pay debt, cover losses, or simply maintain living expenses (in a severe recession). Lending money to the government will either be seen as a poor option, or, not a even feasible.
I think we are going to see something bizarre ... a slowing economy with rising interest rates (because of the financing of the twin deficits - fiscal and current account).
Probably seems bizarre for the United States, when other countries have watched their stocks and bonds go down the tubes together more often. My two phases roughly outlined above are within the context of a severe, not a mild recession. The true nature of the gargantuan, nearly unfathomable supply of US treasuries will appear center stage not in a mild recession, but a severe one--when competition for available capital will be extreme. |
