Tuesday, October 26, 2010

Not that negative – inflation linked

US Treasury sells negative-rate bonds

'The abnormal state of the credit markets came into focus as the US Treasury sold bonds with negative interest rates for the first time and Goldman Sachs prepared to issue its first 50-year debt deal. Both developments on Monday highlighted the difficult choices facing investors at a time when interest rates are at historical lows and the Federal Reserve is moving towards more asset purchases aimed at boosting the economy and staving off deflation. Investors who believe the Fed will succeed in its efforts – which would lead to higher inflation – accepted a yield of minus 0.55 per cent on $10bn of Treasury Inflation Protected Securities – or Tips – which compensate holders if the consumer price index rises.'

Posted by hpwatcher @ 07:57 AM (1861 views)
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13 thoughts on “Not that negative – inflation linked

  • All part of the insanity of having interest rates too low….

    At the same time, retail investors looking for higher yields in the current low interest-rate environment were targeted by Goldman, which prepared to sell $250m of 50-year bonds that are expected to pay interest of up to 6.25 per cent.

    “The Fed has been sending the message that its cheque book is ready and it will do what it takes to reflate the economy,” said Jan Loeys, head of global asset allocation at JPMorgan Chase. “What no one knows is whether inflation will start to show in two weeks or two years.”

    Mr Loeys added: “We are seeing longer-term thinking clients becoming increasingly wary of bonds and hedging against inflation. Shorter-term thinkers are still willing to still buy bonds, on the presumption that they are nimble enough to get out when inflation comes to push yields up.”

    Long-term institutional buyers purchased 39 per cent of the $10bn Tips sale, up from an average share of 30 per cent for the prior six Tips sales.

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  • I have stayed away from the inflation/deflation argument but maybe an explanation of TIPS is in order. It’s a very important market. There is a high profile battle that is currently raging being fought between inflationists and deflationists. It is being fought on two fronts. The first front is being fought on the blog sphere and the second front is being fought by the propaganda machine of the Western policy makers and in the other corner, the TIPS market (Treasury Inflation-Protected Securities).

    I think that it is fair to say that the policy makers have well and truly earned our distrust, so we should at least suspect them of having a hidden agenda or maybe just being misguided. The TIPS market on the other hand has no hidden agenda and a pretty good track record.

    Yield spreads in the TIPS market are complicated and a little opaque to newcomers. However for the purposes of simplification, positive TIPS breakevens predict deflation and negative TIPS breakevens predict inflation. There was a very brief spell in late 2008 when deflation was forecast with a range of “negative TIPS breakevens”. However the TIPS market moved on from that tumultuous period and the resounding message is that inflation is forecast (positive TIPS breakevens). Governments and economists often have complicated agendas. Governments are swayed by political imperatives or by poorly chosen advisors and economists are easily swayed by a pay packet or by a desire to be famous. To be fair to governments, they tend to have a short time in power and they are therefore forced into short-termism. This is why they enact policies that are harmful in the long run but might get them re elected in the short term. The TIPS market, on the other hand is only influenced by hard-nosed, experienced participants who put large amounts of their money at stake. Political imperatives and short-termism are always trumped by the desire to protect the contents of ones wallet

    There is an irony to the creation of the TIPS market. It was introduced in 1997 by the U.S. Treasury. It was intended to (and does to some extent) offer real protection from inflation. Treasury notes are far more of a gamble. They thought that forecasters would subtract the real yield on TIPS from the nominal yield of Treasury notes of the same maturity to give them a market-based measure of expected inflation. Unsurprisingly the intended way of calculating the expected inflation, usually gives us a result that is less than the actual expected inflation (If we believe that there will be less inflation, we are less likely to balk at stimulus policies and govt spending). It didn’t take TIPS participants long to devise an alternative method of calculation that used real yields on both rather than nominal yields on treasury notes and real yields on TIPS. The reason for this method change would take too long to explain. Suffice it to say that much to the chagrin of the US Treasury, it has proven to be pretty accurate. It must be galling to state that you are fighting deflation, while the instrument you created is predicting inflation.

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  • I’m beginning to think that some players in the bond market are moving away from the consideration of yields toward speculation on the capital value of the paper – if true, this can only last a short while, before the reverse kicks in..

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  • Having given a technical description of TIPS, I have to also say that anyone who predicts deflation in the short/medium term is barking up the wrong tree. I am very well aware of all the money supply and destruction of capacity/credit/asset arguments. In my opinion, these arguments are well and truely made redundant by the recent addition of 2.5 billion people to the world economic base. In the old days we could more or less add up the quite stable number of white faces and work out future demand and supply. Now we have billions of new people who all want a share of the world resources. I have no doubt that supply will one day catch up with demand but in the meantime resources are strained and that means inflation. Sometimes we really don’t need charts and theories to tell us what’s staring us in the face

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  • uncle tom: Most bond buying is done on an actuarial basis. The speculative element is relatively small

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  • I’m reminded of all the puzzlement over the low bond yields of a few years ago when we weresaid to be in a ‘goldilocks’ economy, yet yields were predicting recession. Well the bond market was proved right. It seems that this market at least should be taken seriously as a portent of the future. It’s interesting that (trader) people collectively are better at predictions than individuals, no matter what their expertise.

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  • I have to also say that anyone who predicts deflation in the short/medium term is barking up the wrong tree

    the recent addition of 2.5 billion people to the world economic base

    Some good points. Although, won’t the continued increase to the economic base mean more even more people, and fewer and fewer resources – so the cost will increase?
    More and more people chasing less and less assets – of all kinds, not just housing. An interesting statistic I read a while ago was that for everybody in the work to enjoy the same standard of living as the people in the UK, we need another 4 Earth’s. For the US standard of living we need another 6 earths.

    Yes, flash

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  • general congreve says:

    Bond bubble?

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  • 2. flashman

    Let me simplify things for you, the price of oil will double within a year.

    Another cliche? We shall see flashy.

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  • Interesting discussion.

    What about the tail leading the dog and global macro market trending? U.S. leading innovatopn through the industrial revolution. Spreading to Europe, namely for a short time in the early 70’s Germany was the economic leader, then Japan in the late 70s and early 80s. Japan was the model. Remember Kuretzu (sp?). Then financial statement and accounting shenanigans in Japan followed by a decade plus of hyper low rates and deflation. I remember expert economists in 1994 telling my graduate finance class how the corruption in Japan could NOT happen in the U.S. because of the conservative nature of GAAP. Here comes Madoff, unlimited income practices, fraud at the highest levels of corporate power, ala AIG, Lehman, hedge funds, and more.

    Back to the tail wagging the dog. Japan 10 plus years of zero-esque rates. Here comes the U.S. compounded by a world crisis of confidence because U.S. is/was the leading economic power. Now, here’s the kicker. Why is gold breaking new highs w no inflation in site? Because the world exchange rate is contracting as the credit system is imploding. So gold vs all currencies is appreciating. This is because the credit system is breaking.

    Technology is exploding to the upside in the form of the innovation industry, angel and vc money can’t get enought. This is technology’s natural course of action to remedy a broken system with new design, new product, and ultimately a new, more transparent credit system. I’m political system is broken also, so they can’t fix it. It will happen through technology, no doubt, but will take years. And until this bew credit system is created, I can’t see the cost of money (rates) reaching a normalized level.

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  • nickb asked me how I reconcile the deflation being experienced in places like Japan with my ‘inflation’ post (or I think he did). There are all sorts of social, economic and arbitrage trends that can impact individual countries like Japan. In their case, they had an almighty multi-decade economic boom and it looked like they would, economically speaking, take over the world. They of course didn’t take over the world and their brand of deflation is the consequence of the demise of this world dominance expectation. However, the commodities market doesn’t care about their unique ‘deflation’ situation. Japanese factories and builders pay exactly the same amount in Dollars for copper as everyone else (notwithstanding the effects of currency fluctuation). Ultimately, the price of soft and hard commodities is the master decider of inflation/deflation levels and no matter what the local economic situation, there is no escaping the underlying trend (the current high valuation of their currency will of course mask inflationary commodity price rises for as while longer). If you’ve done regular business in Tokyo, you’d wonder at the supposed deflation because a cup of coffee or a taxi ride seems to cost more every year. Once Japan has worked through the collapse in price of several asset types (caused by the demise of the world dominance expectation), they will be buffeted by the same commodity price swings as everyone else. In a more humble way, Ireland is experiencing the same thing, in that they experienced an unsustainable, over-stoked boom and now assets prices and the size of the economy are falling. However their overall price indexes will eventually succumb to the master influence of commodity prices.

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  • This is a very interesting discussion. Flashman, I’d value your opinions on George Soros’ recent ideas and his talk at Columbia last month.

    Namely he states that certainly government spending has gootten a bit out of control. But could you imagine what the effects would be if even hald of the run up in public spending went toward U.S. infrastructure rebuilding, ie the impact on job creation overrall GDP growth and the like? So, instead of just spending, true re-investment back into the U.S.

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  • Adriaan Koreman says:

    The New ‘Das Kapital’.

    Too many people believe that FREE MARKET ECONOMY and CAPITALISM is one and the same thing, as opposed by COMMUNISM.

    Communism is nothing more than a philosophy originating from a study of the poor living conditions of workers during the industrial revolution.

    Capitalism is nothing more than a monetary system originating from the use of gold and later deposit slips for gold as a means of exchange.

    But Free Market Economy is a natural way of bringing offer and demand in balance that already existed in the time of barter trade.

    Capitalism exploits labour to create added value …. or so Karl Marx said.

    But let’s face it ….. The only real existing value in this world is LABOUR! Nothing can be achieved without it. No raw materials can be extracted from the earth without labour …… No food can be produced …… No added value can be created….. No profits can be achieved …… Nothing! On the other hand …… CAPITAL has no real value at all. You can’t eat it. In Mugabe’s Zimbabwe, they burn CAPITAL (paper money) because it is cheaper than firewood!

    Contrary to popular believe: Money is TIME! When you earn money, you have given your time in producing something … in rendering a service of some kind … in trading something ….. or whatever ….. and received money for that! This money allows you to buy TIME from somebody else. You can buy a product that someone created with his time … a service ….. you name it. It is always TIME that you buy! Part of the time that you can buy for your money has already been transferred into products. A car waiting to be sold ….. Food in the supermarket …… Tools of some kind …… A house…. But services still to be rendered ….. products not yet created …… are still in their basic form of available TIME! So when unemployment is skyrocketing we should be so happy! There is so much TIME available! What richness! What wealth for a nation! But are we happy with high unemployment?

    TIME when it is not consumed loses it’s value. At a rate of 100 % per day. We are used to transfer the time that we are owed into CAPITAL in order to be able to transfer it back into TIME when we want to buy something or invest it. CAPITAL keeps, but TIME doesn’t!

    In order to persuade someone to invest his capital he wants interest or profit of 4 % or more or he hangs on to his capital. In order to persuade someone to invest his time in a period of unemployment you can give that person less than what he needs to survive and he will still sell you his time. Something is better than nothing!

    And that is how capitalism is able to exploit labour to create added value. By transferring time owed into CAPITAL and only buying time back when it can make a profit, allowing TIME or LABOUR to be completely lost when it is thought that no added value can be created with it. High unemployment, poverty and crises are the flaws of CAPITALISM. Not of the FREE MARKET! Without transferring the time that we are owed into CAPITAL and having to consume that time without too much delay we would still have a FREE MARKET ECONOMY, but we would not have CAPITALISM!

    So how can we have a Free Market Economy without the flaws of Capitalism?

    Barter trade? Of course not! We live in the 3rd millennium! Even though we still use a money system from the 1st or 2nd millennium! If CAPITAL or MONEY is to be a means of exchange for TIME, then it should have the same property as TIME! Meaning … it should lose value when it is not consumed within a certain period, just as TIME does! But how to achieve that?

    Nothing is easier. Let’s look at one possibility: Substitute V(alue) A(dded) T(ax), which is a punishment for transferring labour into added value, by V(alue) D(iminished) T(ax) on money in possession as long as it is not used. A negative interest Tax on money. For that we would have to change cash money into digital money in our bank account. But hey! We pay with pin, credit card, chip, cheque, internet, mobile phone ….. We are in the 3rd millennium! Substituting VAT by VDT will certainly make us all a lot richer. As TIME or LABOUR is the only real value that exists we cannot accept a monetary system like CAPITALISM that allows it to go to waste.

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