when I look at the sub-zero 5-Year TIP and at the 0.6%/year 6-10 Year TIP I read that as Ms Market decoupling its inflation expectations from its real growth and real interest rate expectations, and not in a good way.
Read the whole thing. Pointer from Mark Thoma. My thoughts:
1. To me, the biggest macroeconomic/financial mystery today is the low ten-year real interest rate.
2. Ten years ago, the biggest macroeconomic/financial mystery to me was the low ten-year real interest rate. That, combined with loose mortgage credit standards, fed a housing bubble.
3, Why aren’t corporations borrowing like crazy? Issuing long-term bonds to buy back stock would seem akin to owning a money-printing press. (And yes, this is an argument that stocks are not overvalued.)
4. One possible story is that savers in China and Russia do not trust their domestic financial markets, so that their savings are pouring into the U.S., and from here spilling over to western Europe. But that would presumably make it expensive for Chinese and Russian borrowers. Is that the case?
I keep hearing that inflation is running super-hot in Venezuela and Argentina and black-market exchange rates are increasingly diverging from the official rate. But bond rates in those countries seem far too low in light of those claims. It’s also a mystery.
Point 3 is not directly an argument that stocks are undervalued. The issuer of equities is not literally repurchasing shares for investment. Investor expectations, rather than inventory, limits such use of stock. The logic of repurchase is simply the logic of payouts.
Number 3: It seems to me that this could well be an argument that stocks ARE overvalued. Could you please explain?
A preceded me by a split second. I think he also misunderstood the argument, Arnold is not taking about issueing equity but emitting long term debt.
I got the argument, but did not clearly link my response to Point 3. Issuing debt to return capital to shareholders does not directly express a belief in undervalued stocks. Looking at the differences between equity issuers and stockholders is just another method of showing the similarities between paying dividends and repurchasing stock. It’s simply a payout, which is ambiguous with respect to bullishness. One would not say that the purchasers of debt are expressing a bearish view on stocks.
Handle: THAT is not a mystery at all. Argentina is in default and sorrily misgoverned. There are chances it will default also in the future. The same with Venezuela.
Increasing inflation and default probabilities should raise bond rates, right? But google the rates and you’ll see they are still quite low. That’s the mystery.
Agreed
Regarding #2:
I also thought it was a big mystery why the 10 year real interest rate was so low 10 years ago. It turned out the market was smarter than we were.
Most people who bought bonds at those rates turned out to be glad they did. Maybe the same will turn out to be true of today’s rates.
#1 and #2:
One of the few views that I struggle with on this site is the idea that policy rates are unimportant. Policy rates determine the liability side of the carry trade (for commercial banks most obviously because bank deposit rates follow Fed Funds but also for dealers and countless other punters who get funding in the shadow markets or via derivatives). This seems relevant to #1 and #2 for three reasons:
1) When the Fed reduces funding costs on carry trades to a pittance, this increases demand for all higher-yielding securities including 10-year Treasuries. (As it did 10 years ago and today, perhaps helping to explain #1).
2) But because yields on other securities don’t fall 1-for-1 with policy rates, ZIRP (or near-ZIRP) also provide carry traders with a bigger margin for error, which encourages lower lending standards (the second piece of your #2).
3) By turning a blind eye to the amount of debt in the economy (as measured by, say, debt-to-productive assets) the Fed also allows the economy to become more sensitive to interest rates. Greater sensitivity to interest rates means that the “natural” interest rate (in most of the many ways this can be defined) should be lower. IMO, this may be the best explanation for #1 – rising debt and falling interest rates are two sides of the same coin.
Low real long term interest rates raise home prices, not because of the effect on mortgages, but because they make the nominal value of homes higher. Convexity in the relationship means that when long term real rates get very low, the upward pressure on home prices becomes even sharper. This is why, for the most part, it wasn’t a bubble, why homes in many countries remain at those levels, and why home prices have begun to rise again without any growth in real estate credit from the banks.
Partly because of the tax treatment of interest vs. profit, I argue that low interest rates actually lead to corporate deleveraging. Here are a couple of posts on the idea:
http://idiosyncraticwhisk.blogspot.com/2014/06/risk-valuations-part-2-low-interest.html
http://idiosyncraticwhisk.blogspot.com/2014/06/risk-valuations-part-3-low-interest.html
“I read that as Ms Market decoupling its inflation expectations from its real growth and real interest rate expectations, and not in a good way.”
I read the article, and I read it as an accidental slam of Market Monetarists (read: Scott Sumner). Not just because of that line, but because of the sheer bewilderment he has trying to understand what the bond market is saying. And yet MM is constantly asserting that the expectations the at control this are real and manipulable, and the results of those manipulations clear, observable, and decipherable, particularly in the bond markets and TIPS spreads.
I have serious doubts on the first part of that, but this was a pretty conclusive (if accidental) refutation about how clear and decipherable it is.