If S&P’s downgrade actually matters, why are bonds up?

I keep reading about how stocks have fallen because of Congress or S&P’s downgrade of Treasuries. Both theories are nonsense. Stocks markets were overvalued (and still are), overbought and overbullish, so this decline was inevitable.

How do we know that S&P’s ratings are meaningless? Well, they almost always downgrade debt after it’s fallen, and in this case the markets are completely ignoring the rating. Here’s the 10-year note not giving a damn:



Congress and its budgets do matter, but there is so little difference between the two parties that the debate is moot. Even the “hard-line” Republicans want to just maybe someday slow down the rate of spending growth. Sorry guys, a negative 2nd derivative doesn’t count as a budget cut.

Eventually yields will turn up, but as I have pointed out for years now, interest rate cycles are very long and don’t have to make fundamental sense, especially not at tops and bottoms. Even if this happens to be the very bottom, nobody is going to get rich quick by shortng Treasuries. Here’s a 180 year chart to put things in perspective:


The dollar’s going to crash, the dollar’s going to crash!

Uh, it already has. The time to be shouting about a crash was 2000, but the dollar-crash meme only got mainstream in late 2007. As you can see in this 10-year chart of the trade-weignted dollar index, the dollar had by then already fallen, and is no lower today than 3 years ago. It may be putting in a triple bottom prior to a secular bull market. The sentiment has certainly been negative enough for long enough to set up a lasting upturn, and the price action in recent years is similar to that of the late 80s to early 90s.


EDIT: Here’s a 30-year dollar index chart.


A secular bull market in the dollar would coincide with more unwinding of risk assets, since the buck has been a favored short for the carry trade (it is weak vs. other currencies, and has very low borrowing costs).

It would also make sense for US Treasury rates to finally put in their secular bottom during the dollar’s bull market, but not in the first phase. Interest rates follow a very long cycle, with the last top in the early 1980s and the last bottom in the early 1940s. Sentiment is still too anti-bond, and there is still too much credit unwinding to come for me to believe that bonds are ready to start falling. Bonds, after all, are hard cash for big players, and people reach out the curve for yield as short-term rates compress during credit stress.

Taleb video: credit crunch not black swan, moral hazard now worse

From Bloomberg:


Some great comments on the OMB (“lying on their forecasts”), Geithner (“who has a mortage on a house not far from mine… who didn’t understand risk and real estate prices”), Summers (“uses wrong mathematics in his papers” and has “systemic arrogance”), and Bernanke (“the one who crashed the plane”).

He has praise for David Cameron, whom he thinks understands how to solve the crisis.

Plenty of fodder for inflationists and bond bears here: Hard assets like metals and agricultural land would be a good way to protect value. Forget the stock market and most real estate.

Does anybody, such as professors, now understand the issues he raises? No. Don’t go to business school, but if you go, don’t take any business class that has equations in it: “it’s all bogus.”

Is the Yen making a giant top?

Deflation has kept a bid under the Yen for 20 years, since the huge load of bad debt denominated in that currency creates demand. The Japanese government took advantage of that bid and ridiculously low long-term rates and has issued unpayable quantities of debt, squandering the nation’s current and future wealth on government jobs and bridges to nowhere, when all they had to do instead was turn their backs on the banks that enabled the 1980s Rising Sun bubble.

Now that sovereign defaults are finally looming on the public consciousness, export markets are shrinking, and the ratio of workers to retirees is still shrinking, it would make perfect sense if the market started to tack a risk premium on all things Yen.

Technically, you can see the weakness of each advance against the USD for the last two years:



USD and US T-bond bears take note: the Japanese are a generation ahead of us in the Kondratieff / credit cycle, and theirs may foreshadow our own experience in winter.


I’m back home from overseas, though a bit tired after running the gauntlet of cattle pens and inquisitors that has ruined the air travel experience. It’ll never be like this again:


Here’s a quick look at the pattern in the long bond, noting a possible 12-13 day high/low cycle:


I see the Yen is still moving in tandem with bonds:

VIX cycles

No strong conclusions here, just some food for thought:



You can also see a possible 30-day pattern: 30 days down, then a ramp. Let’s put this in perspective. Here’s a 5-year weekly chart. All I can note here is a divergence on the RSI over the last few months:


I’ve also noticed how Treasury bonds have resembled the VIX for some time (I put in those RSI buy/sell signals just for fun — not as effective here as in the 60-min chart of Dow futures, but not bad either):


Just goes to show, when you think you’re trading US stocks, Chinese stocks, commodities, bonds and options, you’re really just trading global patterns of fear and greed. It doesn’t matter what market you choose these days. They’re all the same.

I’m with Hendry

Taleb thinks hyperinflation is a strong enough possibility to justify way OTM bets on gold (long) and bonds (short). The one bit I agree with is the long gold / short stocks play (though I think gold is likely to fall with stocks, just not as much), and I suspect that deflationist Hendry would concur.

Hendry thinks that deflation is here to stay, that nations will start to default, and that the market will at least start to worry about sovereign defaults by nations like Germany and the US (even if they don’t actually default, he’ll make money in that situation as the price of insurance goes up).

(The video cuts off when Hendry passes the mic, and I don’t have a link to the rest. If anybody else does, please post it.) ¬†(EDIT: http://2010.therussiaforum.com/news/session-video3/ Minute¬†24:00 and after. Thanks Charles!)

Hendry makes a point I’ve made myself: the euro is like gold for countries like Greece (they can’t print it) so it will have to default.

Hendry says his porfolio is inspired by Nassim, but basically the opposite. He’s fed up with other people’s opinions. The hedge fund guys are “so uncool.” He doesn’t talk to brokers, and he reads nobody else’s research.

Debt loads are bound to squeeze all of the vitality out of the risk takers in the market.

UK interest rates are at the lowest since the Bank of England was established in 1692. He is betting that the central banks won’t raise rates in the next 4 months and he will make 4x his dough if right.

He thinks the sovereign default scenario today is like the mortage bond situation three years ago.

Now, who is the true contrarian? Is hyperinflation really a black swan right now? Every chat board on the net has been buzzing about it for years. When Taleb said every human being should short treasuries, every human being agreed with him!

Some thoughts on government debt during deflation

A question of Keynes vs. Kondratieff

Until recently, the sovereign debt of nearly all governments would rally during panic episodes as stocks and commodities fell. This makes sense, as strong sovereign debt is cash for big boys, and investors are forced to reach further and further out for yield as short-rates are driven to zero or negative. However, starting with Greece, this pattern may change, as bonds are likely putting in a secular top in the 2008-2016 window. Their last bottom of course was the early 1980s, and their last top was 1946-47. The indebtedness and unabashed Keynesianism of all of the world’s governments seem to virtually guarantee higher interest rates in the coming years, even though US, German and Japanese bonds are still finding a bid during panics.

We have already seen the beginnings of this development in municipal bonds and the crappiest sovereign debt, but the market may slowly realize that it is all crap, beyond the short-term credit of the strongest governments.

Prechter makes the point in Conquer the Crash that higher rates on risky long-dated sovereign debt are part and parcel of deflation, an increased preference for the safest cash and cash alternatives. Steepening yield curves fit right into that trend. If the long bond sells off hard, this does not mean the end of the dollar, but the opposite. All else being equal, if T-bonds fell with stocks this year, it would just mean that the US government would finally feel the same pinch as everyone else.

Now for the tricky part. We have to keep in mind that interest rates are more than just a mechanical product of fiscal deficits, savings rates and politics. They are a kind of natural social phenomenon, a reflection of forces I can’t fully understand. They are not rational: why were short-term rates in the low single digits during the second world war when the US had just abandoned the gold standard, had a debt:GDP ratio of over 100% and inflation was running at 8-12%? Why were they still double-digit in the mid-1980s when the economy was good and inflation was 3-4%? (For some charts and discussion of the long-term rate cycle, see this post). The only answers that make any sense are that it was time for rates to bottom and then it was time for them to top.

We are certainly entering what *Kondratieff described as winter, when debts are called in and defaulted upon and cash is at a premium. This is associated with low interest rates, reflecting a low demand for credit, provided that the monetary unit retains value, which it tends to do since this unit is how debts are denominated and settled. And with deflation very much a reality, low rates can provide a high real yield so long as the credit is sound. With housing and wages falling by large percentages and every consumer good on sale, what is the real yield on a 10-year note priced at 3.6%?

There is no telling how long rates will stay low or how low they will go. See Japan, 1990-

Those are the market rates on the credit of a horribly indebted nation with terrible demographics that has been trying to spend its way out of recession for 20 years. Is there a better way to explain this than Kondratieff winter?

If social forces demand that governments start to shift towards frugality and default like the rest of society (and government is a reflection of social mood), this would be very supportive of the current fiat regimes. Think about it: what would happen to the Euro if Greece defaulted (which is what they should do)? Billions in euro-denominated balances would go “poof” and the remaining euros would be worth more.

What if younger generations of Americans, the ones who most enthusiastically support Ron Paul and even phonies like the new senator from Massachusetts, start to exert pressure for the rolling back of that $70+ trillion in retirement and health-care promises? Those are contracts that the government can’t honor, so by definition, it won’t. It will try to pretend otherwise, but it won’t. In effect, much of the debt will be repudiated.

There are huge caveats to the above, such as radical socialism or expanded warfare, but there are going to be real deflationary undertones to social mood that may effect policy and prolong the current paper regimes for longer than almost anyone suspects. Kondratieff winters are not short episodes, but generational, and if the last two turning points in the interest rate cycle are a guide, there could even be another ten years to the bottom.

That is hard to believe right now, but it is possible if social forces demand default. I can’t gauge the odds very well, but I have to consider this longer-term bull case for treasury bonds and a few strong currencies. Bottom line — history has not been kind to paper money and government bonds in times of crisis, but the nature of deflation may give them a longer life than we have assumed.

If you just can’t wait to short some sovereign debt, try Japan before America. They may be a generation ahead of the west in the rate cycle, and really, how much lower could they go?

*Kondratieff waves in the US (click image to expand):

[email protected], 1.23.09

One thing that strikes me in the above chart is how huge the latest wave is compared to the others. At 60 years and running, it is the longest, and prices, rates and stocks have gone up so much more than during any of the previous three. Just out of proportionality, it would be perfectly fitting if rates and prices fell for another 5-10 years.

Here’s a clearer view of the Aaa corporate bond rate from 1919 to 2010:


Also see Rothbard and then Mish on Kondratieff theory. As Rothbard makes clear, winter is not necessarily an awful time to be alive, judging from the strong economic growth of the 1830s-40s and 1880s-90s. This means that prolonged unemployment and war can’t be blamed merely on the credit cycle, but that fingers must be pointed at the socialists, Keynesians and fascists who’s actions directly brought about the nightmare of 1929-1945.

Yen and bonds, two of a kind

I don’t know exactly what to make of this pattern, but it is not unusual to see these two move together. As forms of cash, they each tend to do well when the deflation trade is on. In fact, other than short positions, they are the only things that beat the dollar when everything else falls.


I don’t know what it means that the Yen has been doing so well even as stocks have risen over the last year. Perhaps it’s a vote of no-confidence.

Even if stocks and commodities roll over hard, I actually wouldn’t count on the Yen rallying as powerfully as of 2008, or even at all. Its long-term trend has been weakening.