The bond-market blowup seems to have topped: 10-year Treasury notes touched 3.6 percent, and low-fee mortgages 5.125 percent. Each has rocketed 1 full percent in one month.
In some ways this explosion makes sense, but in others it’s been downright weird. The sensible: We were way overdue for a technical correction from the straight-line drop in rates from April to August. Markets that decline in straight lines rebound in straight lines.
An economy underperforming in spring and summer led to thoughts of double-dip, but now the economy is performing better than forecasts, concentrated in retail sales, up 1.2 percent in November, and October revised to +1.7 percent; and in manufacturing, November production up 0.4 percent.
A pop in export volume is a good hint for the "why" in manufacturing; the big-business types are happy, their global engines humming. Even the small-business National Federation of Independent Business (NFIB) survey is an inch above two-year bottom. New claims for unemployment insurance have held lower in the last two months, at 420,000 weekly.
These are legitimate improvements, consistent with an economy sputtering along just above stall speed. Gain a little growth in altitude, rates up; lose a little, back down.
The dividing line between reasonable and weird has been the reaction to two government actions: 1. The tax-rate extensions, and 2. The Federal Reserve’s latest round of quantitative easing (QE2).
These have given bond investors a case of eye-bulging, screaming bejabbers: conviction that the U.S. economy is now strongly self-sustaining, accelerating into 4 percent U.S. gross domestic product growth and certain inflation.
When measuring economic stimulus, consider a water faucet. If water is trickling forth, so it will until you turn the handle. This "tax-cut extension" was an increase in after-tax income 10 years ago that has flowed on at the same rate ever since, the economy completely adapted to it by 2004. New stimulus would require turning the handle; this extension has no change-impact at all.
QE2 frightened everyone except us central-bank junkies. All civilians saw it correctly as money-printing, but cannot be convinced that it’s necessary and non-inflationary money-printing. Fed Chairman Ben Bernanke went on "60 Minutes" to try, and made it worse.
QE2 is a big thing: The Fed is buying the equivalent of all net-new Treasury borrowing through April. More powerful, it is buying long-dated paper at a rate at least 2.5 times new issuance.
To get this interest-rate volcano going, existing holders of long Treasurys have had to sell at a rate far faster than the Fed is buying, enough to overwhelm market buyers, too. An all-out skedaddle — a true and unseemly panic.
Another marker: The Fed met on Tuesday, and its post-meeting press release confirmed standing policy. The bond market fell apart, again. What had these sellers expected? QE2 stoppage? In the absence of pre-meeting hints, inconceivable. The market seemed frightened just to be reminded what the Fed is up to.
Financial market people do all they can to ignore housing, hoping that one day it will just go away. On current trend, it might.
This notion of consumer-based economic acceleration is fatally incompatible with all four home-price gauges reporting new declines (CoreLogic, Zillow, Federal Housing Finance Agency, Case-Shiller); and new declines in unit sales, with possibly no net absorption of inventory at all. A 1 percent increase in mortgage rates is not helpful.
On actual economic-inflation grounds, this bond rout does not make sense.
However, another reason does make sense. Or could. The great background fear has been that Treasury borrowing would at last overwhelm the world’s willingness to lend. Treasurys traded in markets today: $9.3 trillion (by the way, China holds less than 10 percent), and that was only $5 trillion when the crisis began in July 2007.
We will try to borrow another $1.2 trillion or so each year ahead (the tax-bracket extension does matter, there). An end to our borrowing ability would appear first in the world’s refusal to buy or hold our long-term paper, and that is what is happening.
This may be correlation and not cause, but a foretaste: "The Ghost of Christmas Future."
Nothing on this earth matters more than a U.S. fiscal Big Fix.