Friday, May 22, 2009 Green Shoots and Glimmers of Hope Vesrsus Jobless Recovery As we have recently observed, the 30 year treasury is showing a strong “pattern” correlation to crude oil with a six month lag. The implication is that the 30 year will take out its June 2007 year lows at 11214 as the “great unwind” from the Dec 08 high continues. However, I think the crash pattern will deviate and not be as deep.. In the short run, only the June 2008 year lows at 11214 are at risk.
One of the primary reasons for the “crash” in the treasury market is simple: the US govt is selling $3.25 trillion of debt in FY 2009 ending Sept 30, according to Goldman Sachs. Cumberland Advisors David Kotok observed that “we need to be prepared for what is going to be an onslaught of Federal Debt.” Next week the Govt plans to issue $162 in new treasury debt. They are issuing so much debt that their AAA credit rating is at risk of a downgrade, which would make servicing the 1
debt all that much more expensive. Ten year yields are being push upwards of 3.50 and higher to reflect this growing risk. The government deficit spending is projected to be 12.9% of GDP this year. Geithner told Bloomberg today that it is important that Congress “put in place policies that will bring [the deficit] down to a sustainable level over the medium term.” Good luck with that Tim. A less considered reason, but every bit as valid is the “green shoots, and glimmers of hope” policymakers keep pointing to as they discuss the second derivatives in the economic data that things are “less bad.” Big whoop, right? But, this does allow us to compare the crash in the treasury market since the March 18 FOMC meeting with the crash in the treasuries following the manufacturing recovery in June 2003. Two Great Deflation Unwinds Long-time market participants will recall Greenspan mentioned the remote chance of Deflation in May 2003. This put an incredibly strong bid into the treasury market for several weeks. By midJune, most market participants were long the bond market to hedge against deflationary risks. Then there was the surprise uptick in the NY Empire Survey on June 16 2003 indicating an economic recovery was at hand. Deflation can’t co-exist alongside a recovery very well, so everyone that was caught long the 30 year had to get out of their deflation hedges. That was the first “Great Deflation Unwind.” Fast forward to today, and we have another “Great Deflation Unwind that got underway in December 2008. In the weeks prior to the Dec 2008 peak in the treasury market Bernanke said he would begin quantitatively easing and buy treasuries. Market participants rushed into treasuries to hedge against the day the Fed would begin buying treasuries. In March 2009, when Bernanke announced that the Fed would begin buying treasuries the following week, market participants caught short that day had to cover their shorts in the event that the Fed buyback program would be sufficient to keep up with the $3.25 trillion increase in Treasury supply in FY 2009. Of course it was absurd to think the Fed buyback could possibly keep up with that kind of supply, so after that one day spike the “great deflation unwind” resumed. Now, what is striking about March 2009 was that Bernanke thought he saw evidence of “green shoots” in the economic data and mentioned as much in a TV interview on March 15. Days later, after talking to Bernanke, Obama said he saw “glimmers of hope.” Because green shoots and glimmers of hope hint at a possible economic recovery, (whether this too becomes another false reassurance is besides the point) we can compare market participants reaction to Bernanke’s green shoots to their reaction to the jobless recovery in the summer of 2003. The 30 year got whacked 20.5 points in roughly two months. The unwind of the deflation hedge was a bloodbath. A similar bloodbath would project the 30 year to the 111 handle, just below the June 2008 year low. But when the trade was unwound two short months later, market participants looked around and asked themselves a very good question, if the economy was recovering, then where are the jobs? The prominent feature of the 2003 economic recovery was that it was “jobless.” That was the first post WWII recovery that was “jobless.” According to the BLS figures, jobs didn’t begin to be created until the April 2004 jobs report. When this great deflation hedge unwinds, market participants are apt to ask themselves another poignant question. If there are glimmers of hope and green shoots, then where are the jobs, man? 2
When they finally ask that question and quit freaking out about govt deficits and fiscal spending, market participants will refocus on one fact: how god-awful the economy is and how ineffective are the govt policies aimed at stimulating the economy. That is when the 30 year will walk back up to at least the 124 and likely challenge the March 2009 high in the 133 handle. Please note the price model off the March 2009 high targeting the 111 handle coincides quite well with the great unwinds in Sept 1993 and Oct 1998. Those two unwinds caused the 30 year to plunge slightly more than 20%. A similar plunge targets the 112 handle by 1H 2010. Something tells me we could get there much sooner than 2010.