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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: Mr.Creosote who wrote (46196)	11/28/2005 2:21:12 PM
From: ild	Respond to of 110194

Interesting discussions in addition to the first one from Roach US: Greenspan's Gift US: Defeasing Legacy Costs Global: Debating the Yield Curve morganstanley.com Stephen Roach: As always, we don't have the final answer on this topic. But the argument above can basically be broken down into three issues: the historical forecasting ability of the yield curve; the real interest rate transmission effect; and the location (short or long end) and source of the so-called "conundrum." I think these are all very important areas for discussion but they run the risk of mistaking the trees for the forest. Each business cycle is very different, which means, of course, that it is equally important to distinguish the context of different yield curve inversions. The most distinguishing characteristic of the current US cycle, in my view, is the asset-driven character of the real economy. First equities, then property, the American consumer has been supported by wealth effects as never before. Why else would the personal saving rate be in negative territory for the first time since 1993? Why else would the stock of outstanding household indebtedness have soared by 20 percentage points of GDP over the past five years — equaling the cumulative gains over the previous 20 years? Why else would household sector debt service burdens be at an all-time record in the face of still extraordinarily low interest rates? The optimistic case for the American consumer minimizes the wealth-dependency story — arguing that the recent improvement in the labor market has brought the old-fashioned support of income generation back into the demand side of the US consumption equation. Let the record show that fully 46 months into the current expansion private sector real compensation growth is still tracking some $350 below the norm of the typical business cycle. First jobless, now wageless (i.e., reflecting an extraordinary real wage stagnation), US consumers have turned to wealth generation as never before to support spending and saving behavior. I find it exceedingly difficult to dismiss the role of overvalued asset markets as the main enabler of this binge. The debate on yield curve inversion gets right to the heart of the serial bubble experience of the United States. In my view, America's asset markets have gone to excess, in large part, because of the Fed-sponsored liquidity binge of the past seven years. Beginning in late 1998 with the LTCM-related seizing up of capital markets, continuing through the Y2K liquidity insurance play, and then including the post-equity-bubble shakeout, the Fed primed the liquidity pump big time. The result was extraordinarily easy financing, a profusion of carry trades, and artificial valuation support for financial assets (first stocks then bonds and spread products) and residential property. Income-short consumers became so convinced such asset appreciation was here to stay that they fundamentally altered spending and saving decisions. Yield curve inversion also goes right to the heart of the liquidity-induced excesses in asset markets. In the current context, the normal transmission effect of monetary tightening through the responses of credit sensitive sectors (such as consumer durables, homebuilding, and business capital spending) to changes in real interest rates is less relevant than the sensitivity of asset markets, themselves, in my view. If the Fed delivers on the curve expectations now embedded in financial markets, it will finally take the punchbowl away from the biggest party yet. Unfortunately, the US central bank forgot the imagery behind the punchbowl trick. The key is to take away the drink just when the party is just getting good — not after the party has gotten out of hand. Largely for that reason, the coming yield curve inversion — if in fact it does occur — could well have a more wrenching impact on the real economy than those of the past. Carry trades are the sustenance of asset-dependent economies. America, and by inference, a still US-centric world, is more dependent on wealth effects than ever before. As a result, given the potential for an unwinding of the excesses of the asset economy, this yield curve inversion could be a much tougher pill to swallow. For that reason alone, there is reason to entertain the possibility that a Bernanke-led Fed may, in fact, not be willing to take this gamble.