Lou Barnes investors financial weekly columnBond and mortgage yields have frozen. The 10-year Treasury note in the last three months traded in a slushy harbor 2.60%-2.80%, but you could skate on this week’s 2.58%-2.63%. When a glacier like this breaks up, expect the shattering onset of true up-down volatility and change in trend.

No, I don’t know which way. Harry Truman growled his wish for a one-armed economist. No more on-the-other-hand! Apologies: both of mine are still attached.

Long term rates move with inflation which moves with economic activity. U.S. rates respond to domestic forces, but a globalizing economy applies pressures we’re not used to. I am a U.S. skeptic, and I have company. Janet Yellen: “A high degree of monetary accommodation remains warranted.” She sees faster growth later this year, and inflation rising toward the Fed’s 2% target. However, her predecessor had the same foresight, as had every Pollyanna on Wall Street, and failed for four straight years.

Chair Yellen’s vision of risks this week began with “adverse developments abroad… geopolitical tensions… or intensification of financial stresses,” and then “Flattening out in housing activity could be more protracted than currently expected.”

If the U.S. economy does not accelerate, interest rates are poised to come down.

Don’t bet on that! But it’s true.

The global economy today is held together by four central banks. The Fed, the European Central Bank (ECB), the People’s Bank of China, and the Bank of Japan. Without their exertions, the world would quickly descend into old-time deflation, drowning in excess capacity, excessive investment, excess labor, and heaven knows excess debt.

The PBoC is doing best of all, mostly because Xi Jinping’s new government is working on rational and sustainable reform. The BoJ is in its last ditch, which may still be decades long, as Japan’s sovereign debt is too big to grow out of and sooner or later must be written down. We, of course, have no government but function without.

The ECB has gotten by on bluff alone for three years, but its near-impossible situation has festered and it may actually have to do something. Look for perverse outcomes affecting us.

For Germany the euro’s value at $1.38 is cheap, making it easy for the Teutonic hive to export, its net surplus running 7% of GDP. Life is great in Germany, just enough inflation, about 2%, and its budget deficit melting away in easy austerity. Germany knows that all will be well for the others if they will only become Germans.

But the others are not Germany (one is enough). The others never have had comparable productivity, yet the euro forces them to compete with the hive. The only way they can compete is to embrace the old cyanide of the gold standard, “internal devaluation,” the oh-so-polite term for cutting wages. To serfdom if necessary. Debts remain as they were, or rising, but wages and ability to pay are falling.

How very odd that the result is pan-European deflation. Aggregate European inflation has fallen to 0.5%, still above zero by the miracle of averaging with Germany. Mario Draghi of the ECB has been in hold-me-back mode for years, but the Germans have opposed any stimulus for fear of German inflation above 2%.

Draghi this week at last signaled action in June. What kind and how much, nobody knows. His long-running bluff: the ECB will buy euro-sovereign bonds if anyone dares to short them. And it has worked. Don’t bet against somebody with an infinite checkbook. But the result is simultaneously encouraging, frightening, and absurd. German 10-year bunds pay 1.44%, half the 10-year T-note. French 10s trade 1.89%, and even Italy and Spain are 2.93% and 2.88%, respectively. These yields make sense only in protracted depression/deflation or a state of fear-buying.

The second lesson from the Fed’s quantitative easing (after “It works”): when a central bank enters with stimulus, markets assume it will work and rates rise. If the ECB comes big, rates will rise there and here. If the ECB tries a symbolic dink, down we go, pulled by Europe.

On the one hand….


 10-year T-note, last six months. Volatility will reappear. Click on charts below to enlarge.

Treasury bill rates

10-year T-note last week. Note scale!

10-year T-note last week

The last bar shows the big gain in March payrolls. Accelertion?

U.S. non-farm payrolls chart

Inflation may be bottoming, but 2% is a long way away.

Headline and core inflation chart

“Taylor Rules” are the way central banks calibrate the overnight cost of money. The more an economy operates below capacity, the farther below inflation the “policy rate” should be set. But, if you’re in real trouble, the equation tells you to go below zero — hence QE and “non-traditional” policy. Another fly in the rule ointment: what is “capacity?” It’s the lowest rate of unemployment not causing inflation. Where is that, exactly, in a world drowning in capacity, investment, and labor? Nobody knows. Hence the apparent command, below, to begin to raise the policy rate may be badly misleading.

Taylor rules variant chart

Total compensation of employees chart

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  • Danny Johnson

    Danny Johnson has flipped hundreds of houses over the last 11+ years in San Antonio, Texas. He blogs about flipping houses at FlippingJunkie.com and is the author of "Flipping Houses Exposed: 34 Weeks in the Life of a Successful House Flipper," a best-selling book on Amazon. He also provides real estate investor websites at www.LeadPropeller.com.

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