There is still a lot of talk about the bond bubble with so many people expressing their opinions about bond yields being too low. Maybe.
But I thought it might be informative to show that my bond valuation model says that bond
yields are almost exactly where this “objective” analysis says they should be.
Yes, it is the product of a “model” that may or may not be right and even though I have been using this model almost exactly as it is for some 15 to 20 years there is always the possibility that it will blow up next month.
One interesting point is that the model goes along with the Wall Street Journal’s editorial page quarter century campaign to point out that federal debt and interest rates have a negative correlation. At least they push this idea when republicans are in the White House. They are right that cyclically as the government debt rises rates fall and as the debt contracts rates rise. Of course this reflects that the cyclical federal deficit is inversely related to private credit demands. So on a cyclical basis the large federal debt is largely a function of the collapse in private credit demands.
Note that the fitted value ticked up, suggesting that on a short run basis yields may be bottoming. Interestingly corporate America is starting to issue a lot of long term debt.
For example, IBM just floated a large long term bond. Historically IBM has a good long term history of floating large debt issues around the cyclical bottom in rates. There are some sharp people in the IBM treasury operations.
What’s your opinion on the sheer volume of Federal treasuries and the issues turnover rate?
How will the U.S. Treasury find enough buyers in another five or ten years as the issue volume soars another few trillion without a large jump in yields?
The President’s proposed budget caps treasury issues projected yields at 5.3% out to FY 2020. Is that realistic?
At the right price the Treasury will always be able to find a buyer.
But notice that Japan has been running deficits like this for 20 years and their yields are still about 1%.
Also note that if the federal deficit is contributing to the savings-investment gap the current account deficit must widen to equal the gap. In the type of scenario you are thinking about the trade deficit would be so large and interest rates so high– also probably the dollar so weak and this would be an offsetting negative in my model — that probably would be no competing private credit demands. This is what I mean when I say the deficits do not hurt government much, but they do massive damage to the private economy. Two prices have to adjust to finance the deficit — interest rates and the dollar — and note that under Bush the dollar had to fall some 40% to finance the deficit.
Question, why didn’t you raise this question when the republicans were creating the massive structural deficits you now seem so worried about? I have no sympathy for republican complaints about the deficit,
since it is a product of deliberate republican policy. Yes, Obama did add to the cyclical deficit, but his contribution is minor compared to the republicans role in creating it.
I recently had a client ask me how we get out of this economic stagnation scenario we are in and I said I did not know. But maybe the most likely case was that the market drives the dollar so low that US international competitiveness returns and import substitution becomes the driving force creating growth. But it will take much higher relative prices–probably, but not necessarily, inflation–to achieve this.
spencer – “Question, why didn’t you raise this question when the republicans were creating the massive structural deficits you now seem so worried about? “
I believe that is a misplaced accusation, spencer.
I do not attempt to keep track of what everyone said at different times.