Farrell: Auctions Ahead

The Treasury will hold three auctions this week totaling about $65 billion. Tuesday will be a $35 billion offering of three year paper. Wednesday has a $19 billion 10 year deal followed by Thursday's $11 billion 30-year offering. I am concerned with the 10 and 30 year auction and who shows up and in what force. The Chinese, for example, have added to their total of dollar denominated holdings but decidedly on the short end of the yield curve. There will be plenty of buyers but the key would be the level of oversubscription. A rising 10 year yield translates directly into a rising 30 year mortgage rate which could work, along with rising gasoline prices (the rise in gasoline prices so far this year is about a $60 billion bite out of the consumer pocket versus the low gas hit last year), to cut a recovery off at the knees.

There is a far bigger and more larger macro risk than just getting through this auction. The average maturity for all Treasury bonds and notes outstanding is 4.7 years. This compares for example with Britain that has an average of 14 years. Many European countries are in the 10 plus year range. The U.S. has a continuing "roll over" problem as this debt comes due. It's not just the current deficit that has to be financed but all the existing paper that has to be refinanced as well.

Despite the rise in the interest rate on the two year Treasury and the spike up in the Fed Fund Futures market that is being interpreted as a sign that the Fed will raise interest rates in the near future, the brain trust here at Soleil (that would be Greg and Lyle with me tagging along and pretending) feels there is no chance of that happening in such a short time frame. With unemployment high and rising and capacity utilization at record lows we feel it would be a mistake of epic proportions to raise rates at this time. Stupid mistakes have been made in the past. The FDR "stimulus" package launched in 1933 brought unemployment down from 25% to 11% by 1937. The stock market also more than tripled during that period. Being ignorantly convinced enough was done, rates were raised in 1937 and the marginal tax rate went to 90% . That threw the economy back into recession and created a bear market that saw a 60% decline. Fed Chair Bernanke is as expert on that time period as anyone alive and it's highly doubtful that such a blunder would be repeated.

Consumer credit declined $15.7 billion last month. That was the second largest decline on record. The largest was the month before at $16.6 billion. The savings rate has moved to 5.7% in April. In dollar terms that would be a savings for the month of $670 billion, which would be a record for any month since the numbers were tallied starting in 1959. Some of that money will be showing up at the Treasury auction and that is a plus. An obviously reluctant consumer who is saving more and spending less is probably reason enough to not think about raising rates at this time.

The market was in the doldrums all day Monday and had a late turnaround on the rumor that Paul Krugman, a noted and bearish economist, allegedly said in a conference at the London School of Economics that the recession will end this summer. Maybe it will, maybe he said it, and maybe that's why the market turned. But the gain was on unusually light volume and that has bothered me for a while. Still does.