There's too many men
Too many people
And not much love to go round
Can't you see
This is the land of confusion
"Once you've followed the markets long enough, you begin to 'get the joke.'"
This quote is from a coworker of mine of about a decade ago. I've considered this off and on again throughout my career and it means different things at different times to me.
This past week I thought this quote appropriate.
During the period, Treasuries "backed up" (or, to non-bond geeks, they "rose in yield") across the curve with the 5-year leading the way to the tune of a whopping 37 basis points.
When bond markets move like this there is always a scramble to identify exactly why. Sometimes it can be obvious, like when yields begin to run just after an employment figure is released. But this time, it was less than obvious.
Thus far, I've heard three potentially credible — and conflicting — reasons.
- Tax cut extensions will lead to higher deficits, reducing the value of the dollar sooner and leading to higher inflation. This seems the least likely explanation as it is far to convoluted for bond managers. Heck, I stopped paying attention while typing!
- Tax cut extensions will spur the economy creating economic strength and the need for the Fed to raise rates sooner. This is getting the most play in the media, although I doubt this is the full story. I don't recall a lot of bond managers screaming for tax cuts as if they alone could lead the economy out of today's doldrums.
- Tax rates were a significant uncertainty which was resolved quicker than expected. Perhaps Washington can clear up some other uncertainties soon so the economy can begin to move forward.
OK, I admit I haven't actually heard #3 anywhere else, but this makes the most sense to me.
In this game we call the "economy," investors, consumers, workers and governments come together to transact. Of these players, only governments have a singular voice (OK, nearly singular) and can make sweeping changes to their own behavior almost immediately.
In the past few years we've seen massive healthcare reform (18 percent of the economy), financial regulatory reform (financial companies are necessary at every step of the economy), and the destruction of the mortgage market (mortgages drive values of homes which are the single largest asset of the consumer) with little talk of resurrection.
When it comes to future government involvement, confusion is rampant and even Fed Chairman Bernanke is not immune.
In March 2009, in an interview on "60 Minutes" this exchange occurred:
Scott Pelley: "You've been printing money?"
Bernanke: "Well, effectively, and we need to do that because our economy is very weak and inflation is very low."
Then, a week ago Sunday, Bernanke stated, "One myth that's out there is that what we're doing is printing money. We're not printing money." (By the way, there is a very entertaining clip from the Jon Stewart show on this topic.)
Writing a column each week, I understand the perils of misspeaking and certainly don't wish for anyone to compare my last 100 or so columns for inconsistencies — I'm sure they exist. But sending such mixed messages as this have become part of the norm for Washington as they tinker and adjust support programs across the board.
If, instead, we had real debate regarding how the government should interact with the economy over the long term, I believe the other players would soon find their place. Until then, we will continue to live in the "land of confusion."
Last week's market move only hardens my view on this point.
One interesting line of thinking regarding QE2 goes like this:
If you look at fund flows for public and private (hedge) funds, you'll find more investors reentering the markets in the private fund sector. It is reasonable to assume these folks have higher incomes and therefore pay taxes at a higher marginal rate.
One of the goals of QE2 is to support the stock and other risk markets, which, of course, would create more capital gains for these investors who are paying higher rates.
Could this be Bernanke's way of fighting the deficit?
The University of Michigan confidence index rose to 74.2 in the preliminary December gauge, up from 71.6 the previous month. This is a six-month high, fueled by a strong stock market and greater optimism for a better 2011.
Wholesale inventories rose more than twice as much as forecast in October as companies stocked up to meet the holiday sales. The 1.9 percent increase in inventories followed a revised 2.1 percent rise in September.
Consumer borrowing in the U.S. rose in October by $3.38 billion, after rising $1.2 billion the previous month. The increase was led by non-revolving credit, including student loans held by the federal government.
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