BarnacleBob
05-15-2003, 10:39 PM
Dare we say that one of the world's biggest securities markets has got it all wrong? Futures on the 30-year T-bond impaled a hidden-pivot target yesterday that we first proffered here quite some time ago. The target, 118.09, was far more bullish than we could have explained when we first advertised it months ago; nor can we explain it now. The prediction was based on purely technical factors, and we made no attempt to rationalize it based on our understanding, such as it is, of how the world works. The fact that the bonds have obliged us with a rally that few expected, and even fewer can comprehend, is rendered even more puzzling since, like most of you, we are always hoping for rates to come down so that we can refinance our mortgage at some absurdly lower rate. Did anyone actually believe, when mortgages were bottoming at 5.50% a while back, that they might go still lower, triggering off yet another massive wave of refi's? (Actually, our expert's expert, Howard Hill, did, but he was alone as far as we can recall.) Well, the next refi wave is still a little ways off, since ten-year Treasury paper must fall even lower to create the spreads needed to make mortgage lenders salivate. But the prospect of yet another refi boom is no longer remote, notwithstanding the anomalous fact of a very weak dollar.
But to return to the question of whether buyers of T-bonds may have gone off their rockers, we think the answer is yes, they have, and here is why. According to the Wall Street Journal, the buyers are enthused because they are no longer worried that the Fed is going to raise interest rates, even if business should pick up. To be sure, the central bank has made clear lately that it is targeting deflation, not the old dragon of inflation, with monetary policy. Any bondholder who survived the 1970s price spiral undoubtedly has come to regard inflation as the enemy, since in dollar terms it was even more devastating to capital than the 1973-74 bear market was to shareholders. But we think they are mistaken to think, as they evidently do, that inflation's theoretical opposite, deflation, will ultimately be bullish for bonds. Their error is based on a textbook understanding of deflation, implying as it does falling asset prices, a weak economy and a strengthening dollar. But as we have pointed out here many times before, it is not a textbook deflation that has quietly been gathering power for the last decade or so, but rather one that must eventually run up against the paradox of a weak -- make that, fundamentally worthless -- dollar. The textbooks say that in a deflation, cash is king. Clearly that will not be the case this time. The standard argument to the contrary holds that the Fed's unprecedented easing of the last several years must eventually result in inflation. While it is true that the world has experienced a dollar/credit blowout of unprecedented proportions, we see the amount as puny relative to the $100Tr of global debt it has come to support. We also believe this debt can only precipitate out as deflation, fulfilling the late C.V. Myers' dictum: "In the end, every penny of every debt must be paid in full -- if not by the borrower, then by the lender." With deflation inevitable but a dollar manifestly unsuited to the role of "king," it is clear that the coming deflation will not be the anything like the one our grandparents faced, and neither will U.S.-bond holders continue to enjoy it. In the meantime, if there is a bond that we are comfortable holding, it is one that is linked to gold.
http://www.marketwise.com/MW_WiseG/BBF_Archive/20030514.htm
But to return to the question of whether buyers of T-bonds may have gone off their rockers, we think the answer is yes, they have, and here is why. According to the Wall Street Journal, the buyers are enthused because they are no longer worried that the Fed is going to raise interest rates, even if business should pick up. To be sure, the central bank has made clear lately that it is targeting deflation, not the old dragon of inflation, with monetary policy. Any bondholder who survived the 1970s price spiral undoubtedly has come to regard inflation as the enemy, since in dollar terms it was even more devastating to capital than the 1973-74 bear market was to shareholders. But we think they are mistaken to think, as they evidently do, that inflation's theoretical opposite, deflation, will ultimately be bullish for bonds. Their error is based on a textbook understanding of deflation, implying as it does falling asset prices, a weak economy and a strengthening dollar. But as we have pointed out here many times before, it is not a textbook deflation that has quietly been gathering power for the last decade or so, but rather one that must eventually run up against the paradox of a weak -- make that, fundamentally worthless -- dollar. The textbooks say that in a deflation, cash is king. Clearly that will not be the case this time. The standard argument to the contrary holds that the Fed's unprecedented easing of the last several years must eventually result in inflation. While it is true that the world has experienced a dollar/credit blowout of unprecedented proportions, we see the amount as puny relative to the $100Tr of global debt it has come to support. We also believe this debt can only precipitate out as deflation, fulfilling the late C.V. Myers' dictum: "In the end, every penny of every debt must be paid in full -- if not by the borrower, then by the lender." With deflation inevitable but a dollar manifestly unsuited to the role of "king," it is clear that the coming deflation will not be the anything like the one our grandparents faced, and neither will U.S.-bond holders continue to enjoy it. In the meantime, if there is a bond that we are comfortable holding, it is one that is linked to gold.
http://www.marketwise.com/MW_WiseG/BBF_Archive/20030514.htm