Deflationary Bust for Treasury Market?
By
Mike Mish Shedlock
Dec 31, 2008 8:45 am
"Irrational" long-bond curve not at all irrational.
 |
|
By ignoring housing prices, CPI massively understated inflation for years. The CPI is massively overstating inflation now.
If one substitutes the Case-Shiller Housing index for Owners' Equivalent Rent in the CPI, as in the following chart (courtesy of my friend TC):
Click to enlarge
In spite of massive cuts in the Federal Funds Rate, real interest rates are still positive by 3.1%.
Previously, when rents were in synch with home prices, it didn't matter if one used OER or actual home prices. It's a remarkably different story now. We have just seen the biggest housing bubble in history. At the peak of the insanity, home prices were 3 standard deviations above rental prices, and 3 standard deviations above wage growth.
Now, home prices are crashing, though we still have far to fall before we reach the norm. Housing can therefore be expected to be weak for quite some time.
The Treasury market seems to have figured all this out quite nicely. Those screaming "Treasury bubble" clearly have not.
In the summer of 2005, the chart shows CPI at just over 4%, with the federal funds rate just under 4%. CS-CPI, a better measure of the CPI, was near a whopping 8%.
Notes from TC
1. The relative importance of OER has changed over time - it was 19.10 in 1987, and is now 23.942. I've included the yearly weight within the data.
2. The Case-Shiller 20-City Composites represent sales from several months previous; wthe CPI reflects the previous month.
3. I've modified the CS-CPI to reflect the 20-City Case-Shiller Index vs. the national Case-Shiller Index used in last month's chart. The quarterly national index lags by far too much.
4. For November 2008, the CS-CPI was a whopping negative 3.1% year-over,year, as compared to a positive 1.7% for CPI-U.
5. The divergence between the 2 CPIs is increasing, as the government OER data continues to move higher.
In fact, since the housing market's peak in July 2006, the 20-City Case-Shiller Index has declined over 24%, while the government's OER has increased nearly 7%. Deflation is clearly here, and the Treasury market is responding to it. You just need to know where to look.
No positions in stocks mentioned.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2010 Minyanville Media, Inc. All Rights Reserved.
Copyright 2010 Minyanville Media, Inc. All Rights Reserved.
(5)
Reply
2008-12-31 09:49:37
Maybe I'm not thinking about this clearly, but it seems like if the government is so hell bent on an inflationary policy (it is), then the government should be focused on making the CPI calculations as accurate as possible. Housing is a monthly cost that's priced in either a mortgage (plus condo or coop maintenance costs if applicable, plus property taxes) or rent. This is how a renter evaluates a home purchase. While an individual home owner's cpi might be flat for some time after a home purcahse, a broad survey would pick up the growth or decline in these costs on an aggregate basis. Is the government unable to calculate a more accurate weighted presentation of these costs and their growth? Because if someone really believes that an inflationary policy can work, then it presumably is critical that it can be accurately measured and controlled in the hypothetical target range. Because using a measure like OER, which smooths things out over cycles (to the point where it hides housing bubbles to the point where they barely register in the boom or the bust as you've demonstrated), works against the inflationist's own agenda by letting "real" inflation potentially get too far out of control. For the record, I think an inflationary policy is pure folly, but I just don't get the practical (as opposed to the theoretical) usage of the OER metric in the first place.
2008-12-31 09:50:12
Bond Market Bubble
The characteristic of a bubble is that it is perfectly rational when it happens. Oil went to $150 with predictions of $250 because the world would consume more than it would produce. Housing soared because prices would keep going up. Tech stocks went up b/c the Internet was changing our lives etc. Now bond prices are soaring b/c we're in deflation. It's hubris. Bonds soared b/c the Fed said they would buy bonds to forcibly push yields down so mortgages would become cheaper. Does anybody really believe that over 30 years with the kind of money flooding the system we won't see significantly higher prices than today? If you want a good indicator of inflation expectations, watch gold, not bonds. Bonds are mispriced b/c of government intervention. But this will pop too, some day. And as history has shown in the recent previous three bubbles, when it pops, it's fast and furious.
2008-12-31 09:54:59
Excellent Article
Great conclusion - let the market set the rates.
I am betting that will be the last thing the government considers. B-52s loaded with greenbacks will dump megatons in the attempt to re-inflate.
MY guess is that the govt mandated low rates as well as oil exporting countries liquidating dollar-denominated assests (while not having the means or desire to buy more US debt) will add to the B-52 supply and create another bout of stagflation.
I am betting that will be the last thing the government considers. B-52s loaded with greenbacks will dump megatons in the attempt to re-inflate.
MY guess is that the govt mandated low rates as well as oil exporting countries liquidating dollar-denominated assests (while not having the means or desire to buy more US debt) will add to the B-52 supply and create another bout of stagflation.
2008-12-31 15:09:29
Inflation or Deflation
John,
The government has no intention of correctly measuring inflation and hasn't since the late 70's and early 80's. In fact, most economic numbers have become political footballs, manipulated to justify government policy.
Spend some time at www.shadowstats.com and see how this has been done. CPI is no longer a comparison of inflation from one decade to another. Neither is unemplyment or GDP for that matter.
For example, let's say you're replacing your 2003 GM sedan. The new 2009 sedan comes standard with side air bags, anti lock brakes, cruise control and so on, all things that were either not available in 2003 or you paid extra for.
Based upon the changed calculation methods for CPI, the government might just calculate that because you are receiving more "value" from these extra standard items, even thou you are paying 20% more for the car, they will put it down as a decrease in price.
If you really wish to understand what's happening, stop accepting the goverments' numbers as truth. Then the world will begin to make some sense.
The government has no intention of correctly measuring inflation and hasn't since the late 70's and early 80's. In fact, most economic numbers have become political footballs, manipulated to justify government policy.
Spend some time at www.shadowstats.com and see how this has been done. CPI is no longer a comparison of inflation from one decade to another. Neither is unemplyment or GDP for that matter.
For example, let's say you're replacing your 2003 GM sedan. The new 2009 sedan comes standard with side air bags, anti lock brakes, cruise control and so on, all things that were either not available in 2003 or you paid extra for.
Based upon the changed calculation methods for CPI, the government might just calculate that because you are receiving more "value" from these extra standard items, even thou you are paying 20% more for the car, they will put it down as a decrease in price.
If you really wish to understand what's happening, stop accepting the goverments' numbers as truth. Then the world will begin to make some sense.
2009-11-25 20:37:04
People all over the world know the abercrombie and fitch,but not everyone really knows how fashion the abercrombie is,hollister is the Legend maker. Everybody wears the hollister clothing would be the abercrombie mensand the abercrombie womens, if you want know you can search the Ruehl No.925 or abercrombie outlet in the www.google.com .
Get real-time options trading ideas from Steve Smith, veteran options trader and newsletter author, plus let him show you the way to cut risk and boost your returns through the strategic use of options. Click here for a free 14 day trial to OptionSmith by Steve Smith.
Copyright 2010 Minyanville Media, Inc. All Rights Reserved
