Why has the dog not barked? Quieter, wiser heads are worried about our economy

If the Fed's 'quantitative easing' was good for the economy, its absence is not

Worried dog image via Shutterstock.Worried dog image via Shutterstock.

Most year-end forecasts are now on hold, or ought to be. Expectations for a faster economy and higher rates? Later, dear.

Some days the financial markets are beautiful things. Not just because you’re winning a bet, but by clarifying who has done what to whom. Not mere correlation as cause, offered by shills every day, but unmistakable event and effect.

Before New York markets opened on Thursday, news flashed: Markit’s measure of January manufacturing in Europe rose from 52.7 to 53.9, but in China fell from 50.5 to shrinkage at 49.6 — almost a percentage point below forecast.

The Dow opened 150 points below Wednesday’s close, and emerging-nation currencies tanked, Argentina almost 20 percent.

Lessons: Nobody believes in European recovery. China matters.

In the old days, “When the U.S. sneezes, the world catches cold.” Today, duck when China reaches for a hanky.

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World trade is a continuous conveyor connecting everyone. Low-end goods are exported from low-productivity economies to join high-end goods, often in China, to be re-exported all over hell and gone. When the conveyor jumps a drive tooth at the China station, then so does demand for emerging-nation and commodity exports. Not good for stocks anywhere, and emergings suddenly struggle to pay foreign debts.

Enjoy low inflation and this low-rate patch while they last, which may be quite a while."

The 10-year T-note, under pressure from a Fed tapering and accelerating economy, was by now supposed to have broken through 3 percent, up into a range not seen since 2011. Instead, it has fallen in each week of the New Year, on the China news now to 2.73 percent, crashing through technical “resistance.”

But there is a lot more to this move than China. Certainly a weakening world would push money to the dollar and U.S. bonds, but the 10-year has been doing better for weeks.

Sometimes a missing puzzle piece is most illustrative. Scotland Yard: “Anything else of note?” Holmes: The curious incident of the dog in the night. Scotland Yard: “The dog did nothing in the night.” Holmes: That was the curious incident.

Why has the dog not barked? You’d never know from the media happy-talkers, certain that QE was an excessive stimulant, but the 10-year move says that quieter, wiser heads are worried about our economy with the Fed pulling back. If QE was good for the economy, its absence is not.

Then, the overall economy aside, too hard to predict in an unprecedented cycle becoming an era, the big deal for long-term rates always is inflation. And it’s still trending down, core measures in the 1-1.5 percent range.

In the modern era, the yield on a 10-year T-note tends to be a little less than 1.5 percent over inflation. Voila: The 10-year under 3 percent is not crazy — not unless you think either the Fed will be raising its overnight rate soon, or you believe that inflation is soon to rise.

Two groups think inflation will rise soon.

One is the crowd eager to refight granddaddy’s war. The 1970s will be back any day! Put the gold bugs, the currency debasers, and money printers in this bunch. We have nothing to fear from them; they get a lot of ink but don’t move markets.

The second group is worth study: the Fed. The Fed has insisted for a year that inflation will rise back to its 2 percent target. Delayed, perhaps, and contained, but will rise.

The downward pressure on inflation is real, but true deflation is not likely, and required to spook the Fed to new easing. The fracking boom is big, especially in oil, but natural gas really can’t fall below three bucks, too low for drilling.

At that level a huge benefit to American commerce, but not a global-price undercutter. Oil could drop, but a fall in its price is more stimulative than deflationary, low gasoline prices a booster.

Wages feel deflationary pressure, especially in the West and the emerging world. But they are not likely to go negative, just not rise much. One odd upward push on inflation: rents — depending on the measure, as much as 30 percent of inflation indices.

So, enjoy low inflation and this low-rate patch while they last, which may be quite a while. Not too hot, not too cold. One eye on China.

Lou Barnes is a mortgage broker based in Boulder, Colo. He can be reached at lbarnes@pmglending.com.

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