Minutes for the latest Federal Open Market Committee (FOMC) meeting were released yesterday afternoon sending the stock market down and Treasury yields up largely due to the hawkish tone of the release. Committee participants noted stronger signs in labor markets and improvements to output as lacking necessity for further easing. Outspoken hawks, President Lacker being the only one, stated that the current degree of policy accommodation beyond this year would be “inappropriate.”
Yet despite the meeting’s tone, members’ hawkish comments and the securities markets’ reactions, we will most certainly be seeing continued accommodation and likely further easing before the year’s end.
Why?
The following two charts:
The first is a 5-year chart of Treasury Bonds:
The second is a 25-year chart of commodities prices:
Selling in long-dated Treasuries has pushed yields up to uncomfortable levels. Despite Bernanke purchasing more than $40 billion per month under Operation Twist, yields on the 30-year Treasury Bond have gone from 2.7 percent when Bernanke first commenced the unprecedented buying program to just over 3.4 percent in yesterday’s trade. They are expected to go much higher. As selling pressure persists, the Fed will likely purchase more to offset the rise in yields that has been persistent since last October either through extending Operation Twist or by announcing another round of bond purchases.
The one thing that would stop the Fed from such a move is inflation pressures. This is where the second chart comes into play.
Bernanke has remained consistent pointing to a slack labor market keeping wages down and so holding off inflation. Recently he has also been pointing to declines in commodity prices (highlighted) as a sign that the initial rise in commodity prices was indeed transitory as he predicted throughout its rise.
The combination of dangerously high Treasury yields (yes, when the Federal Debt is nearing $16 trillion, even 4.5 percent on a 30-year is unmanageable), a slack labor market, and “declining” commodity prices is reason enough to continue debasing our currency.
But take a look at the charts again. Much of the weakness in commodities, or rather the slight pullback in prices, can be attributed to lower demand from the Eurozone. Similarly, some of the money pumped into Treasuries over the last nine months has come from sales of Euro area debt and other Euro securities. Recent trends point to this continuing.
Despite nearly $1.5 trillion in loans from the European Central Bank (ECB) pumped into banks and institutions since December and more than $100 billion of additional direct purchases of sovereign debt over the year, European periphery debt is still pricing in downside risk. The ECB’s efforts have attracted significant interest from domestic buyers, but institutions abroad in the US and elsewhere have not participated, and many have sold into the backstopped Euro buyers. Without further accommodation from the ECB, bond auctions in Spain, Italy, and Portugal will continue to disappoint and push up yields (as can be seen following today’s Spanish auction). Couple this with negative growth over all of 2012 and most of 2013 in the Euro periphery, as projected by the IMF (more severe projections by most economists), and one has to conclude that commodity pressures will continue to ease.
That gives Bernanke the green light.
Unless US employers start kicking up wages, inflation will be kept in check. This is regardless of the trillions printed by the Fed and the trillions more in the pipeline. Wage increases won’t broadly occur until unemployment hits closer to 6 percent, and that isn’t in the cards for……..? So, as long as the current US and Euro picture persist, Bernanke will soon once again hit the gas. Both the Fed and the Treasury can ill-afford any rise in Treasury yields.
And they are rising.
Banks and institutional investors are exiting long-dated Treasuries in droves. Yields on the 30-year and 10-year Ts are 3.4 percent and 2.3 percent respectively. That is up from 2.7 percent and 1.7 percent last fall. European buyers are parking funds that would otherwise be allocated to Ts into German Bunds which have decoupled from US Ts following the massive injection from the ECB. German 30-year and 10-year paper trades at 2.5 percent and 1.8 percent respectively. This is a significant spread from Ts, which before the ECB easing used to trade with similar yields.
Bernanke knows that without buyers from European institutions, and with domestic institutional selling, current Treasury yields cannot be supported. The Eurozone weakness and the US slack labor market is a godsend to further accommodation.
Signaling aside, the Fed is not finished. They won’t be until either Congress forces their hand, or for some reason American employers decide to bump wages and share the wealth. At present, a larger percentage of corporate earnings are going towards profits than to wages than at any other period since 1947. That may help shareholders, and the wealthy, but it is short-term and does not improve the economy as a whole. Expect more easing, expect more wealth divide, and expect more central bank control of the “free market.”