If there was one surprising reaction in the financial markets this week, it was the poor performance of US Treasuries.
The asset class clearly primed to benefit most from the terrorist attack on the World Trade Center and the ensuing disruption of economic activity, already on the slide when two hijacked planes slammed into the twin towers, was safe-haven Treasuries.
By the time the Federal Reserve ratified investors' expectations, lowering its benchmark lending rate by 50 basis points to a seven-and-a-half year low of 3 percent before the stock market opened on Monday, Treasury prices had nowhere to go but down. With the Dow Jones Industrial Average registering its biggest one-day plunge ever Monday of 722 points, it was hard to understand how yields on super-safe two-year notes could rise. Bond yields are up 20 basis points since last Friday.
Lots of reasons were bandied about for the market's lousy response this week. Traders absorbed the implications of the week and boiled it down to one conclusion: Bye-bye surplus.
Until Bob Rubin came to Washington in 1993, economists were of one mind on the correlation between the federal deficit and interest rates: there was none.
Historically it was the performance of the economy that determined the level of interest rates, not the other way around.
When the economy was weak or in recession, tax receipts fell and entitlement spending rose, so the deficit widened. With the Fed easing, it was a pretty sure bet that interest rates -- short and long -- would be falling.
That paradigm went out the window with Trader Bob, who put the cart (shrinking deficit) before the horse (faster economic growth). It was a good excuse for a tax increase; it was bad economic theory. If lowering long rates was the key to financial health, then Japan, with its sub-2 percent 10-year yields for the last four years, would be a powerhouse instead of the stumbling, bumbling economy that it is.
Before you write to tell me Rubin was right and the economy soared as a result of the fiscal austerity exercised during the Clinton years, recall that the presumed conduit for the boom -- long-term rates -- rose almost 200 basis points from the fall of 1993, when the Clinton deficit reduction plan was passed, to November 1994, when the Republicans gained control of both houses of Congress, Contract With America in hand.
Long rates peaked on Election Day in 1994, which is probably no coincidence. Revisionist history holds that it was the deficit reduction that created the economic boom, when the causality goes the other way.
I argued adamantly in early 2000, when the Treasury embarked on its buyback operations, that the economy, not the size of the debt, would determine the direction of interest rates. I was dead wrong.
At the risk of being wrong again, I'd argue that if the economy is going down for the count, long rates will follow short rates even as the surplus shrinks. (Full disclosure: I'd like long rates to fall so I can refinance my mortgage.) What matters -- what should matter -- is why the surplus is changing, not the change itself.
After all, "private credit demands dwarf public credit demands," says Jim Glassman, senior economist at J.P. Morgan Chase. Which is why interest rates fall in recession even though the government is borrowing more.
On the monetary side, the Fed is flooding the system with bank reserves, sending the funds rate down close to zero Tuesday. In fact, Tuesday's effective funds of 1.25 percent was the lowest since December 1965, according to Corey Redfield, chief fixed-income strategist at US Bancorp Piper Jaffray in Minneapolis.
"Economic policy makers all see the risks as one-sided," says Henry Willmore, senior US economist at Barclays Capital Group. "They are willing to make only one kind of policy mistake, which is being too accommodative." After stumbling on Monday and Tuesday, Treasury note yields resumed their slide Wednesday as bonds continued to struggle.
"The 30-year bond had a premium based on the idea that it was going to be a museum piece," says Paul DeRosa, a partner at Mt. Lucas Management Co. "People have reconsidered that idea." The Treasury reconsidered as well, canceling its September buyback operation. The buybacks are to resume in October.
There's no question the combination of falling tax receipts and rising expenditures -- Congress already approved US$40 million in emergency spending, with a fiscal stimulus package being considered -- has implications for Treasury finance and the federal budget, according to Ward McCarthy, economist and managing director at Stone & McCarthy Research Associates in Princeton, New Jersey.
Looking at the calendar of maturing coupon issues in 2002, if Treasury left its current auction schedule in place "it would pay down US$125 billion next year," McCarthy says.
That compares with the most recent Congressional Budget Office forecast of a US$176 billion surplus next year.
It's conceivable that a weaker economy, emergency spending and a fiscal stimulus package could conspire to eat up the entire 2002 projected surplus. Even if it does, the rise in bond yields as a result of the "supply" story doesn't make sense.
I heard an economist on TV Tuesday bemoaning the stickiness in long rates. If long rates don't fall, he said, there isn't much the Fed can do to stimulate the economy.
Maybe this dismal scientist would feel better if long rates fell spontaneously, tumbling below short rates. Such an inversion of the yield curve would suggest the demand for credit is falling faster than the Fed can increase the supply -- hardly a harbinger of strong economic growth. Be careful what you wish for.
The government is aiming to recruit 1,096 foreign English teachers and teaching assistants this year, the Ministry of Education said yesterday. The foreign teachers would work closely with elementary and junior-high instructors to create and teach courses, ministry official Tsai Yi-ching (蔡宜靜) said. Together, they would create an immersive language environment, helping to motivate students while enhancing the skills of local teachers, she said. The ministry has since 2021 been recruiting foreign teachers through the Taiwan Foreign English Teacher Program, which offers placement, salary, housing and other benefits to eligible foreign teachers. Two centers serving northern and southern Taiwan assist in recruiting and training
WIDE NET: Health officials said they are considering all possibilities, such as bongkrekic acid, while the city mayor said they have not ruled out the possibility of a malicious act of poisoning Two people who dined at a restaurant in Taipei’s Far Eastern Department Store Xinyi A13 last week have died, while four are in intensive care, the Taipei Department of Health said yesterday. All of the outlets of Malaysian vegetarian restaurant franchise Polam Kopitiam have been ordered to close pending an investigation after 11 people became ill due to suspected food poisoning, city officials told a news conference in Taipei. The first fatality, a 39-year-old man who ate at the restaurant on Friday last week, died of kidney failure two days later at the city’s Mackay Memorial Hospital. A 66-year-old man who dined
EYE ON STRAIT: The US spending bill ‘doubles security cooperation funding for Taiwan,’ while also seeking to counter the influence of China US President Joe Biden on Saturday signed into law a US$1.2 trillion spending package that includes US$300 million in foreign military financing to Taiwan, as well as funding for Taipei-Washington cooperative projects. The US Congress early on Saturday overwhelmingly passed the Further Consolidated Appropriations Act 2024 to avoid a partial shutdown and fund the government through September for a fiscal year that began six months ago. Under the package, the Defense Appropriations Act would provide a US$27 billion increase from the previous fiscal year to fund “critical national defense efforts, including countering the PRC [People’s Republic of China],” according to a summary
‘CARRIER KILLERS’: The Tuo Chiang-class corvettes’ stealth capability means they have a radar cross-section as small as the size of a fishing boat, an analyst said President Tsai Ing-wen (蔡英文) yesterday presided over a ceremony at Yilan County’s Suao Harbor (蘇澳港), where the navy took delivery of two indigenous Tuo Chiang-class corvettes. The corvettes, An Chiang (安江) and Wan Chiang (萬江), along with the introduction of the coast guard’s third and fourth 4,000-tonne cutters earlier this month, are a testament to Taiwan’s shipbuilding capability and signify the nation’s resolve to defend democracy and freedom, Tsai said. The vessels are also the last two of six Tuo Chiang-class corvettes ordered from Lungteh Shipbuilding Co (龍德造船) by the navy, Tsai said. The first Tuo Chiang-class vessel delivered was Ta Chiang (塔江)