The bond market appears to have lost its way
Back in 1962, the benchmark ten-year US Treasury bond paid interest at an annual rate a bit below 4%. From there, it quickly climbed, reaching its all-time apex almost twenty years later at 15.84%, in 1981. In other words, the rate more than quadrupled. A $100 ten-year zero-coupon bond with a present value of roughly $96.00 at 4% interest is worth only about $84.00 at 16% interest (more with compounding, but for simplicity’s sake). Bonds got killed from 1962 to 1981. However, after 1981, ten-year bond yields declined, reaching a nadir in July of 2012 at 1.51%, the lowest since record- keeping began, which also meant that bond prices were the highest ever. Bond traders have had it real tough making money since the eighties. Never mind the stock markets, bond markets have been relentlessly accommodating.
After reaching its nadir in July of 2012, the ten-year yield bounced up a bit, in fact doubling by December of 2013, to a bit above 3%. Temporary pain for bond traders. Then last month, because of the weather or that Santa Claus didn’t bring what people wanted or that ISIS keeps cutting off people’s heads in quite dramatic fashion or that the realization began sinking in that Ukrainians will soon be learning Russian, pick your rationale, bond yields cratered, again, declining in little over a month by over fifty basis points, falling from 2.27% on December 24, 2014 to 1.68% on February 4th. And through the month of January, yields rose and fell unpredictably, often five and six percent per day. It must have been a rollicking fun ride for the Bill Gross wannabes of the world. (Bill Gross is to bond trading what Warren Buffett is to stock trading). Now yields have climbed back over 2%, to 2.14% as of Wednesday, February 18, 2015. Down over fifty basis points in a little more than a month (a 22% decline) only to climb back up almost to where they started (roughly a 27% increase).
It is clear that the bond market hasn’t a fucking clue what is going on. Which is somewhat unsettling. Because bond markets throughout history have been generally very good at anticipating economic, political and social upheavals and trends. I think everyone understands that the world is reaching some sort of inflection point that will determine the path for the near future. If nothing else, in a bit less than two years, Obama will no longer be president. Considering how important politics has become to economics, the bond market is apt to be confused more and more as it gets closer and closer to election time, particularly if there arises an overbearing level of uncertainty as to who his successor will be. A fifty-fifty election would not auger well for the bond market.
But there are bigger trends that matter, rather than just the American election. The whole of the developed West (and Japan) is being shunted aside by the rising powers in the Orient, India and China and others. Europe is losing its preeminence. The decline started gradually, beginning around the end of the nineteenth century, but seems to be gathering momentum. Who was it said that they went bankrupt gradually, and then all at once? China still has some scores to settle with the West, particularly with Britain, who forcefully pried open China’s markets so it could sell its citizens opium. When the Chinese terra cotta army was commissioned by her first emperor, the people in what is now Great Britain were barbarians too savage for admission to the Roman Empire. History cycles, sometimes in quite expansive arcs, but cycle still it does. China is rapidly regaining her lost preeminence on the world stage. And that, in a rather indirect and convoluted way, might explain some of the decline in yields on US Treasuries. Or not.
The decline in Europe and Japan is even more pronounced. Japan effectively charges its lenders for safekeeping their money, sporting a negative yield on some instruments. And Europe’s governments, even ones with quite dicey prospects like Spain and Italy, pay less to borrow money than does the US government. Germany’s yield is comparable to Japan’s, as is Denmark’s.
So the bond markets are a confused mess. I can’t find any commentary that plausibly explains the situation. The US has the strongest economic system in the developed world, yet pays more than any other developed country when it borrows money, and the UK follows close behind in both economic strength and the rate at which it can borrow. The obvious answer is that the flat yields in Europe and Japan indicate expected future weakness, as has usually been the case. But yield also reflects risk, and if their economic systems aren’t expected to do so hot in the future, then the prospect of repayment dims.
All that can ultimately be said is that the bond markets are a quandary that nobody quite understands. They seem, like a Ouija board, to be trying to say something, but only a huckster would pretend to know exactly what.
Walmart plans to set its minimum pay at $9/hour
Walmart claims it is having trouble with turnover. Of course it is. Like most other low to middle-end retailers, Walmart treats its ‘associates’ not much differently than a carton of asparagus it pushes out the green grocer’s door—as resources to be exploited. It pays them the bare minimum it believes it must in order to get them to do its bidding. It does not consider them as anything other than commodities. It believes as much is part of its secret to delivering “value”. Walmart has come to represent all that is wrong with American capitalism vis a vis the people who the system is intended (or should be) to serve.
Walmart is not raising wages because it has suddenly, like the Tin Woodman in the Wizard of Oz, found a heart, but because it is beginning to realize that it may well cost more to depend upon antagonistic employees barely making enough to survive than it would cost to just share a bit of the profits with them. The stock price declined on the announcement but I think that’s foolish. There is a trickle-up effect to treating workers well. Pay them better and treat them better and they feel they are a valuable part of the team, and become more committed to doing their part well. The money lost to better pay and working conditions is more than made up in greater effort and efficiency.
For the high-powered human resources executive, the lesson perhaps is that you get what you pay for.
Citigroup Economic Surprise Index plunges
Leave it the guys at Citigroup to derive this second derivative index. It is not an index of leading economic indicators—things like employment and interest rates and housing starts and durable goods orders , and etc., that measures whether those things are increasing or declining. No, it is an index of whether the expectations for those sorts of things were exceeded by reality or disappointed by it. So, if the employment number for February is expected, presumably according to some poll taken of economists, to come in at 250,000 new jobs, but instead comes in at 300,000 new jobs, that would be a positive for the Citigroup Economic Surprise Index. If it comes in below expectations, that would be a negative. Assign weights to positives and negatives according to the impact each factor has on the overall economy, add them all up and you get a number. If the number is negative, people aren’t quite gloomy enough. If the number is positive, people aren’t quite ecstatic enough. At zero, the gloom and ecstasy balance out. I couldn’t make this shit up if I tried.
Lately, the index has plummeted from a recent high of 72 in mid-January, to -4 on Wednesday, February 18, 2015. It apparently operates with something of the volatility of Alabama’s winter temperatures. But the only thing the index really measures is how errant and ineffective is our ability to forecast the future. In particular, it should be a lagging indicator, as the main tool for forecasting the future is to assume it will look like the past, with a patina of optimism thrown in because nobody likes a sourpuss, even if he’s right, or perhaps exactly when he turns out to be right. But there will be those occasions, such as towards the end of the last recession, when pervasive gloom descends as if financial Armageddon were upon us, where the index will turn riotously positive for the assumption that things can only get worse. In effect, the index magnifies the latent manic-depressive psychoses of the markets and the economic system. I would say that it is to be ignored, except as an artifact to be studied of a socio-neural psychic network run amok with meaningless analyses. But it may well indirectly measure sentiment, and in a world with a glut of savings, sentiment can create its own reality. If enough people believe the market should be going up, actions taken commensurate with that belief will compel just that to happen, which will reinforce the sentiment, which will cause people to take further actions commensurate with their sentiments, etc., ad infinitum. Of course, the positive feedback loop can go either way.
In any event, sentiment can be brutally unpredictable, but this contrived index may provide some advance warning of the direction in which it may be heading.
There was a paucity of economic numbers that came out this week. But the ones that did obviously disappointed, including mainly new housing starts, which were off 2% last month, seasonally adjusted, from December. This decline was unexpected, so it would have factored into the Surprise Index’s decline. Housing starts are still up by almost 20% over January of 2014, and housing prices continue to climb, so nobody expected that starts would fall, or even stall. Expectations might be getting a bit ahead of reality, as so often happens in this greedily optimistic American culture.
Perhaps reflecting the volatility, if only indirectly, of the bond markets, stocks have moved mainly sideways since retracing in the first part of February the ground that was lost in January. They started the week a bit off all-time highs, but mainly moved in minor increments, almost like it should be expected of these sorts of assets, which at least nominally represent the long-term prospects for a company, if the intervening psychological games of trading them in markets didn’t so often overshadow their true value. Their lazy stroll ended late Friday afternoon, when the ECB announced it had reached an extend and pretend agreement with Greece regarding debt that Greece will never pay back mainly because it doesn’t want to. In a few minutes, all the US indices shot upward, both the Dow and the S & P 500 ending at new all-time record highs. Down initially, fearing the worst if an agreement weren’t reached, the Dow traveled 262 points over the course of the day to end up about 150 points. Ho hum.
It would be an interesting study to investigate the correlation between bond market volatility and stock market volatility. My bet is that there is a generally negative correlation. When one is calm and quiescent, the other should be frustratingly unpredictable. The future is always uncertain. Apparent certainty in one of the arenas contrived for betting on the future ought to inure to the instability of another. While stocks were languidly trading all week until the last trading day, ten-year Treasury bonds violently whipsawed, starting the week a bit above 2%, hitting a high of 2.14%, and then settling back to roughly 2.04%. On Friday alone, yields tumbled about 8 basis points (from 2.12% to 2.04%) before retracing all that and then some, closing up slightly for the day.
There seems to be little agreement among bond traders as to what the future might hold. For stock traders, there seems to be no disagreement that there is no limit to how high stocks can go. Every day, week and month, it seems they believe, new record high valuations should post. The only thing with a more unitary upward direction than the stock market is the planet’s temperature. Bond traders perhaps better understand the dangerous implications of such beliefs.
The Ukraine/Russia war
Even as the videotaped beheadings posted on the internet by ISIS seem to have cornered the market on the macabre aspect of warfare, what ISIS is doing in the Middle East is of far less importance than what Russia is doing in Eastern Europe. In the grand economic scheme of things, the forlorn deserts of the Levant, where Syria and Iraq’s broken states are no longer powerful enough to govern, matter very little. Let ISIS have the Mad Max-looking deserts. It won’t matter. But let Russia take Ukraine, which has by now become almost an inevitability, and there will be real repercussions.
Vladimir Putin claimed this week, in a speech celebrating the 70th anniversary of victory in what Russia calls The Great Patriotic War, that Russia’s military might is unmatched the world over. This is at once delusional and partly true. Russia’s military might is certainly unmatched in Eastern Europe. Not even Germany matches up. After what the West calls World War Two ended, the US had been a counterbalancing force to Russian (or formerly, Soviet Union) hegemonic designs. But US presence and power has been drastically scaled back since the Cold War ended in the early nineties.
Imagine if Russia launched a full-scale offensive through the Fulda Gap in Germany, as the American Army stood ready for 45 years to repel during the Cold War. The prolonged peace has steadily eroded the West’s capacity for defense. But the probability of Russia trying such a thing is still very, very slim.
What most certainly will continue is that Russia will keep poking and prodding and pressing the West, to see how far it can go without ruffling the feathers enough to incite a military response. The West does not want to fight a ground war in Europe again. Russia doesn’t either, but is less reluctant, as such a war would be defending what it considers home turf. The West thinks and desperately hopes that ground wars in Europe ended with victory in the Cold War. The American political philosopher Francis Fukuyama went as far as to proclaim in “The End of History and the Last Man” that the end of the Cold War heralded the end of mankind’s sociopolitical evolution. The West would desperately like to believe it. Putin understands the West’s latent pacifism, but the West doesn’t really understand as much about itself, violating Sun Tzu’s first tenant of warfare to know thyself, which is no small part of why Putin has won in every confrontation so far, military or diplomatic.
Make no mistake that what is going on in Ukraine is a war with Russia. It is not a civil war between Ukrainian loyalists and Ukrainian separatists. The Ukrainian separatists are Russians with Ukrainian citizenship who are loyal to and supplied by Russia. They are no ragtag group of rebels like, for instance, ISIS is. They are winning at every turn, mostly recently taking the important rail hub, Debaltseve, (in violation of a recently implemented cease fire) at least in part because they are better equipped than the Ukrainian loyalists. The separatists have the latest in Russian artillery and tanks. True rebels are never better equipped than the state-sanctioned armies they seek to defeat. Ukraine’s military has arms and munitions mainly leftover from the Cold War.
So far as Ukraine is concerned, Putin’s claim that Russia’s military might is unmatched is true. While it would be easy enough for the West to supply Ukraine with better and more armaments, it is reluctant to do so out of fear that it might provoke a wider conflagration with Russia. If the West won’t even lend arms to a foe of Russia, then Putin may well be correct in perception, if not in reality. Russia’s military knows no match because it appears no one is willing to risk a head-on confrontation with it.
Greece gets another four months to pretend it might pay Germany back
Short of Germany invading, which seems taboo to even imagine (which is part of why, as previously noted, Putin is so easily having his way in Ukraine), Greece is never paying Germany back. But stock traders are like children. Or perhaps dogs. Their memories are short, incapable of recalling much of the past or imagining much of what the future might hold, which explains why they chased this car of a Greece debt deal all the way to record market highs as soon as the deal was announced late Friday afternoon.
Greece has been playing this game with Germany since at least 2011. And nothing’s changed, nor will it. Greece can’t pay back its debts short of liquidating its country and Germany, its biggest creditor, won’t invade to force liquidation, so extending in this instance really is pretending.
There is, though, precedence for a German invasion. France invaded Germany after World War One to force (mostly unsuccessfully) the repayment of reparations as agreed upon in the Treaty of Versailles. And Germany has invaded Greece before. During World War Two, it invaded while Greece was fighting a civil war between Communists and Nationalists. The Nazis naturally supported the Nationalists, who eventually won, but not before thousands died of starvation for the deprivations that occupation and civil war caused.
Greece won’t pay back its debts but it doesn’t matter whether it does. Just call it a German haircut and get it over with. In fact, if Greece actually mattered, there would be wailing and gnashing of teeth by now that the “crisis” hasn’t yet been conclusively resolved. Greece doesn’t matter to the Eurozone or to the world economy. Greece is too small to matter. It could leave the euro and you’d have to listen closely for the hiccup in economic activity its leaving caused. Stock traders would temporarily panic, but that’s because they’re paid to be either panicked or euphoric all the time, like children. It’s how they keep the markets in turmoil, which is how they keep the commissions flowing. The fact Greece is making headlines shows how little there is to report on about now.
Europe’s slow grind to second-tier economic status will mostly not be newsworthy. It will be like watching grass die in a drought. And the patch of grass that is Greece is already dead and has been for a long time.