Market Correlation

Some analysts set about crunchin'
A proven statistical function
For why stocks and debt,
Which used to offset,
More recently move in conjunction.

At the end of it all they succeeded,
Having crunched all the data they needed,
Finding no other fact
So truthfully tracked
As expected expanse of QE did.

Safe Investments?

Said a strategist, airing his views
On central bank rumors and news:
"You've booked every gain
And best not retain
Your bonds, which are certain to lose."

Inflated Expectations

The specter of higher inflation
Makes investors want more compensation,
Thus driving up yields,
While prices of deals
Will fall, in an inverse relation.

The longer the stated maturity
Of a given fixed-income security,
Then all the more great
The effect of the rate,
As the market may show us with surety.

Bond prices tend to be countercyclical with stock prices and the economy as a whole.  In good times, or when inflation is elevated (or when both happen at once), bond prices tend to fall because rates are rising.  In bad times, or when investors show aversion to risk, there is a "flight to safety" that pushes them into bonds, driving up the price - and thus lowering the yield.  As The Wall Street Journal never fails to remind us: "Bond yields fall when prices rise." These dynamics were prominently on display in January, when 10-year bond prices fell 2.6% while the S&P 500 gained 5%.  In part, the bond selloff reflected more economic optimism and relief over the (partial) resolution of the fiscal cliff.  The higher yields also responded to awakening inflation anxiety, as the Fed's long-term inflation projection crossed over 3% for the first time in many moons.  Going forward, there is plenty for bond investors to feel anxious about - from the US debt ceiling to the eurozone - and little prospect for rapid economic growth, so inflation fears may not be driving rates any higher (and prices lower).

Mint the Coin

With the Debt Ceiling coming up soon, it
Is time (although some may impugn it)
For coining a halt
To a US default
With a really big monet'ry unit.

A one-trillion coin, it is said,
Could be minted and shipped to the Fed,
In order to pay
What the US of A
Might be forced to renege on instead.

This sizeable denomination
Would be kept out of mass circulation,
The better to sidestep
That such an untried step
Precipitates hyperinflation.

When Republicans finally come round
From running bond issuance aground,
It's back to the Mint
For the Coin, where its stint
Will be wound up with melting it down.

So let's mint The Coin out of platinum!
Though objections there be, we may flatten 'em.
There are ways besides cash
'Round the Debt Ceiling clash,
But there's nothing as clever as that in 'em.

It's an idea so crazy, it just might work: the US Treasury could circumvent the looming debt ceiling showdown by minting a very large denomination platinum coin of, say, $1 trillion. The coin could be deposited in Treasury's account at the New York Fed, where the new funds could be used to pay any of the Federal government's many obligations. First proposed in a comment on an economic blog in 2010, the Coin is within the legal powers of Treasury, which "may mint and issue platinum bullion coins and proof platinum coins in accordance with such specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the Secretary’s discretion, may prescribe from time to time." Never mind the fact that this law was intended to facilitate minting bullion coins for numismatists - it's on the books. Of course it's absurd to speak of minting a $1 trillion coin to keep the government out of default, but the debt ceiling itself is absurd, as is the threat to throw the nation into default for political purposes. So, it's a case of fighting crazy with crazier.

The "Mint The Coin" movement has been gaining steam thanks to the (only slightly tongue-in-cheek) advocacy of such leading economic writers as Bloomberg's Josh Barro and Business Insider's Joe Weisenthal. For those who fret that the issuance of a $1 trillion coin would ignite inflation of Zimbabwean proportions, a former head of the US Mint (who wrote the 1996 platinum coin law) has weighed in with a cogent explanation of why that would not happen. It all comes down to a choice: would we rather the US Treasury default, or do something absurd?

Belt-Tightening Blues

In the stock market sell-off's severity,
There's a White House political rarity:
While private demand
Is too soft to expand,
There's a Democrat talking austerity.

As millions of Americans fretted about S&P's Friday night downgrade of US sovereign debt, Monday's stock markets saw a tsunami of selling that began in Asia and rolled across the world, ending with the S&P 500 stock index down 6.7% for the day. However, the downgrade itself was not the catalyst, as evidenced by the fact that Treasury prices actually rose. The market was much more spooked by waning growth prospects, caused in part by government belt-tightening at a time of slack private demand. How ironic that, following a Republican President who stimulated the economy with spending and tax cuts, and his Democratic successor announces years of growth-dampening spending cuts ahead.

Weekend Worriers

Whenever a bombshell discloses
After Wall Street on Friday night closes,
The market is fraught
All weekend with what
The chance of new highs or new lows is.

Listening to the weekend's feverish speculation as to the market effect of the S&P downgrade of US sovereign debt, one could not help but hark back to the Lehman failure in 2008, when the world waited breathlessly for the Asian markets to open and point to our global economic fate. Early results this time around indicate a sharp sell-off of anything risky, though not necessarily US Treasury bonds themselves, the risk perception of which has not really changed.

Downgrade Dilemma

That the GOP's debt ceiling polity
Viewed a US default with frivolity
So provoked S&P
That investors may flee
To Treasury bonds for the quality.

In a move that surprised no-one, the Standard & Poor's credit rating agency downgraded the debt of the US government to AA+ Friday evening, citing primarily the "weakened...effectiveness, stability and predictability of American policymaking and political institutions at a time of fiscal and economic challenges." Since, as many market analysts pointed out, the move was long overdue, no material market reaction was expected. Indeed, the expectation is that Treasurys will remain the safe haven whenever investors panic, so, to the extent that the downgrade has lowered the general risk tolerance, it may even cause net inflows to Treasury bonds. Let the Asian trading day commence!

Negative Outlook on Uncle Sam

Said Moody's: "Our negative view on
The debt deal you voted anew on
Ponders revenue ruts
Caused in part by the cuts
Which we anyway doubt you'll come through on."

In announcing its negative outlook on the Aaa rating of US sovereign obligations, the Moody's rating agency cited the untested framework set up by the debt ceiling bill passed by Congress and signed into law yesterday by President Obama. Moreover, said Moody's, Congress may lack the fiscal discipline to make the hard decisions required later this year to narrow the deficit by another $1.5 trillion over the next ten years. Finally, the rating agency pointed out that federal revenues may not rise as fast as government forecasts assume. Of course, in the feedback loop between fiscal policy and the economy at large, deficit cutting can contribute to a slower economy.

Plan Beta for Beijing?

To the US said China: "We trust you will
Pay your bills, as you've often discussed you will,
But on Treasury debt
We may lower our bet,
And diverge to the Dow Jones Industrial."

Economists such as Shanghai-based Andy Xie have suggested that, with the political cloud of uncertainty hanging over US Treasury bonds, China - the largest foreign holder of US sovereign debt - would do well to diversify into US stocks. In doing so, it would have the benefits of strong US corporate earnings backed by rising exports to emerging market countries such as itself; proof that what goes around, comes around.



Weekend Radio Recommendation

For financially sound information
Find your town's public radio station,
Where the Marketplace crew
And Dr. Goose, too,
Will firm your financial foundation.

Tune into public radio's Marketplace Money with Tess Vigeland this weekend, as she talks debt ceiling limericks with David Lefkovits, alter ego of Dr. Goose. Find your local station and time or subscribe to the podcast.

Capitol Thrill-Seeker

A fellow who loved a good thrill
Made a bet on the debt ceiling bill,
Going 7 to 3
On a "yes" from the G.-
O.P. Caucus on Capitol Hill.

As the debt ceiling crisis heads toward the Default Date of August 2 with no resolution in sight, many are aware that this impasse has been manufactured by the Republican House majority to force spending cuts on the President and Congressional Democrats.  However, some extreme GOP representatives appear to want to force concessions on their Speaker as well.  The Wall Street Journal reports that Senators Rand Paul (R-KY) and Jim DeMint (R-SC) wrote to House colleagues that Speaker John Boehner's plan to cut $1.2 trillion in expenses doesn't go far enough.  The GOP may yet vote "yea" on a budget compromise, but don't bet your life on it.

What Happens if We Default?

On a US default, we deduct,
If the GOP reps can obstruct,
Our economy's fatally,
Foolishly, finally,
Fittingly, fecklessly f***ed.

Simon Johnson writes in Project Syndicate that some Tea Party Republicans hope that a US default will radically reduce government's role in the economy,

But the consequences of any default would, ironically, actually increase the size of government relative to the US economy – the very outcome that Republican intransigents claim to be trying to avoid.
The reason is simple: a government default would destroy the credit system as we know it.

The entire dollar-based credit system is founded on the assumption that US government debt is riskless; the entire economy is founded on credit; without the one, the other will contract fitfully, fiscally and ferociously.

Hat tip to Tess Vigeland of Marketplace Money.

Warning to Washington

Said the national raters of credit:
"The Congress appears not to get it;
We may downgrade a notch
While we wait and we watch
To see how out of hand they will let it."

The August 2 deadline, by which the US Congress must raise the federal debt ceiling to avoid defaulting on Treasury bonds and other obligations, is rapidly approaching. However, both Moody's and S&P have now warned that a downgrade of America's sovereign debt rating may come earlier, if the deadline looms closer without an apparently likely political compromise. This of course has alarmed the financial community, which may finally tip the political scales toward reaching a solution.

Treasury Bill

Said Clinton: "If loopholes would close,
And the government's revenue rose,
Then the corporate rate
Could greatly abate,
As Republicans like to propose."

Former President Bill Clinton may have found a way out of the standoff between Republicans and Democrats over a budget deal to raise the federal debt limit. Mr. Clinton points out that, although the US corporate tax rate is 35%, the average rate actually paid is more like 23%. Some masters of tax avoidance pay zero, as in the notorious case of GE. Why not lower the rate to a level that everyone will actually pay, such as 25%, while getting rid of special write-offs and exemptions?

Know Your Limit

When reaching the debt limit really,
One must balance the budget ideally,
So the rich are more taxed
(With their conscience relaxed)
And the middle class needy, but steely.

Washington politics reached the borders of business as usual yesterday, with the news that the $14.3 trillion federal debt limit has been reached. Although it is possible simply to increase it, the Republicans in particular do not want to do so without a plan for drastic reduction of the budget deficit, expected to hit $1.5 trillion this year. The GOP and Democrats remain far apart over how (and to whom) the pain of budget-balancing will be administered.

Fed-Up Stock Market

Sinking rates was the Fed's one desire
In becoming a big T-note buyer;
Though for naught they did meddle
In bonds, they can settle
For driving stock indices higher.   



The Wall Street Journal's Ahead of the Tape columnist, Kelly Evans, notes that "QE2" (the second round of quantitative easing) failed in its goal of lowering long-term interest rates, but has been correlated with a 19% increase in the S&P 500 index since August.  Should we take stimulus any way we can get it?

TIPS Under Zero

The Treas'ry's inflation-linked note
Is yielding a negative quote;
If deflation holds sway,
It's investors who pay,
Though the likelihood may be remote.   

For the first time ever, the Treasury Inflation-Protected Securities (TIPS) were issued at a negative yield: -0.55%. Since the actual interest payments will include an inflation premium (currently expected to be 1.7% per annum over the five-year life of the notes), investors will likely receive a net interest rate of something like the current 5-year T-note yield of 1.18%. However, if inflation slows, investors earn less, and may even end up paying interest to the Treasury.

It's All Relative

The US isn't having its best year,
But the world hasn't ceased to invest here;
Since Europe is weaker,
A typical seeker
Of safety may feel not as stressed here.