I have been fond of saying that the equity traders are the hormonal teenagers of the capital markets (traders think of markets as a daily version of Hot or Not?).
In our metaphor, the Bond market is the so-called adult supervision. Bond vigilantes have long been thought of as applying much needed pressure to the Feds to keep inflation under control, and rein in the deficit spending habits of the Federal government.
This is a quaint but somewhat outdated perspective, according to Peter Schiff. He writes that the Bond markets have slowly abandoned their responsibilities. Some recent changes amongst bond traders:
– they no longer focus very intently on CPI reports.
– they "admit" current signs of rising inflation are backward looking
– Yields are below Fed funds rate, despite inflation running at its fastest pace since the 1980’s
How could this have happened? How could professional bond investors speed through these stop signs at 75 mph? Schiff states it happened step by step:
"The first step was convincing the markets that hedonic adjustments were okay. Next came the legitimization of substitution bias. Then the Fed convinced everybody to ignore monthly increases in food and energy. When that wasn’t enough, it got everybody to ignore yearly increases in food and energy. Finally, when even all these tricks were not enough to conceal the growth of inflation, the Fed finally played its trump card by telling the markets that inflation is the poor step-child of its much more import parent, GDP growth.
This week, when the government reported better then expected PPI and CPI, data, the bond market went ballistic, as traders took the government’s bait hook, line and sinker. Equities went along for the ride, and a good time was had by all. Lost in the shuffle was the renewed weakness in dollar, which has lost about 2% of its value relative to other currencies over the past month. The Fed pause has given currency traders the "all clear" to sell the dollar. Combine that with a poor technical outlook and I look for the dollar to meet with some intense seller pressure in the coming months."
His somewhat controversial conclusion? We can no longer look to the Bond market to determine if inflation is contained; Instead, the Smart Money is looking to the Forex markets, where the penultimate inflation gauge — the value of the US dollar — gets measured.
"Since the value of the dollar is the single biggest determinate of prices, it is amazing that Wall Street can celebrate a victory over inflation based solely on one month’s data despite the poor monthly performance of the dollar itself.. If the dollar continues to lose value, it’s only a matter of time before sellers demand more of them in exchange for their wares. If they fail to raise their prices, the net effect is that they suffer a price reduction. So while Wall Street looks to the bond market as evidence that inflation is well contained, the smart money looks at the forex markets to realize just how much worse inflation is likely to get. Remember, bond yields do not reflect what future inflation actually will be, only what bond investor think it will be. Action in the currency markets will reveal just how wrong these bets are likely to be. (emphasis added)
Fascinating stuff, and very consistent with my own inflation expectations . . .
>
Source:
The Bond Market Has it Wrong
Peter Schiff
EuroPacific Capital, Aug 18, 2006
http://www.europac.net/externalframeset.asp?from=home&id=5867
I think the bond market is still that responsible adult it used to be. Inflation was an issue a year ago when we did not make it an issue. Now we are trying to make it an issue, but it shouldn’t be. Except for energy, most prices seem to be contained (or declining). Take SUVs. GM is practically giving them away, and will continue to do so as oil prices stay high. I noticed in Dell’s monthly mailing, PC prices continue to decline. Home prices are declining now too.
It just seems to me that there is too much competition for too few dollars in todays economy to support inflation.
Yeah, Peter Schiff was the guy who was yelling at the top of his lungs at the start of 2005 about a Dollar CRASH. Crash my foot.
He was labeled by Forbes as one of the person who got the currencies market wrong completely.
I guess you must need a thick skin in this business and hope that people will forget your wildly inaccurate calls and then have the nerve to come back and tell the bond market that it is wrong.
If the Bond market is priced on what inflation expectations are to bond investors , what do FX traders look at as a different indicator do judge what they think inflation is ?
DITTO AND DITTO…! Thank you…!
the $ sell-off that Peter talks of – 2% this past month – is based on a few things : …. ECB , BofE , BofJ raising rates , making $ assets less valuable on a relative basis …. Fed not raising rates …… economic #’s weakening … these are all related to the different interest rate cycles in the US and the world …. the $ was up 2% in the previous month on the exact mirror-image of these events … a month or 2 or more is not necessarily enough to make a judgement on
i find it hard to believe that bonds traders base their decision on official CPI numbers. the quotes repeat well known facts. the truth is that there is demand for the gov bonds
Fascinating. I wonder what Peter thinks about the other market based indicators reflecting lower inflationary expectations? For example, spot gold is making lower highs and has been in a downtrend since the Aug. 8 FOMC meeting. The TIPS spread has been basically flat since Aug. 8. And of course, treasurys have been screaming since well before the Aug. 8 meeting.
Maybe everyone in the $8.5 trillion treasury market blindly accepts the data manufactured by the bureaucrats at the BLS and the interpretation of that data by the 12 guys on the FOMC. But I doubt it. I think they have too much at stake and do tons of independent research to arrive at conclusions about inflationary expectations and set prices accordingly.
And I still think that if those treasury investors are willing to lend their money to the federal government for 5 years and only demand an interest rate of 4.75%, the inflationary expectations 5 years out of those investors is de minimus. He’s right that the actual inflation will be different from the current expectations. But to say the current price/yield for 5 year treasurys doesn’t incorporate the current consensus for investors best guess of what inflation will be 5 years out defies logic. He needs to offer a completely new analytical framework for valuing treasurys to make such an assertion.
I think we’re entering long term trading ranges for Treasury rates and the US dollar. Look at a long term chart of the dollar…if you lop off the “outlier” of the ’90s bubble, the dollar has entered the longer term comfort zone.
Bonds have a similar feel to me…I expect to see rates stabilize and range between 4-5% long term.
This is certainly not concensus.
It doesn’t make much sense to compare the current bond market to the bond market of 10 years ago when the bond market vigilantes were still alive.
Today the bond market is dominated by hedge funds and foreign central banks.
Hedge funds are leveraged and so don’t care directly about inflation. Their primary focus is financing cost which is why they manically focus on Fed moves.
Also foreign central banks buy treasuries to fix their currencies to the dollar and US inflation isn’t their main focus and objective.
So I wouldn’t read too much into the message the bond market might be sending.
I have to agree with Schiff. So what if he made a bad call, has no one here ever made a bad call? The fact is that the Fed is running a huge confidence game. The fools have bought into it hook, line and sinker.
Making people believe that there are ‘deflationary biases’ in the markets is how the Fed justifies printing $$ to maintain this ponzi scheme finance economy of ours. My vote is with Schiff, Fleckenstein, Saville and Ritholtz…there IS inflation, ask me about my school books, my gas, my grocery costs, my electric bill, my tuition etc…they are all UP!
I believe Peter is too married to a particular outcome. The bond market may just be telling people things aren’t like the 1970s. The outcome is easier to predict than how we get there. One of these days, when I feell like writing a two thousand word essay, I’ll lay it my worthless opinion similar to everyone else’s worthless opinion. lol. Maybe next weekend.
If I had Viavoice, it woudl be done.
I once made a bad call once (lol)
More than once . . . I’lll estimate it at about a million times .
http://www.abstractdynamics.org/linkage/archives/008267.html
The Big Picture: Does the Bond Market Have it All Wrong?…
Unless the guesses are wrong, or the bond markets have switched to relative instead of absolute returns too, or the demand for bonds from institutions is unstoppable.
Or all three :-).
If you got long term institutional money to invest, what do you do nowadays? There is so much cash going around that a lot of it goes into bonds.
I actually liked your comments this weekend in Barrons, Barry.
I love to hear more on your view of the oil markets (crowded longs) with storage capacity approaching 100%….we could see some huge pain in the commodity markets soon (watch the CRB). While energy shares would be a damper on the market, the key would be where that $$ goes…I see tech and finacials as the liquidity sponge in this regard. Transports are over sold as well.
This is a very bearish sentiment :-). Because a nominal 5% implies either that real rates stay near zero as they have been for the past 10 years, and then inflation is around 4% long term, or that inflation goes back to 2% or less, and then real rates triple.
The past ten years have been based on free money and low inflation. Rates at 5% cannot be compatible with both…
It should not be too surprising that Oil storage capacity is extrememly high right now. Commodity hoarding is a classic symptom of inflationary times.
People rather keep their wealth in Oil than Dollars.
The big surprise is why Oil producers keep pumping Oil even though they are flush with dollars and don’t need any more of them.
“then inflation is around 4% long term, or that inflation goes back to 2% or less, and then real rates triple.”
I don’t follow you here at all…I expect over the next few years to see another leg of (tech spending led) productivity that will put the nail in many long term inflation thesis. I recognize this is a minority opinion!
..and if his bad call was a bearish dollar call, the $/Euro is down, what, 5% since last summer? That’s no crash, but hardly the Worst Call Ever. And the current account deficit hasn’t gotten any prettier. Perhaps all he had wrong was the timing.
On the bond market, what you want to look at are current-account-surplus country reserves. The Chinese and Saudis are putting them somewhere.
That said, on inflation as separate from the dollar, this is one subject on which I tend to buy PIMCO’s current argument rather than Barry’s. Like us, PIMCO sees a housing market slowdown impacting growth. Unlike Barry, they see this rallying US bonds. [BR — And that differs from me how???]
For the moment I am still agnostic, since I see a risk, however small, that an exodus of oil-and-exporter money prevents treasuries from moving up the way they normally would in a slowdown.
these 2 markets are not incompatible but complementary of each other :
if inflation slows , if housing falls , then the Fed will not have to raise rates —so bonds rally …. and the $ will slip as its relative interest rate value to other countries FX will be less
I’d have to agree with Blissex.
I think the problem with the bond markets is the same problem with all the markets. The fed is printing too much money. I think most of the bond money is flowing through pension funds as boomers begin to save madly for retirement and pension funds have few places to put their excess cash.
All that cash is thus driving up the price of bonds and forcing down yields which is making the ‘adults’ look downright dopey. That is probably exactly what the fed wants.
It would appear fiat money is the opiate of the masses(and the bond market!)
What’s the opposite of “fiat money”?…that term always crack me up.
How rational is it for dollar holder to sit tight while the Fed devalues the dollar again after the housing bust?
Are we to assume that dollar holders aren’t rational and didn’t learn anything from the Tech bust in 2000.
This is why inflation and inflation expectations are now structural. In fact one could argue that inflation will have a tendency to accelerate on fears of a US slowdown and Fed accomodation.
Well I know Don Hays is not well thought of here, but I found it very interesting that in his missive today, he highlights his Bond Momentum indicator..this comes from the “Coppock Momentum Formula”. When the chart crosses the -100 line, it has given a buy signal
(lengthen maturities). It has been correct EVERY TIME in nailing a bull bond market for the last 25 years.
Jack: How many cars and computers do you buy over the years (or perhaps per year)? I bought my latest (respectively) 5-6 years ago, and I plan to hold on to the car for another 5 years unless I see a very compelling case to purchase a hybrid or whatever else more fuel-efficient they come up with, while I’m entertaining the thought to buy a new computer sometimes soon, but if in doubt will keep my current one until it gives out.
Based on those depreciation schedules, as a rough estimate I alone spend more on food than both car and computer combined. That excludes car maintenance and gas. My wife eats too, and we don’t have another car. And every once in a while we go to the doctor, and even with our supposedly good medical/dental plans that costs us a bit.
I agree with the comments above citing foreign central bank, carry trade, current account/trade deficit and global monetary growth issues as being culprits in shifting signals from the bond market. The bond market now tells us less about inflation because the market composition has changed, the motives of market participants have changed and the international monetary, exchange and reserve systems have changed dramatically.
The bond market continues to have low rates not because of anything to do with inflation. It goes back to simple supply and demand. The world has printed soooo much money that it all has to go somewhere. That is why prices of all assets are up /staying up – Commodities up alot over the last several years, Stock Markets up a good bit over the last few years, and Bonds staying up and hence rates staying down. The bond market is no longer controlled by investors determining what rates they want based on forecasted inflation. Prices and Rates are controlled by supply and demand just like everything else and right now with piles of money needing to get invested somewhere demand is high keeping prices up and rates down.
SS asks “What’s the opposite of “fiat money”?…” -> The answer is GOLD my friend!
the $ bears are a bit too crazy here ….. Euro was $1.18 when first floated , it’s up 8% in 7 years …… and it’s + 8% vs. the Yen in those 7 years …. not the disaster the Euro bulls / $ bears call for is it ?
That was a great linkfest yesterday Barry.
Hoo, I don’t think most dollar bears are necessarily euro bulls (*until there is a positive rate differential in favor of the euro). After all, the euro is just another fiat currency. Most USD bears are bullish on hard assets. That said, it’s not just the euro that is up against the dollar….look at the loonie (Canadian $) for example or gold.
I’m with B on this one, Schiff is constructing his reasoning around his vision of the outcome.
I have no idea what Jack buys, but I’ve see my own PCE up signifcantly. Of course, most of you would sh*t a brick if you took a walk through the grocery aisles up here. Fresh produce, milk, and meats especially are insane compared to the lower 48.
It is just arithmetic: if nominal rates are around 4-5%, then what matters are real rates, and these depend on how high ”inflation” (of whatever) is.
In the past ten years most of the time real rates have been arguably mostly in the -1% to 1% range, but let’s say 1% for the sake of argument.
If this continues, that means that inflation will be around 4% (as in 5% rates – 1% real rate => 4% inflation), and if it does not, and inflation goes to 2%, that means that real rates will triple from 1% to 3% (as in 5% rate – 2% inflation => 3% real rate).
This is simple arithmetic… And it all depends on your assumption that nominal rates «will stabilize and range between 4-5% long term».
Now, there is nothing extraordinary about say real rate being 3%, or inflation being 4% for the long term. But both scenarios are very different from the past 10 years.
I think this is a bit crazy, but if you think this is the case, why do you think nominal rates will be 4-5% in the long term?
But Pete, you can afford it because Alaskan real estate is still going up thanks to oil. That and your fine trading skills will buy you a quart of low fat organic milk…
core cpi year-on-year mar-jul 2.1%, 2.3%, 2.4%, 2.6%, 2.7%. is that a downtrend for inflation?!
The bond market continues to have low rates not because of anything to do with inflation. It goes back to simple supply and demand. The world has printed soooo much money that it all has to go somewhere. That is why prices of all assets are up /staying up – Commodities up alot over the last several years, Stock Markets up a good bit over the last few years, and Bonds staying up and hence rates staying down. The bond market is no longer controlled by investors determining what rates they want based on forecasted inflation. Prices and Rates are controlled by supply and demand just like everything else and right now with piles of money needing to get invested somewhere demand is high keeping prices up and rates down.
SS asks “What’s the opposite of “fiat money”?…” -> The answer is GOLD my friend!
The “Coppock Momentum Formula” is correctly identified as the Coppock Curve. I haven’t looked at it on a ten year bond but I wouldn’t doubt it is flashing a momentum change. What’s the point? Stocks are now a buy? I’m sure the same widget, which is not perfect btw, especially in low volatility markets like the ten year has been in, likely flashed a buy in 2000 as well. Did that mean stocks were headed up?
Pete, that’s because you make so much more money than we do down here. You guys ought to be swimming in it with oil at $70 and Congresspersons able to get approval for some of those boondoggle projects. My mom & dad just went to Alaska on vacation. As I understand it, they ended up sumo wrestling a grizzly bear named Pete. lol.
With all of that cash, I thought maybe you’d be buying out Barry and putting your name on the shingle.
SS asks “What’s the opposite of “fiat money”?…that term always crack me up.” Attempting to be funny or just a freudian slip? Fiat money is truly Funny Money!
The opposite would be redeemable currency, as in “Silver Certificate”. Investopedia: Money that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves.
ss asks:
What’s the opposite of “fiat money”?…that term always crack me up.
I looked it up before I blurted out the answer but I was going to say tangible goods since fiat is only good because of the force of law behind it.
According to the dummies website(and no insult intended here):
Money’s money because we say it’s money
Most of the world’s money is called fiat money, meaning it is accepted as money because a government says that it’s legal tender, and the public has enough confidence and faith in the money’s ability to serve as a storage medium for purchasing power. A fiat system is based on a government’s mandate that the paper currency it prints is legal tender for making financial transactions. Legal tender means that the money is backed by the full faith and credit of the government that issues it. In other words, the government promises to be good for it.
Fiat money is the opposite of commodity money, which is money that’s based on a valuable commodity, a method of valuation that was used in the past. At times, the commodity itself actually was used as money. For instance, the use of gold, grain, and even furs and other animal products as commodity money preceded the current fiat system.
This was found in a great little primer on the fiat money system
How Money Works: The Fiat System
BDG….what do you mean, what’s the point? The thread Barry started above was on the bond market.
Have some coffee and relax. ;o)
We do have a relatively high per-capita income and very low tax burden. But it’s also -50 freakin’ degrees in the winter. Wanna trade?
I’m moving to the lower 48 in about 6 weeks. And the funny thing is, I still haven’t decided where. Probably back to the PacNW, but anything is possible.
I’d buy Barry out, but how much Kudlow bashing and general whining could ya’ll take? Audience size would crater and I’d have a worthless asset. And I’d have to rename the blog “The Big A-hole”.
Whether it’s currencies acting as the adult supervision, or it’s treasuries, that only covers the “how”. Maybe the better questions are where, who, and why.
Instead of New York and Zurich, the adult supervision is increasingly coming from Riyadh and Beijing. I suspect the future path of treasury prices will be determined at the margin more by what’s in their best interests, and less by the internal value of the USD.
Ah…Estragon hit on the interesting point, imho.
The “sellers” to us, (that get $$’s) can’t let the US currency collapse. Who would buy their (now expensive) stuff? Truely maturing GLOBAL markets are all inter-related, and co-dependant. Down the road, when China is self sufficient — don’t need our consumption, it’s a different story I agree. This is a long way off imho.
Canadian $ has risen as oil has , not because the US$ has fallen …. so has the Australian $ …. they are commodity-based economies and as such their currencies rise when their export rise
The Dollar is the reserve currency. It devalues against tangibles like Oil and Gold and not other currencies. This is simply because other governments wont allow their currencies to appreciate against the Dollar for trade purposes.
True, CAD & AUD have risen with commodity prices. Alternately, they’ve held their value versus the commodities while the USD has lost value versus those same commodities. Potayto Potahto. In both cases though, they’ve let markets value their currency cross rates rather than accumulate large foreign reserves.
Comparing and constrasting the responses of CAD/AUD versus China & Saudi Arabia (just to pick examples) is interesting. The former are politically and socially stable, and by allowing their currencies to rise, they effectively flow the extra import purchasing power through to consumers. The latter are (charitably) less politically and socially stable, and by accumulating large foreign reserves they’re able to direct the purchasing power in ways that suit them. As such, it seems to me that “what suits them” bears watching.
I remember Howard Simons wrote an article on RM “disproving” the “bonds are the smart money” theme. I’ve had so much trouble w/ RM’s site today that I’ve been unable to find the article; I’ve searched Google as well, but no immediate luck. I realize that just because HS says it ain’t so, doesn’t mean it ain’t so, but the reason that article stands out in my memory is because we’ve all been taught that “bonds are the smart money” theme. HS demonstrated little correlation to bond market expectations and subsequent reality, over his chosen time period. FWIW.
found them: from 5.13.2003 “smart markets, foolish choices” (http://www.thestreet.com/options/futuresshocktsc/10086910.html) and from 5.20.2003 “stocks and treasuries: is one market smarter?” (http://www.thestreet.com/options/futuresshocktsc/10088497.html)
the CAD and AUD hold their value to commodities because that’s what they’re economies are : commodity-based exporters … potayto potahto …. most other currencies have fallen vs. commodities
i dont know if i agree with everything stated here..
but as a person that trades the 10yr and 30yr bonds, i didnt care about building a short position in the bonds after the CPI PPI because of what was coming the following week…
the Iran Aug. 22nd announcement and dont forget, the peak hurricane season (late aug-mid sept) is now here.
Last year right after Katrina the bonds spiked to over 118 and i dont think traders want to be caught short into either of these events imho.
Estragon, you are correct sir… However, there are many factors convoluting here. Does it make sense that bonds are steady….? Yes of course, the Fed has paused… Does it mean that they will continue to move higher…? Only time will tell… I’m not ready yet, but when I feel that the timing is right, I’ll be looking to probe the short side… I still feel that we need to keep our eye on the dollar…. Manipulated or not, it will tell us the best story. I vote for a lower dollar, a much lower dollar.
test
From Economic Focus-The Uses of Adversity
The Economist August 19th, 2006
* “But today’s Fed acts quickly to supress recessions, which they recognize are mostly due to a lack of demand, not an excess of track (i.e. supply).”
* “The internationalists have long feared that a recession might lie ahead should foreigners abruptly abandon the dollar. The prospect of a more conventional downturn -engineered not by foreign central banks, but by America’s own-suggest the cart and horse belong in a different order. ”
* “Workers who lost their jobs in the 2001 recession did not return to the same industry during the recovery. Companies saw the recession not as an event to be weathered but as an opportunity-or even a mandate-to reorganize production permanently, close less efficient facilities and cull staff.” (So Mark H. at H/P is early).
* “If a 2007 slowdon curbs inflation, narrows the trade deficit and clears space for an American manufacturing revival it will prove a surprisingly fruitful period of dearth.”
I have been waiting for the $ to crash but it hasn’t yet. The alternatives are “pegged” so the other currencies have been losing value faster the $ can fall. Free trade and all that.
Inflation central keeps on chugging. I had sticker shock at Cosco’s this weekend. Average price increase from two months ago seemed about 20 %. Copper continues in nosebleed territory even as it’s major markets deteriorate and inventories rise. Wonder how that could happen?
hello from germany,
i read peter shiff for about 2 years now. since the first reading he has called for a weaker $, higher goldprices,higher oil, investments in dividendpaying stocks outside the us.
seems to be good advice with very high returns.
to pick the one from 05 is not quite fair. the $ has lost 30% since 2002.
http://immobilienblasen.blogspot.com/2006/08/und-strong-dollar-policy.html
for those who look for a $$ crash …. the question is vs. what ????? Gold ? the Euro ? the Yen ? the Ruble ? the Yuan ?
Trackback from
http://theroxylandr.wordpress.com/2006/08/22/did-bond-traders-get-it-right/
Recently Barry Ritholtz almost changed his opinion about bond traders being adult supervisors over the markets to the one that bonds do not predict inflation expectations well enough. Heu2019s referencing the article of Peter Schiff where itu2019s claimed that bond traders….
[read more in my blog]
>>> SS asks “What’s the opposite of “fiat money”?…” -> The answer is GOLD my friend!
What’s the gold? Ah, it’s that yellow metal to make wedding rings?
Do you expect big jump in weddings?
When bad times come, I rather see less weddings and rings getting smaller and cheaper, so the gold demand should decrease and price go down.
Lesenswertes
Heute wollte ich einfach mal einige Links vorschlagen. Die Artikel fand ich interessant, lesenswert und auch gute Grundlage für weitere Gedanken und Meinungsbildung. Does the Bond Market Have it All Wrong? Sinkende Zinsen in Europa und Amerika Und Komm…
Thank’s a lot Barry for leaving a comment at my blog!
The next step in fame for me is to get into the picture with Bush or something :-)))
Did bond traders get it right?
Recently Barry Ritholtz almost changed his opinion about bond traders being adult supervisors over the markets to the one that bonds do not predict inflation expectations well enough. Hes referencing the article of Peter Schiff where its …
Lesenswertes
Heute wollte ich einfach mal einige Links vorschlagen. Die Artikel fand ich interessant, lesenswert und auch gute Grundlage für weitere Gedanken und Meinungsbildung. Does the Bond Market Have it All Wrong? Sinkende Zinsen in Europa und Amerika Und Komm…
Personally I agree that the currencies are a better gauge rather than the bonds, as they reflect the confidence in the economies of given countries. In addition, I prefer to look at the decrease in dollar valuation as dilution rather than inflation. The value of real money doesn’t change, but the value of the promissory notes (dollars) does.
Market is a strange thing! I am reading some materials about forex trading system and i think that everything is too comliacated! Good post!
An Unfunny Fed Joke
The Fed walks into a bar. The bartender doesn’t ask the Fed what it wants, because nobody can afford to go drinking anymore since all their money isn’t worth a damn, even as prices for just about everything are going up, and therefore the bar is closin…
I really liked this post. Keep up the great work.