Nearing the Boiling Point

There’s way more going on in this wild and whacky world than we can keep up with.  We scan the headlines with wide eyes and a gaping jaw…gawking like our four year old son when he first saw the grotesquely large pigs at the LA County fair.

Like the oversized pigs, the headlines are disturbing and hideous… Still, we can’t bring ourselves to look away.  We pinch ourselves on your behalf, collecting our thoughts and connecting the dots…all just for you.

For instance, on Tuesday we learned, according to the World Health Organization, our cell phone is a possible cancer causing agent.  In fact, the health agency’s put it in the same category as gasoline engine exhaust and coffee.  Good grief!

We intentionally drink coffee every morning.  We like the taste and, more importantly, we like its effect.  We unintentionally breathe gasoline engine exhaust every day driving on the 405 freeway during rush hour commute.  We don’t like the smell, or the effect.  But there are those that do…

Last weekend, Sarah Palin told a gathering of motorcycle-riding veterans at the Memorial Day “Rolling Thunder” event at Washington’s National Mall: “I love the smell of the emissions.”  Can you believe it…a gas huffing politician?  We couldn’t make this stuff up if we tried.

But if you think an affinity for the smell of motorcycle emissions is a tad crazy, you should get a load of these markets…they’re certifiably insane…

Just What the Federal Reserve Needs

On Tuesday, the DOW jumped 126 points.  Then, on Wednesday, it dropped 279 points…erasing Tuesday’s gain by a factor of 2, plus change.  By yesterday, no one knew what to make of it – the DOW finished the day off with a 41 point loss.

Stocks may be bipolar, paranoid, and schizophrenic, but that’s nothing.  The real madness and insanity is taking place over in the debt markets.  On Wednesday, if you hadn’t noticed, investors bid up the price of Treasuries – pushing the 10-Year Note yield below 3 percent.

“[Treasury] prices soared as data on private payrolls and manufacturing came in well below expectations,” reported Reuters.

Obviously, weaker payrolls and manufacturing are evidence of a slowing economy.  In an economy with a stable money supply and a soft handed central bank, Treasuries would be just the place to be.  The possibility of a stock market free fall makes Treasuries a safe place to park your money and preserve your capital.

But we don’t live in an economy with a stable money supply and a soft handed central bank.  We live in an economy with an expanding money supply and a heavy handed central bank.  A slowing economy and rising unemployment is just what the Federal Reserve needs to do something really foolish – like stimulate the economy with even more funny money.

What’s more, the federal government’s up to its eyeballs in debt.  If Congress can’t come to an agreement to increase the deficit ceiling by August 2, the U.S. will stiff their creditors – or pay them back with printed money.  We don’t quite know what this means, but we’re of the opinion the risk demands more than a 3 percent yield.

Near the Boiling Point

What will likely happen is Congress will reach an agreement at the 11th hour.  They’ll pretend to have solved the debt problem with spending cuts, and things will continue as they have.  Along those lines, we’re confident the Federal Reserve will eventually succeed at their stated intention of positive inflation.

What we mean is that sometime in the next 10-years inflation will rise above 3 percent…pushing the real interest rate on today’s 10-Year Notes into the negative.  When that happens, those investors who bought Treasuries on Wednesday will essentially be paying a fee to loan the government their hard earned money.

For proper edification on what’s going on in the bond market we turn our attention to Bond King Bill Gross.  Yesterday Gross likened bond investors to a frog in a pot of water as the temperature is gradually increased…

“Much like gradually turning up the temperature on poor froggy’s kettle of water, monetary policy in developed countries has been lowering the temperature and absolute level of yields for the past two and a half years post Lehman Brothers.  Teeter-totter yields down, teeter-totter prices up, and froggy’s total return euphoria at present seems to know no bounds.  But once the potential for even lower interest rates is minimized by the zero floor, our future frog-legged entrée is left with a rather uncomfortable feeling.  He’s resting inertly in this caldron as prices near the boiling point with the Fed, the Chinese and the banks all buying up whatever Treasury bonds are offered.  Everything appears well.  But bond investors with a survival instinct (being one and the same as our cooking frog) should reflect on that old teeter-totter metaphor and realize that prices near the boiling point automatically imply yields near subzero.  Granted, 5-year Treasury rates near 1.70 percent are not zero and 10s and 30s are even better, but much of the Treasury yield curve now rests in negative territory when compared with expected future inflation, and that should send our bond investor into a hoppin’ funk.  Prices are already nearing the boiling point and his coupons are subzero, CPI adjusted.  Total return…and our frog…are cooked.”

Sincerely,

MN Gordon
for Economic Prism

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