Farrell: Hope Green Shoots Is Not 'Grasping At Straws'


We all have been focused on the "green shoots" of economic recovery the past few weeks. Most of the news has been less bad as opposed to outright good news. The NY Empire Manufacturing Index, for example, was down a -4 which was a lot better than the -38 at its bottom, but still down. Industrial Production was off .5% which looks great compared to the prior five months average of -1.7 percent, but it was still off.

The capital markets have opened their arms wide on almost every level. Over $50 billion in new equity has been raised. The month of May has seen $72 billion in investment grade debt issued and over $15 billion in "junk" debt offerings which is the most of that category since October of 2007. American Airlines CEO was quoted in the paper over the weekend that they have been able to issue over $174 million in equipment lease financings and that he sees a distinct "thawing" in the credit markets.

Three month Libor has been down 37 days in a row; the commercial paper market in the U.S. has improved dramatically; 30 year fixed rate conforming mortgages at 4.82 percent mark the tenth week in a row at less than 5 percent, while the interest rate on the benchmark 10 year Treasury has risen to 3.45 percent it is still below last year's average of 3.65 percent.

The spread between the basic 10 year Treasury and the ten year Inflation Protected Treasury is 1.78 percent - read that as the expected inflation rate for the next ten years- and while there is no magic number for this it did average 2.44% from 2005 to 2007.

Last week the Leading Indicators (LEI) report showed a significant rise of 1 percent and gains like that have in the past been associated with expansions. Finally, the Purchasing Managers Index for the euro zone had a big jump last week as well.

But overshadowing all of these green shoots are two issues that haven't been encountered before. The creditworthiness of the U.S. Treasury has been called into question and some (many) are wondering about the dollars position as the world's reserve currency.

The concern about private credit that brought about the financial typhoon we have experienced is shifting to concern about sovereign credit. Foreign demand for U.S. Treasury bonds is still healthy- for now. Foreign purchases of U.S. debt instruments was $25.9 billion last week and $23.5 billion the week before.

That is the best two week demand total in many a month. But with Mexico's first quarter GDP down 21.5 percent on an annual basis, Germany's down 14.4 percent and Japan off 15.2 percent is it just that the U.S. is the best house in a bad neighborhood? China's demand for Treasuries has actually grown, but they are selling agencies like Fannie and Freddie and have considerably shortened the maturities they are willing to buy.

Our Federal Reserve stepped into the market to buy Treasuries last week to continue their previously announced program of support and their $7.4 billion order to buy was met by $45.7 billion of bonds for sale. That is a sign U.S. dealers are nervous about the future trends of interest rates.

The Treasury is offering an enormous amount of debt this week The combined total for the two year, five year, and seven year auctions will be well over $100 billion. With enormous budget deficits, projected auctions like this will be common and the question is what the markets appetite will be for such a relentless agenda of debt offerings and what are the implications for interest rate and the value of the dollar.