Greenspan Faces Jilted Treasury Market (bond market now poised for strong economy ala 1992)

TheStreet.com ^ | 7/16/03 | Aaron Task

[Steven W.]

Like Lucy in the classic TV series, Alan Greenspan has some 'splaining to do. The Federal Reserve chairman needs to come clean before the Treasury market, that amorphous yet incredibly powerful body that is increasingly jittery about his intentions.

Day one of Greenspan's two-day congressional testimony presumably didn't go according to plan: Treasury prices plummeted Tuesday, sending yields sharply higher. Stocks also slipped, but their decline was tame compared with a more-than 1-point decline by the benchmark 10-year note and a more than 2-point fall for the 30-year bond. Nonetheless, this increase in long-term bond yields indicates the yield curve is steepening, a classic signal of stronger economic times.

Because most economists foresee solid growth ahead, "he needed to give a speech explaining why deflation is an imminent problem [and] a super-accommodative policy" is appropriate, said Jim Bianco, president of Bianco Research in Chicago. "He failed [to do so] , and the bond market had a heart attack," suffering one of its worst one-day point declines since October 1998.

Of course, had Greenspan focused too much on any deflationary threat, the stock market might have suffered a coronary. At this point, the chairman seems more concerned about satisfying his constituents among equities investors vs. those in bond land.

"He is going to try and pull out all the stops to make sure stock investors make money, the economy keeps moving -- and if bond investors lose bucketfuls of money, so be it," Bianco surmised. (Those investors include those who, according to AMG Data Services, plowed more than $133 billion into bond funds in 2002 and another $45.3 billion in the first quarter.)

It's dangerous for the Fed chairman to treat Treasuries like an unwanted child. Although stocks garner most of the public's attention, the fixed-income market is much bigger and has a far greater influence on the broader economy. Most notably, Treasury yields establish lending rates for mortgages and refinancing activity. Anything that unsettles the housing market, the economy's main ballast for the past two years, is likely to frustrate Greenspan's efforts to get the overall economy back on track.

He wants to see the economy do better, but he just locked the refi door," Bianco said, suggesting higher bond yields will curtail recent record-setting demand for mortgage refinancing.

As discussed in Greenspan's prepared testimony, this is no small matter. Estimated mortgage refinancings, net of cash-outs, exceeded $1.6 trillion in 2002, Greenspan noted. And refinancing activity accelerated from that record pace in the first half of 2003 as rates fell further still -- until very recently that is.

"Households have taken advantage of new lows in mortgage interest rates to refinance debt on more favorable terms, to lengthen debt maturity, and, in many cases, to extract equity from their homes to pay down other higher-cost debt," Greenspan said. "Debt service burdens, accordingly, have declined."

Higher mortgage rates will clearly curtail refinancing activity and also diminish the affordability of home purchases. Either development threatens to undermine strength in the housing sector, which provided a huge boost to overall household wealth in recent years, thus helping consumer spending stay strong despite rising unemployment and sluggish overall growth. Tuesday's stronger-than-expected June retail sales report was the latest evidence of this trend.

On a separate but related note, the S&P Homebuilding Index fell 4.5% Tuesday amid big percentage declines by components such as D.R. Horton (DHI) and K.B. Home (KBH). One wonders if this latest backup in bond yields -- and selloff in housing stocks -- will make Berkshire Hathaway's (BRKA) $12.50 per share offer more appealing to shareholders of Clayton Homes (CMH). Several institutions, including Brandywine Asset Management, have expressed opposition to Berkshire's bid; a vote on the offer is scheduled for Wednesday.

Something Borrowed, Something Blue

"What the bond market has essentially done is taken all [Greenspan's] work -- the eases and monetary stimulus -- and canceled it by raising interest rates," Bianco continued. Although bond yields remain low by historic standards, "the bond market has no margin for error," he said. "He's got to talk to the bond guys [Wednesday] and tell them 'my policy is not antibond, won't produce inflation and you guys can start buying bonds again.'"

Unfortunately, Bianco is skeptical that there's anything the chairman can say to placate the Treasury market's new breed of vigilantes. "Then again, I've never understood how you can increase inflation expectations and decrease rates at the same time," he said, referring to the unusual combination Greenspan is trying to create.

As with most things involving Greenspan, there's another side to this story. Tuesday's selloff was mainly focused in long-dated Treasuries because the chairman dampened hopes the Fed would take the unusual step of buying such securities, as had been widely anticipated in recent months. As a result, the yield curve -- or the spread between yields on short- and long-term Treasuries -- widened sharply.

The yield on the benchmark 10-year note settled Tuesday at 3.91%, while the yield on the two-year note was 1.47%. That's the widest gap since November 1992, Bloomberg reported, and compares with a sub-2-point spread as recently as May 23.

Positively sloped yield curves are generally believed to be harbingers of improving economic activity. By contrast, inverted yield curves -- when short-term rates exceed long-term rates -- often presage recessions. Therefore, optimists are likely to be encouraged by Tuesday's Treasury market action and equity bulls relish any and all references to 1992, when the 1990s bull market was in its nascent stage.

Then again, there was tremendous pent-up demand from consumers in the early 1990s and the Internet "revolution" lay ahead. Today, by contrast, corporations are still reeling from the largely misguided spending on online ventures, while the American consumer is mainly satiated after a spending splurge. Notably, that spending was largely facilitated by generational lows in interest rates, something that appears to be reversing in rapid fashion.

Yes indeed, Alan Greenspan will find himself in a tight spot on Capitol Hill Wednesday. Although most equity investors will be focused on Tuesday's barrage of postclose news -- including earnings from Intel (INTC) and Citigroup's (C) offer for Sears' (S) credit card business -- rest assured the Treasury market will be listening closely to the chairman.

[Steven W.]

Positively sloped yield curves are generally believed to be harbingers of improving economic activity. By contrast, inverted yield curves -- when short-term rates exceed long-term rates -- often presage recessions. Therefore, optimists are likely to be encouraged by Tuesday's Treasury market action and equity bulls relish any and all references to 1992, when the 1990s bull market was in its nascent stage.

[Support Free Republic]

A horse walks into a bar. The bartender comes up and says "Hey pal, what will it be?"

The horse orders a beer.

A few minutes later, John Kerry walks in and sits at the bar. The bartender walks up and says "Hey pal, cheer up. Why the long face?"

I'll stop if you guys will donate and get us over our fundraising goal

[Beck_isright]

Meow. Meow. Meow. Thud. Silence.

[Steven W.]

apparently you bears + liberal doom & gloom types are beyond hyperbole, clearly running out on empty today as dead cat bounce jokes only apply to those holding gold or treasuries ROFLMAO

[Mears]

I read the entire article and I haven't a clue what it means,but I'm sure many of you will.

Please enlighten me in 25 word or less !!!!LOL

[AntiGuv]

Although stocks garner most of the public's attention, the fixed-income market is much bigger and has a far greater influence on the broader economy. Most notably, Treasury yields establish lending rates for mortgages and refinancing activity. Anything that unsettles the housing market, the economy's main ballast for the past two years, is likely to frustrate Greenspan's efforts to get the overall economy back on track.

[Mears]

I read the entire article and I haven't a clue what it means,but I'm sure many of you will.

Please enlighten me in 25 word or less !!!!LOL

[AntiGuv]

Although stocks garner most of the public's attention, the fixed-income market is much bigger and has a far greater influence on the broader economy. Most notably, Treasury yields establish lending rates for mortgages and refinancing activity. Anything that unsettles the housing market, the economy's main ballast for the past two years, is likely to frustrate Greenspan's efforts to get the overall economy back on track.

[Mears]

I read the entire article and I haven't a clue what it means,but I'm sure many of you will.

Please enlighten me in 25 word or less !!!!LOL

[Mears]

I read the entire article and I haven't a clue what it means,but I'm sure many of you will.

Please enlighten me in 25 word or less !!!!LOL

[AntiGuv]

It means the bond bubble is bursting, the real estate bubble is living on borrowed time, and the stock market is off in Wonderland..

[Steven W.]

means the bond bubble is bursting

1 out of 3 Correct - anybody who continued holding long term treasuries or gold over this past month with all of the signs at bay are now paying for their foolishness big-time.

the real estate bubble is living on borrowed time

that's not true - real estate is sustainable at rates below 10% - it's currently trading around 6% for 30 year mortgages and that is exactly where things were a month ago for those who weren't smart or quick enough to lock in at the lowest of the low rates ~ 5% with no points or costs.

and the stock market is off in Wonderland

completely and totally wrong - the whole point of the story is the correlation between the moves in the bond markets and how they're now poised for a major economic recovery which will continue to over-reward those holding equities. the bears have never been much for logic or facts, preferring hysteria & hyperbole, instead, and this is the point where their fearmongering begins to break down because the bond market's moves are now clear to most everyone and those who still can't see it (and I realize a lot of foolish bears have been continuing to get burned here) will continue to lose lots & lots of (so-called) "smart money" ROFLMAO

[Steven W.]

to the contrary, this is the sign for those who've continued waiting for rates to go lower & missed the best opportunities to get in will now have an additional incentive to get on with their planning. the bears are now faced with a dilemma that shows them to be so totally disengenous with their fearmongering - they can't now say that the rates for 30 years being 6% are too high and can't sustain real estate when just two months ago they were complaining 6% was too low and were trying to scare people with the foolish guise of deflation.

[AntiGuv]

the whole point of the story is the correlation between the moves in the bond markets and how they're now poised for a major economic recovery which will continue to over-reward those holding equities.

Ummm.. No. That's only the whole point of your navel-gazing parenthetical and interjected remarks. The whole point of the story is:

Although stocks garner most of the public's attention, the fixed-income market is much bigger and has a far greater influence on the broader economy. Most notably, Treasury yields establish lending rates for mortgages and refinancing activity. Anything that unsettles the housing market, the economy's main ballast for the past two years, is likely to frustrate Greenspan's efforts to get the overall economy back on track.

Perhaps the fourth reading will kickstart the verbal comprehension reflex...

[lelio]

Greenspan said. "Debt service burdens, accordingly, have declined."

So instead of being in debt up to their eyeballs, its down to lower lip level?

will make Berkshire Hathaway's (BRKA) $12.50 per share offer more appealing to shareholders of Clayton Homes (CMH)


$12.50 is below today's price of $12.98. That's an odd bid price. Of course by making this bid price BRKA might be able to get the price to fall as people dump the stock thinking that it isn't worth that much. Comparing it to KBH isn't pretty, as that stock's up 100% over the 2 year price, which CMH is the same. Maybe its poised for a breakout. Although I can't see much upside in building more homes that people can't afford.

[Beck_isright]

Liberal? Moi? Apparently your knowledge about myself is about as shortsighted as your investment horizon. When you turn 14 and daddy gives you the keys to the Benz and permission to talk to your trustee, please, let us know.

[hripka]

If you think it will take interest rates of 10% to kill the real estate market, wow, how hot is the RE market in you area?

Stocks are overvalued, and higher interest rates won't help a bit.

[ambrose]

Buffett is a snake in the grass. Won't be surprised in the least if he massively shorts CMH while the bid is pending...

[ambrose]

Take a deep breath... let's see what the bonds do over the next couple of days now that Greenspan's testimony is done.

[Southack]

"It means the bond bubble is bursting, the real estate bubble is living on borrowed time, and the stock market is off in Wonderland.."

No, it only means that bond investors have taken advantage of the most flimsy of excuses to dump their taxed holdings.

As of 2004, bonds are taxed but dividends from stocks are not.

It's a safe bet that there is going to be some money reallocated due to the new tax paradigm.

[ambrose]

Muni bonds are not taxed.

[Southack]

"Although I can't see much upside in building more homes that people can't afford."

Perhaps you are looking at the housing market all wrong.

It's no great sin to look at the cost of brick, mortar, and lumber, add in two months worth of labor by a team of 12, and come up in your head with a ballpark figure for what a home should be worth. By that measure houses are overpriced and you're a genius.

So why haven't you been able to accurately predict where housing prices would head so far, genius?!

Well, maybe it's that other way to look at value.

What is a person's cost not to build a house, but to live in one?

On average, an American lives in her house for a little more than 7 years (don't quote me on the precise figure, please). In that time, per the national average, her house has appreciated in value 4% (simple, not compounded) per year. So she sells it, pockets 18% (yeah, 28% would be nice but the average American uses a real estate agent and pays hefty transaction costs), and moves to a new home, where the cycle begins again.

In the meantime, she's gotten a tax deduction for her mortgage interest, if any, and she's avoided losing $800 per month in average rent that she would have had no possible way to recover.

So for the average American, it's cheaper to buy a house even at "inflated" prices than it is to rent. Moreover, there is the light at the end of the tunnel that she may own a house free and clear in 15 years, and a further chance that her house might be one of those that appreciates at a much greater pace than the national average, providing her a better-than-lottery chance of getting rich...and all of this from an "investment" that she'd have to be making monthly no matter what (I mean, it's either own, mooch, bum, or rent).

So it isn't that she can't afford to buy a new house (seriously, the median home price in the U.S. is $155,000 grand, which at today's interest rates is less than a grand per month, something that the average American - $36k/yr -can easily afford to spend).

No, it's that she can't afford the alternative, which is to lose $800 per month in irrecoverable rent.

And that's the reason that **demand** for housing is so strong. Not only do you have national population increases that need additional housing, but you also have an existing population that has already made the judgement call about the relative value of owning versus renting, and the better perceived investment is obvious.

[ambrose]

that time, per the national average, her house has appreciated in value 4% (simple, not compounded) per year. So she sells it, pockets 18% (yeah, 28% would be nice but the average American uses a real estate agent and pays hefty transaction costs), and moves to a new home, where the cycle begins again.

Not too bad if she paid for the house in cash. If she's paying 6% interest or more, then than 4% appreciation is vaporized. Then there's insurance, maintenance, property taxes, etc.

[ambrose]

So it isn't that she can't afford to buy a new house (seriously, the median home price in the U.S. is $155,000 grand, which at today's interest rates is less than a grand per month, something that the average American - $36k/yr -can easily afford to spend). No, it's that she can't afford the alternative, which is to lose $800 per month in irrecoverable rent

In Los Angeles, I can pay 250k for a "condo" which is no better than the apartment I rent for $800 a month...

[lelio]

seriously, the median home price in the U.S. is $155,000 grand, which at today's interest rates is less than a grand per month, something that the average American - $36k/yr -can easily afford to spend

Maybe I'm a clod but I don't see many people making $36k a year affording a $20k down payment and paying $900 a month for a place. Throw in property taxes, insurance, utilites, and you're over $1100.

[Southack]

"Not too bad if she paid for the house in cash. If she's paying 6% interest or more, then than 4% appreciation is vaporized. Then there's insurance, maintenance, property taxes, etc."

How will it compare to losing the full $800 per month in rent?!

[Southack]

"In Los Angeles, I can pay 250k for a "condo" which is no better than the apartment I rent for $800 a month..."

California has an odd situation in that your property taxes out there reward renting and punish new sales, at least on a cash flow basis. So long as the same person owns property out there, property tax rates are held down near their purchase time rates, give or take a few percent.

But sell the house, and the new owner gets hit with substantial property tax penalties.

It's that property tax hit to new buyers that slows down the real-estate market in California from its real potential (which is an amazing level if it were to be realized), and it also has the odd side-effect of keeping rents lower than mortgage payments for the same piece of property, something that the rest of the nation doesn't see. This is because the same old owner can rent at a lower rate due to her lower property taxes than the new buyer will pay in monthly payments to own due to the fact that the new buyer will have substantially higher property taxes than the old owner.

Americans outside of California can almost always buy for less per month than for what they can rent the same exact place. Not so out where you live, though.

[ambrose]

The renter isn't stuck in some overpriced dump when the house of cards collapses. The renter has free capital to invest in rental properties or equities.

Look, I understand that there are good reasons to buy instead of renting, but it isn't as clear cut as the Realtors would have us believe.

It is like buying a car vs leasing. People always say that buying a car is better.. but not if you're trading it in every three years, which is the national average.

[Southack]

"Maybe I'm a clod but I don't see many people making $36k a year affording a $20k down payment and paying $900 a month for a place. Throw in property taxes, insurance, utilites, and you're over $1100."

A person who buys a $155k house at 5% interest on a 30 year note with $20k down will make a $724.71 monthly mortgage payment, plus taxes and insurance (you're going to have utility payments no matter whether you rent or own, so scratch that additional comparison).

Considering that under Bush's new tax cuts, a family of four earning $40,000.00 per year only pays $45 (yup, just fourty-five Dollars) per year in federal income taxes, so you've got almost $3k per month take home after SS Medicare, and state taxes. $3k per month can easily pay a $725 monthly mortgage payment, plus property taxes and insurance.

But who has $20k to put down when they are only earning $40k per year?

No problem, home loans routinely close with only 3% down, and for the case above that only raises the monthly mortgage payment to $807.11 instead of $725 (in other words, the average monthly mortgage payment for the average American coincides with the average monthly rent payment of $800...go figure).

But the average American LOSES the full value of the rent payment. 30 years of renting versus 30 years of making mortage payments will reveal an enormously different financial picture in the end for two different "average" Americans who earn the same but choose to rent or own in contrast to the other.

No one ever got rich renting, but more Americans have become millionaires through owning real-estate than from any other single activity.