Friday, May 8, 2009

How serious was yeseterday’s Treasury auction?

From the Asia Times' Inner Workings blog:

A prominent economist writes today that he has taken his personal money out of dollars and put it into Australian and Canadian dollars, the commodity currencies. The sloppy 30-year auction today, he believes, is a true crack in the dam.

I am less certain: my core view is that America will undergo something closer to the Japanese scenario, in which economic growth stays extremely low, asset price deflation does not reverse, short-term rates stay close to zero, savings rates remain elevated, and bond yields stay low. All that has happened since March is that the end-of-the-world premium has been taken out of the Treasury market.

Remember that credit protection on the United State of America reached 75 basis points in early March — that’s where protection on Brazil was trading pre-crisis. It’s now down to “only” 35 basis points, given the success of the Fed’s and Treasury’s efforts to refloat bank equity with a few trillions of dollars of liquidity.

What the Federal Reserve and Treasury have set in motion is the mother of all crowdings-out. The Fed is compelled to buy substantial amounts of Treasuries to prevent the federal deficit from turning into a $1.8 trillion black hole that sucks in all the free savings of the world and then sum. The moment that yields start to rise, the stock market reacts negatively. There is no “give” in the economy for any substantial rise in yields: the penalty to growth expectations is exacted immediately....MORE