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Friday, May 8, 2009

The Stress Tests, The Jobs Numbers, and the Bond Offering: a Full Round Up

It's been a busy week for economic activity and I, for one, believe that we are no less clear on the direction of the economy than we were before everything was revealed. The stress tests told us little. More than half the banks still need capital and it's a grand total of $75 billion more. Some are saying this is good because it's not a very large amount and most should be able to raise it in the private market. I don't see how openly announcing a bank is in desperate need of billions would make it easy for that bank to do anything though. Furthermore, these stress tests were done under the assumption that unemployment would be at 10.3%. Well, we should break through that level between September and the end of the year. At that point, these stress tests would no longer be relevant and I assume we would have another round of "stress tests".

Second, we have the jobs reports. The job losses were 530,000 which is significantly less than the 700,000 in job losses that we had in March and less than the 650,000 job losses we had in February. Furthermore, this report includes 66,000 new jobs related to the census. While a job is a job, such temporary public sector jobs mask a weak private market for jobs. So, the next two months will be critical to see if we are in fact moving in the right direction. If we continue to lose more than 500,000 jobs each of the next two months, then all this euphoria is premature. If we see jobs fall to 400,000 or less, then we can say that we are seeing a pattern forming of slow down in job losses.

The most troubling news was that the U.S. Treasury bond offering yesterday was a miserable failure.

The government had to pay greater interest than expected in a sale of 30-year Treasurys. That is worrisome to traders because it could signal that it will become harder for Washington to finance its ambitious economic recovery plans. The higher interest rates also could push up costs for borrowing in areas like mortgages.

Investors also pocketed some gains after strong rally in stocks this week and ahead of the government's April employment report on Friday. Investors were jittery ahead of the formal release of results from the government's "stress tests" of bank balance sheets, which came out later Thursday.

There was simply no appetite for U.S. Treasury bonds. It caused a spike of more than one tenth of one percent yesterday in the Ten Year bond. Since its low of 2.08% in January, it has spiked up to over 3.3%. This is very important because this is the first of several rounds of bond offerings and the U.S. Treasury is set to borrow still north of $1.5 trillion more this year alone. Such weakness in this bond offering signals that Treasury rates will continue up.

That will take almost all long term rates with them: mortgage, car, credit card, school loans, corporate, small business, etc. Higher borrowing costs will stunt whatever recovery we have.

This offering maybe a sign that Obama's entire fiscal policy is a house of cards. If we are unable to sell our bonds, rates will shoot up. If all of this deficit spending leads to higher rates, either significant or even mildly, there is no recovery. Real estate prices will be stopped in their tracks if current 30 year mortgage rates, now at just over 5%, turn into 30 year mortgage rates at 6%. If small business and corporate debt becomes a full percentage point more higher, that means expansion is stunted. We appear to be in the middle of a cycle I predicted back in December. If so, we are about to see all long term interest rates go higher, much higher. As such, borrowing costs go up, real estate values are stunted, business expansion is stunted, car loans are stunted, and ultimately the economy suffers.

The other option is to have the Federal Reserve print money furiously and buy up all these bonds that no one else will buy. Such a move would in fact keep interest rates low but would eventually produce the sort of inflation that turns countries into banana republics.

1 comment:

Anonymous said...

That, or Bernanke's talk about the beginning of the end of Quantitative Easing was really really premature.