Tuesday, November 16, 2010



Today’s (i.e., Tuesday, 11/16’s) Wall Street Journal features a page A1 article entitled “Bond Market Defies Fed.” It seems that, despite the Fed’s creating money (okay, technically creating reserves for those Pecksniffian types desperately looking for material with which to defend this ongoing debasement of the world’s reserve currency) at a pace that would make Richard Petty dizzy, the bond market is performing badly. Indeed, since September 30, the yields on the 30, 10, and 5 year treasuries are up 64, 37, and 21 basis points respectively. For some reason, this is puzzling to experts both inside and outside the Fed. That this is puzzling to these wunderkinds reminds loyal readers of the Pontificator and its predecessors, the Insightful Weekly Commentary and the Insightful Irregular Commentary, of the bafflement of Alan Greenspan, perhaps world history’s most overrated man, that a sharp reduction in long rates did not follow his profligacy with the money supply as the night follows the day.

As I said in the Insightful Weekly Commentary when Alan Greenspan was playing Rumpelstiltskin with the money supply, what is mystifying is that such renowned experts as Mr. Greenspan, and now Obsequious Ben Bernanke, their henchmen at the Fed, and their sycophants on Wall Street were surprised that spinning new dollars out of (not even) whole cloth had the counterintuitive, to them, consequence of increasing medium to long term rates. While I am apparently no expert, it seems to this troglodyte that creating new money at a nausea inducing pace might just have the effect of causing inflation, a phenomenon that bond markets, for reasons mysterious to the Olympians at the Fed and on Wall Street, don’t seem to like very much. Such inflation, or even apparent inflation, causes the inflation premium in long bond yields to increase. Thus money creation, even if such money creation involves purchasing medium to long term treasuries, should have the effect of steepening the curve and, in most cases, increasing longer term rates. Indeed, since September 30, the 2 year to 10 year and the 2 year to 30 year spreads have increased by 29 and 56 basis points respectively. Indeed, the 2 to 30 year spread, at 383 basis points, is about as wide as I can recall seeing it.

For further confirmation of my theory, which apparently seems an utter absurdity to the Titanic minds at the Fed and on Wall Street, that being fast and loose with the money supply leads to inflation fears that in turn lead to higher long rates, look to the implied inflation expectation in the spread between conventional treasuries and TIPS. Since September 30, the implied inflation expectations imbedded in the 5, 10, and 30 year treasuries have increased 25, 29, and 51 basis points respectively.

The only thing that is surprising about the Fed’s purchasing of long term bonds having resulted in higher long term rates is that the Fed, and most of the economics profession, is surprised by this result. In fact, that these eminent experts, who have been put in charge of the Republic’s, and the world’s, monetary affairs, can’t seem to figure this out is at least as alarming as it is surprising, at least to this non-expert.

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