When Fed Chairman Ben Bernanke first said the government would buy U.S Treasury bonds in the open market the 10 year fell to around a 2.5% yield to maturity. The thought was the Fed would keep rates that low via its buying power. They quickly rose over a few weeks period of time to a 3.35% yield and at least one government official said on Bloomberg news the rise in yields was due to "increased economic confidence." Could be, but what does the recent fall back to 3.1% tell us? Probably it is a sign of a more muted economic tone. I think we all got too far out over our skis trumpeting less bad economic news as actual good news.
My Boston colleague, Todd Douglas, sent around a late afternoon story from the Wall Street Journal that said "Economists in the latest Journal survey see an end to the recession by August, but that it will take years to eat up the slack created by the downturn." Half of those surveyed think it will take three to four years to close the output gap and another 25% feel it will take longer. As a group, they feel unemployment will rise to 9.7% by the end of the year. They would know better than I but I feel they are at least directionally correct. The news has turned decidedly less bad, but only that. Not to be overly negative today I would remind us that the market usually turns sharply upward six or seven months before unemployment peaks.
Unemployment claims, which I think are an excellent co-incident indicator to let us know what is happening now, turned back up today to rise 32,000 to 637,000. That is still below the recent March peak of 674,000, but not by much. The four week moving average rose a bit to 624,500. It too is slightly below its peak but we need consecutive weeks of declining claims to feel truly better. The numbers were undoubtedly pushed up by the Chrysler bankruptcy, but those folks are still unemployed and the number of auto workers losing their jobs will be rising. As an aside, the pipe dream that the Chrysler bankruptcy will be a short one with a target of just a few months before reemerging is just that- a pipe dream. This will take a few years is my best guess.
On the other hand, BAA bond yields broke below 8% Monday (I get a read with a one day lag) and the commercial paper market shrank again last week by $81 billion to about $1.3 trillion. This is the fourth week in a row that the total has declined. The shrinkage is a sign of financial stability and indicates government backing via the Commercial Paper Funding Facility is less and less important as credit worthy firms stand on their own. More companies are moving to the slightly longer Temporary Liquidity Guarantee Program which allows for maturities of up to three years. But, and this is an important but, the lack of the need for commercial paper funding is also a sign of subdued economic activity. So, yes, it's good news that the CP market has revived, but it's only less bad news about the level of economic activity.
We have been looking at Libor and the TED spread regularly and while we can celebrate that the Libor rate has fallen to a record low and the TED spread is approaching a normal level, it could be partly due to lack of demand for borrowing as well as banks willing to lend at low rates. There is no clear and unambiguous sign of an all clear yet. And that is why I think we need to correct the rally we have had. A 30% bounce off of a bottom is almost always (almost) followed by at least a one third correction of the move. The S&P turned in a good showing Thursday rising to 893 after hitting 882 during the day.
People I trust tell me the 20 day moving average is at 880 and traders will make an attempt to draw a bit of a line at that level. I think over the next few weeks we will slide back to the lower 800's to fulfill the one third correction idea and spend some time around the 100 day moving average.
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