Photographing Phantom Invisible Bond Vigilantes
Robert Waldmann
A specter is haunting Paul Krugman — it is the specter of apparently sophisticated forecasters who predict a huge spike in US long term bond rates in the near future. He notes that most investors can’t believe this or rates would already be high. He also notes that some of those who are predicting a spike seem to be top advisors somewhere in the Obama administration.
He is puzzled by this phenomenon. I just note that it is not new at all. Basically such apparently sophisticated people predicting a spike in long term US interest rates are (almost) always with us. So far they have always been wrong. This issue is extensively researched by Nazaria Solferino et al in an article forthcoming in the journal of forecasting.
The phantom invisible bond vigilantes are not a new phenomenon. Consider Blue Chip Forecasts TM an organization which aggregates forecasts of, among other things, rates on Treasury bonds.
Usually there are some forecasters who predict that long term US interest rates will spike in the near future. There isn’t one such chicken little in the blue chip TM sample every month, but there is most months.
The interesting thing is that, so far, they have always been wrong. In an article forthcoming in The Journal of Forecasting Nazaria Solferino and I show that is it is possible to use a very simple formula to identify 1082 forecasts of US 30 year interest rates which are too high without one single solitary error so far. That’s a record of 1082 to zero (so far). The vast majority of the forecasters in the sample made such an incorrect prediction of a long term interest rate spike at least once. See
http://ideas.repec.org/p/rtv/ceisrp/135.html
There is no such fat tail of always wrong bond doves and almost no such 100% (so far) identifiable errors in forecasts of short and medium term interest rates.
Basically, phantom bond vigilantes are always with us. Almost always someone is convinced that the US is heading to high sustained inflation and that everyone else will agree a few months from now. It is an astounding feature of forecast data.
Robert,
Usually there are some forecasters who predict that long term US interest rates will spike in the near future.
They were all over the place following Bush’s tax cut. Then it turned out that the highest interest rates under Bush were lower then the lowest under Clinton. So the link between deficits and interest rates is more complicated then a simple fixed money supply demand story.
Be careful looking at low interest rates today. They are an artifact of fed policy and given the massive profits in the financial sector they appear atrifically low and are probably intended as a back door subsidy to try to restore the banks capital base.
Robert — FWIW
http://ideas.repec.org/p/rtv/ceisrp/135.html says there is no download restriction and has a download button. But clidking on the button tries to fetch the file from http://www.ciestervergata.it … and can’t find the server. Can’t ping it either. It may very well be down.
No big deal. I was just curious whether your studies went back to the 1960s and 1970s when, as I recall, interest rates rates spiked a lot. Surely someone would have predicted some of the spikes by chance?i
But if your thesis is that future long term interest.rates are one of the many things that economists can’t predict very well but that being consistently wrong doesn’t discourage them, you’ll get no argument from me.
Yes many economists predicted that high US budget deficits would cause a spike. I think the key player is the People’s Bank of China. There will be a spike if and when they decide that propping up the dollar is not worth the cost (they will take a hundreds of billions bath if they ever try to buy anything with their dollar denominated securities). The decision is up to a few very secretive men (and we don’t evern really know who they are — I sure don’t believe that the People’s bank is independent). This makes for panic. I panic myself sometimes, but I don’t claim to be an expert forecaster.
I think there is also a strategic element. If I predict a spike and it comes I become very famous. If it doesn’t, everyone forgets my prediction. Consider the case of Nouriel Roubini — he predicted doom and events made him famous.
Finally, I’m not naming names or anything, but there is this guy who lost a lot of money for an organization he headed by betting that long term US rates would rise. People don’t like to admit they were wrong. Especially some people. This guy is in a rather influential position.
On current fed policy, I think everyone assumes it is temporary and that this explains most of the term premium (on the order of 3.5%). The phantom vigilantes are predicting a huge spike above the current level which seems already to be based on the assumption that Fed policy will return to normal sometime pretty soon.
As for me, I own no, 0 (zero) long term dollar denominated instruments (and never have) so I obviously don’t think they are underpriced.
Odd. that server is down the hall from my office. I hope the building hasn’t exploded or anything.
The Journal of forecasting wants money. I can e-mail you a pdf if you e-mail me at robert.waldmann@gmail.com.
Actually the odd thing is that the economists aren’t consistently wrong. The extreme forecasts are extreme compared to the average of month old forecast by the same forecasters. Different forecasters more or less take turns panicking.
“Yes many economists predicted that high US budget deficits would cause a spike. I think the key player is the People’s Bank of China.”
Robert are you saying that there are political factors which can overdetrmine technical ones? I.e., without the PBC the underlying causal chain identified by the standard theory would be correct? Or are you saying the standard theory is wrong? It is more than a curiosity to me because it seems to me that the belief in the standrd theory (let us call it the ontological vision) is so strong that that is why people keep predicting a spike even though they most always get it wrong because they think the ontological model is the cente of gravity and not the ad hoc political factors.
By the way ever been to that little Domo in Orvieto where the fourth crusades was launched?
Guest,
I would go witht he supply demand story on loanable funds and the effect on available capital and tight supplies driving up interest rates. But the fact remains that deficits jumped up under Bush while interest rates kept falling. And under this president deficits are going ballistic while interest rates are not moving. So we are left trying to explain a situation where you would expect rising interest rate yet this expectation is is being contradicting with what we see in the markets.
I don’t think slugs and Krugman’s explanation that we are in a liquidity trap squares with the data of record profits on Wall Street and 3.5 percent growth in the third quarter. So it really seem the low rates are being driving my market manipulation from the Fed and outside sources like the PRC, and maybe some other factors.
Cantab,
At last summer’s Robbins Lecture at the London School, Krugman had a slide that showed private and public saving. It was stunningly obvious that the world was awash in savings and despite massive government deficits just about everywhere, those deficits were still not big enought to completely soak up private saving. As to 3.5 percent growth in the 3rd qtr, do you think that we would have seen that growth without ARRA?
I would pretty much agree with you although I doubt that the purported massive profits in the financial sector would stand up to honest, arms length, auditing. It seems pretty likely that long term interest rates are set by the interaction of many forces of which anticipated future rates are only one — and not necessarily the largest — component.
Robert,
You said that you looked at 30 year interest rates. How did you do that for the years during which the Fed suspended 30 year bonds? Or were you just looking at secondary markets for those 30 year bonds? If so, would that bias the sample because the term structure of outstanding 30 year bonds would be different?
Second question. When you looked at actual versus forecast interest rates, I’m assuming that the errors were all in terms of looking at the returns from the perspective of someone in the US. In other words, when an investor in Dubai forecasts interest rates they are not just looking at a forecast of nominal Treasury rates, but at the exchange rate adjusted interest rate.
Last point. About 10 years ago there was some study (I think it was in Econometrica ???) that compared the GDP forecasts of private forecasters versus academic economists. Most of the private forecasters were, not surprisingly, associated with financial entities. While neither group covered itself with glory, it turned out that the academic economists outperformed (or at least didn’t do as badly) as the private forecasters.
I have been to the Orvieto cathedral. Very beautiful. Orvieto is all wonderful.
The PBC can keep the yuan down as long as they want. A country can’t always keep its currency valuable but it can make it cheap (I mean it can print all the Yuan it Yuants to print).
Yes I think the key is that many people deeply believe that deficits must cause high interest rates sooner or later and, pretty much every month at least someone thinks the long term bond which are over priced bubble will burst. I guess I am one of those people. I think it has to happen sooner or later.
Our data were all from the period with new fresh 30 year bonds (the variable to predict was their price on the secondary market immediately after issue). Our data were all from 87-96 so lots of forecasts from lots of forecasters but not many years. Even with a much longer time period, there is no way to rule out peso problems, but our time frame was really short (see VT’s question).
The forecasts are of nominal interest rates. Those don’t interest me at all (I live in Italy and I care about returns in Euros). I don’t touch dollar denominated assets.
I don’t know about that article.
Oh the time period was just 87 through 96. We have a huge number of forecasts from a large number of forecasters (different maturities different lags of the forecasts so over 28000 total forecasts of which somewhat more than 1000 are howlers). However, we don’t have many years of the underlying variable. We can’t ever rule out a peso problem, but our limited data set makes that especially a worry.
“The PBC can keep the yuan down as long as they want. A country can’t always keep its currency valuable but it can make it cheap (I mean it can print all the Yuan it Yuants to print).”
But that is not the issue. The issue is will the (world) Chinese keep buying US debt. It seems to me that in a closed economy then maybe the ontological model makes sense but in an open economy (for sovereign debt at least) then the ontological model needs to be significantly modified. Seems like a choice between political economy and economics.
We have all been waiting for the (world) Chinese to dump the dollar or demand higher interest rates for how long? That is, this game of lose- lose chicken has become the central operating parameter and it is not just the Chinese and the US who have invested in it as such. Systematic irrationality (from a rational base of win-win beef) is not really the standard ontological model (SOM). The ontological model says that we never get here in the first place.
Although I must confess that I too think it must come crashing down at some point but I have been saying this for 9 years now because I too have a ontological model in the back of my head that says at some point fundamentals will overwhelm political compacts. Alas alas a lack.
Anyway yes the central (new) Domo in Orveito is beautiful but it is the one down the street (or the first one if you come from the central gate) which is where the (4th) crusade was launched from.
“The PBC can keep the yuan down as long as they want. A country can’t always keep its currency valuable but it can make it cheap (I mean it can print all the Yuan it Yuants to print).”
But that is not the issue. The issue is will the (world) Chinese keep buying US debt. It seems to me that in a closed economy then maybe the ontological model makes sense but in an open economy (for sovereign debt at least) then the ontological model needs to be significantly modified. Seems like a choice between political economy and economics.
We have all been waiting for the (world) Chinese to dump the dollar or demand higher interest rates for how long? That is, this game of lose- lose chicken has become the central operating parameter and it is not just the Chinese and the US who have invested in it as such. Systematic irrationality (from a rational base of win-win beef) is not really the standard ontological model (SOM). The ontological model says that we never get here in the first place.
Although I must confess that I too think it must come crashing down at some point but I have been saying this for 9 years now because I too have a ontological model in the back of my head that says at some point fundamentals will overwhelm political compacts. Alas alas a lack.
Anyway yes the central (new) Domo in Orveito is beautiful but it is the one down the street (or the first one if you come from the central gate) which is where the (4th) crusade was launched from.
“The PBC can keep the yuan down as long as they want. A country can’t always keep its currency valuable but it can make it cheap (I mean it can print all the Yuan it Yuants to print).”
But that is not the issue. The issue is will the (world) Chinese keep buying US debt. It seems to me that in a closed economy then maybe the ontological model makes sense but in an open economy (for sovereign debt at least) then the ontological model needs to be significantly modified. Seems like a choice between political economy and economics.
We have all been waiting for the (world) Chinese to dump the dollar or demand higher interest rates for how long? That is, this game of lose- lose chicken has become the central operating parameter and it is not just the Chinese and the US who have invested in it as such. Systematic irrationality (from a rational base of win-win beef) is not really the standard ontological model (SOM). The ontological model says that we never get here in the first place.
Although I must confess that I too think it must come crashing down at some point but I have been saying this for 9 years now because I too have a ontological model in the back of my head that says at some point fundamentals will overwhelm political compacts. Alas alas a lack.
Anyway yes the central (new) Domo in Orveito is beautiful but it is the one down the street (or the first one if you come from the central gate) which is where the (4th) crusade was launched from.
Cantab,
at last summer’s Robbins Lecture at the London School, Kurgan had a slide that showed private and public saving. It was stunningly obvious that the world was awash in savings and despite massive government deficits just about everywhere, those deficits were still not big enough to completely soak up private saving.
What argument are you making here?
As to 3.5 percent growth in the 3rd qtr, do you think that we would have seen that growth without ARRA?
Without the stimulus maybe it would have been something like 3.2 percent. If you look at the recovery.gov they show around 640 thousand new jobs from the stimulus. And I digress: They show the number as being 640,329.18. How do you like that fraction of .18? First, nobody believes these bozos are creating anywhere near the total number, and these nincompoops decide to show the fraction just to add digits so it will look bigger against the cost, where they truncate the fraction. This is small potatoes but when you see peccadilloes like this one has to ask where there’s smoke there is probably fire and analogy of fire is that the agency producing these numbers has been corrupted by the political people. End of digression. A simple analysis of the unemployment numbers from the household survey show a labor force of 153,975,000. 10.2 percent of that has the number unemployed at 15,705,450. Now take out the 640,329.18 jobs that the folks at recovery.gov claimed were saved by the stimulus and we are at 16,345,779, or an unemployment rate or 10.6 percent (taking recovery.gov numbers at face value is certainly a huge leap of faith).
So the democrats promised 8 percent unemployment, we got 10.2 percent, and they screwed up the differential between the doing nothing which today according to their exaggerated statistics would have unemployment only 0.4 percent higher without their stimulus so they screwed up the differential too.
ref: http://www.recovery.gov/Transparency/Pages/home.aspx
Today, 1:25:53 PM– Flag – Like – Reply – Delete – Edit – Moderate
I must have seen the old one too. China keeps the Yuan down vs the dollar by buying dollar denominated assets, so keeping the Yuan down and keeping the US interest rate down go together. In simple models exactly together. In the real world the PRC has capital controls which changes things.
The Recovery.gov numbers do not represent total jobs saved or created; they represent the minimum number that can be documented. Most independent analysts put the actual number in the 1 million range.
As to GDP growth with and without ARRA, there have been several independent analyses and they all pretty much come to the same conclusion. The ARRA added something in the neighborhood of 2 percentage points to where GDP growth would have been in the absence of ARRA.
What about the decimal points, do you want to explain that one?
Cantab,
You’d probably complain if they left off the decimal places. You’d accuse them of rounding errors.
I complain because they are stupid deceiving shmucks.
Here it is again.
http://www.recovery.gov/Transparency/Pages/home.aspx
Cost: 158,976,620,895 Jobs: 640,329.18
versus
Cost: 158,976,620,895 Jobs: 640,329
What’s the point of that .18. It adds nothing to the analysis. Look at it. Isn’t it obvious that they wanted more digits to make the benefit seen bigger versus the cost? Please, he honest here.
I have read Krugman’s various pieces on this matter. Perhaps he should take a look at the quarterly refunding charts and latest minutes of the Treasury Borrowing Advisory Committee. I know that he is in London at the moment, but he’s still writing about this stuff.
I don’t believe that Robert has added much to support Krugman’s position. Same for DeLong in a piece that I read today. There is no evidence provided that any of the three have reviewed in detail the projected financing requirements, auction offerings, or overall global government financing requirements that exist now or over the course of the next year.
Certainly, there may be no immediate rise in interest rates for long term or medium term issues, but that is projected to unfold down the road, say 2014. When the governments of the world throw this much new debt on the market, terms will change.
The U.S. Treasury is expressing concerns as evidenced in the Nov 3 meeting minutes of the Advisory Committee (dated 4 Nov). That info is probably floating around New York bond circles.
http://www.treas.gov/offices/domestic-finance/debt-management/qrc/
http://www.treas.gov/offices/domestic-finance/debt-management/adv-com/reports/
I don’t know about Krugman, but I confess to schizzofinancing, that is, I am turning the efficient markets hypothesis on and off. My immediate reaction to your comment is that you disagree not only with Krugman but evidently a whole lot of investors as expected future 5 year rates should show up in the price of 10 year bonds of a certain age.
I don’t believe that markets are efficient. I really can’t appeal to the efficient markets hypothesis in a debate. I just note that you sure seem sure you can beat the market.
Actually the time period is not so bad. It includes the evidently famous long term interest rate spike of 1994.
http://krugman.blogs.nytimes.com/2009/11/22/1994/
Fact is, that spike was nothing compared to the spike regularly predicted by a shifthing minority of forecasters.
MG,
Actually Krugman and Zandi have commented on this potential problem of having to refinance a lot of debt when interest rates are high.
There are three answers. First, it is easier to refinance a $10T debt with a healty economy than it is to refinance a slightly smaller debt with a weak economy. Second, you don’t have to pay it all back in 10 years. And third, the world is awash in savings right now, so government borrowing is a good thing. Suppose the private sector had borrowed the world’s savings instead of government. The private sector would still have to face exactly the same future refinancing issue. So the argument against government borrowing during a liquidity trap driven recession seems to boil down to an argument against all kinds of lending, public or private. And it’s because there is no private sector investment demand that interest rates are not a problem. No crowding out.
What we have is a world where forecasters assume very weak growth and conclude that government deficits will be a problem because they probably will cause the sluggish
growth they assumed at the start of their analysis.
One of the big incorrect meme making the rounds is that we solved the problem of huge deficits after WW II by paying down the debt. But we only ran surpluses for two years in the post WW II period. We did not resolve the problem by reducing the debt, Rather we resolved the problem with strong economic growth so that the deficit was a smaller share of an even
larger economy.
There is, if memory serves, pretty good statistical evidence on causal factors for interest rates. The big three are, in order of importance, inflation, growth and deficits. When those three don’t push in the same direction, then the impact of deficits can be obscured by the more important factors. That would very likely be the case now. This has made it possible to argue that deficits don’t matter, even though they do.
This collection of factors, and their ranked influence, also makes clear that credible policy provides greater fiscal flexibility. If investors trust the central bank, fiscal authorities can get away with quite a bit – up to the point, I suppose, that fiscal policy becomes an large inflation risk in itself.
Since the link is hinky, may I ask for a few details? When writing of “long-term debt” were you taking estimates of 10-year yields, bond yields, and average of all note yields? What time horizon were you using when finding expectations of a spike? I ask not because I want to pretend to critique the study, but rather because I am curious about the findings themselves? Wooly-headed forecasts expect a spike in what yield over period?
Looking at Bloomberg (rather than Blue Chip) estimates, the most extreme spike in the rates anticipated over the next 18 months or so is at 2-years, which seems to assume a rapid rise in Fed rates – possibly in response to the very sort of event that could trigger higher rates at the long end.
i like the paper’s rainbow effect
cone cap types flip themselves out
every once in a blue moon
its like flush
but what i must say captures my gaze
the use of these predictions by policy magicians
like lerry s
on their eager bemused innocent listeners in decider positions
if the intent is to spike a too fast recovery
by squelching a big bad fiscal thruster
why ?? import sedation ??
if that’s the real agenda
not unspike yet to be formed expectationals
of future gusty inflation => hypered interest rates
one couldn’t actually come out and say it
folks we’re gonna keep the economy in low gear here
to rebalance trade
btw
i like the implied notion
of expected expected inflation
only real merlins can see that deep
larry of course is just such a merlin
Robert,
I didn’t say that I disagreed with Paul Krugman. I questioned whether he, you, and Brad DeLong had taken a hard look at the projected financing requirements, auction offerings, or overall global government financing requirements that exist now or over the course of the next year. Moreover, I explained that some concerns were raised by the Treasury Borrowing Advisory Committee and provided a link that will allow anyone to review the Nov meeting minutes. This is the type of information I would review prior to quickly laughing off Morgan Stanley and others. In other words, see the whole field. Then speak.
Do I agree with Paul? I don’t know. I understand his general point in the near term, but I also noted that the Nov 12 auction of 30-year treasuries indicated that the market participants were gagging on the $16 billion offering. The bonds sold at 4.469%. Now, Treasury didn’t have any problem with the shorter term bonds but there is apparently some resistance in buying the 30-year offerings. As such, this may support the Morgan Stanley positions that yields may jump by the end of 2010. Perhaps not as high as MS is suggesting, but headed in that direction nonetheless.
I recommend reading the Committee minutes, as some news articles are starting to cite statements from the minutes. Moreover, you might take a look at the worst case scenario report released by Société Générale last week. That report is generating some talk on both sides of the Atlantic. Many investors read this information; who knows how it will affect their buying behaviors.
I don’t have a black and white firm view of the market conditions including bond sales. What I see is a significant increase in the debt coverage needs (securities sales) in the USA and elsewhere around the world. How that will play out remains to be seem. I do expect interest rates to pop up by 2014-15 or shortly thereafter. Beyond that observation, I am not convinced that we’re out of the woods on the financial front.
Société Générale Worst Case Debt Scenario Fourth Quarter 2009
Released to clients in Nov 2009
http://www.scribd.com/doc/22776263/Societe-Generale-Worst-Case-Debt-Scenario-Fourth-Quarter-Nov-2009
See page 11
Morgan Stanley – U.S. Interest Rate Strategy, 22 October 2009
http://www.scribd.com/doc/21966360/Global-Investment-Perspectives-October-29
slugs,
What are your yield projections for 30-year bond offerings by the U.S. Government over the course of the next twelve months?
This Huffington piece has generated over 4100 comments as of 11:27 PM EST.
US Debt A ‘Phantom Menace,’ Krugman Argues
I don’t know what you mean.
Robert writes:
“China keeps the Yuan down vs the dollar by buying dollar denominated assets, so keeping the Yuan down and keeping the US interest rate down go together”
Not sure about that. Most followers of the Chinese xchange regime would probably argue that the rate is set by fiat and does not rely on the purchase of US dollar denominated assets. Unlike say the YEN the Yuan does not circulate externally and cannot be used to purchase goods services and assets outside of the PRC . One can imagine a low Yuan in absence of high US reserves.
Is there not some way that the triplicate postings can be resolved?
Here’s Menzie Chinn’s take and his estimate of the effect on interest rates one year out. Turns out that he co-authored a paper on this very issue.
http://www.econbrowser.com/archives/2009/11/debt_and_intere.html
2slugbaits,
I didn’t ask you what Chinn said. I know what Chinn said as I read his posts all the time.
My question: What are your yield projections for 30-year bond offerings by the U.S. Government over the course of the next twelve months?
Do you have a projection? If so, what is it?