Economy of means
Try foretelling time well spent
No telling in these trying times
To tell the truth you tell it slant
That time does not repeat but rhymes
Past performance does not guarantee future results. But ignoring the past guarantees future underperformance, while distorting history results in futures disfigured. If journalism is a first draft of history, financial-economic journalism is its first overdraft, managing both ignorance and distortion at once. But readers demand explanations, narratives that make sense of "market reaction" (a perennial complaint), whether to real news or to the release of economic statistics. Such statistics are a necessary shorthand, for all their shortcomings (and revisions) a corrective to anecdotal speculation, but frequently become a basis for wilder economic extrapolations, economical with nuance and with fact alike. So I'm pet-peevishly returning to the yield curve and the shape of things to come, but first reprising some commentary over at FT's Long Room (a semi-private area of the FT Alphaville blog):
from early December:
First time as tragedy, second as farce
April 2010
1) Greece teeters on brink of default
2) SEC goes after financial misdealings in Goldman Sachs / hedge funds
3) Oil spill impacts offshore drilling
November 2010
1) Ireland totters on brink of default
2) FBI goes after financial misdealings in expert networks / hedge funds
3) Document spill impacts offshore dealing
to which I'll add: relief at results of Portugal's latest bond auction are reminiscent of Greece's a year ago ...
from September (back when double-dipping was all the rage):
The Mild Depression
What's in a name? Calling the latest contraction "The Great Recession" manages to both overstate and understate the case, and sets in place false expectations for the shape of recovery. I propose "The Mild Depression" as more appropriate to the circumstances.
The difference between recession and depression evolved through common usage. The term "recession" gained currency to differentiate from The Great Depression (itself a term one-termer Hoover popularized; in the last episode of similar magnitude to today, one deserving of the moniker "The Great Recession", Alfred Kahn's proposal for "banana" never quite gained traction). "Depression" has come to mean a GDP contraction on a massive scale, at the expense of useful qualitative and other quantitative distinctions, for example deflationary vs inflationary impact, employment levels, or duration of effects.
David Rosenberg's corrective assessment of our current economic malaise underscores how this episode differs from prior post-war experience, but is misleading in its implicit comparison to the inter-war one: as historical analogues go, the past decade or so more usefully viewed (at least from a financial economics standpoint) as a centennial historical re-enactment, the last 3 years (and the consequent ongoing rejiggering of the regulatory regime) corresponding to the 1907 Bankers' Panic (and to the establishment of the Federal Reserve System, trust companies being the shadow-bankers of the time). But ramifications were more local, as the US was not yet a leading player on the world stage. It's not merely a matter of getting the right metaphor, it's getting the metaphor right; pace Rogoff and Reinhart, not just this time, but every time, it's different.
But relative to what to measure the differences? Just as recent experience defies the prevailing economic frameworks, the historical analogues fail to account for substantive structural changes. The most severe past global contractions predate the consolidation of fiat currencies, multinational corporations (especially in finance), and the service economy. The lead political actors seem to understand that 'beggar thy neighbor' tactics ultimately boomerang, and that a lovely little world war is no longer a viable exit strategy; historically speaking, the degree of coordination among governments has been remarkable.
One place to look for guidance is in how recent recoveries have deviated from expectations. The inelasticity of the US jobless rate in the last two mild recessions does not augur well. The ultimate profitability[?] of Resolution Trust/Funding Corp., the government's excursion into cleaning up the S&L crisis, hits a brighter note (cf TARP), as does the fact that commercial real estate hasn't cratered. Still, the artificial floor that has been installed beneath the residential housing market indicates that it will be a long time before that becomes an engine of recovery in the US, meanwhile skewing CPI lower (in my book, statistics come after lies and damned lies, but before demographics), while consumer demand seems likewise on a lower growth path, and so with business investment, and so on.
Taking a more global perspective, the burgeoning of sovereign balance sheets is most important in a relative sense: it's not the absolute level so much as how much that level exceeds peers (pot, kettle, minstrel show). One silver lining is that the crisis in developed countries has served to better integrate into the global economy those emerging markets whose balance sheets had improved since the Asian contagion. The banks' balance sheets now have Basel III as benchmark, the long phase-in mitigated by more proximate market discipline. In the US it's the household balance sheet that weighs most heavily against potential growth (and not on average, given the rising Gini coefficient).
Economic theory, much maligned in the course of events, still seeks an elusive equilibrium, now to incorporate financial intermediaries as players rather than just facilitators. I suppose this is rational behavior, at least by their lights, but I note that economist jokes have lately overtaken lawyers in popularity. The economy's itself in a transitional state (when isn't it?), the myriad interventions clouding where it will find what will be called a new equilibrium, regardless of what fundamentalist IS-LMists may say. Statistically, the lesson to be drawn from recent events is to only listen to economists whose name begins with the letter 'R': Roubini, Rajan, Rogoff, Reinhart, Roach ... Rosenberg?
Yogi Berra once said, "It's tough to make predictions, especially about the future." Much of the current commentary seems not to have much of a grasp of the past, much less the present, distorted by focus on a preferred prospective state of affairs, making it much tougher to get right. But then Yogi also said "The future ain't what it used to be."
So, as I was saying ... I've been bemused by continuing economic commentary and forecasts relying upon the history of the 2yr-10yr spread in U.S.Gov't notes. In normal times this may be a fair characterization of the shape of the yield curve, but these are far from normal times and the curve is warped by ZIRP and quantitative easing. (And the last "inversion" in 2-10s was of negligible magnitude relative to its supposed effect, but I've been over that before.) This isn't to say that there aren't signals to be discerned from the curve: one positive sign is that the area of maximum slope has migrated back below the 5-year mark. More widely, the hold of the bipolar "risk-on / risk-off" trade on the markets has weakened, as have correlations between asset classes (good: differentiation may cause sectoral pain but is return to systemic health) and co-ordination between governments (not so good, although not necessarily dire).
So how are my predictions holding up? Pretty well: for the 7-yr note recommendation, with recent yield curve resteepening, change over the past 18 months in the 5-yr yield have been largest (-0.7%, or -1.4% with curve roll-down), while unannualized total return (including coupons & roll-down) has been 10% for 7- & 10-yr, vs 8% for 5- and 30-yr; compared to 6 months ago, the 7-yr held its overall return while everything longer lost value and everything shorter eked out tiny gains. As for the benchmark bond swap spread, I was low by 5 basis points on level but otherwise on-target: I said -10 to 0bp for 2-3 months, then 0-5bp; we had -5 to 5bp for 2 months, and, except for a month-long excursion into the low teens post-election, 5-10bp since.
But where do we go from here? I don't know, I'm not going there ... I'd say your guess is as good as mine, but it probably isn't. I leave regular econoblogging to those who think they know better. Oh, if only they did ... and by now you'd think they would.
No telling in these trying times
To tell the truth you tell it slant
That time does not repeat but rhymes
Past performance does not guarantee future results. But ignoring the past guarantees future underperformance, while distorting history results in futures disfigured. If journalism is a first draft of history, financial-economic journalism is its first overdraft, managing both ignorance and distortion at once. But readers demand explanations, narratives that make sense of "market reaction" (a perennial complaint), whether to real news or to the release of economic statistics. Such statistics are a necessary shorthand, for all their shortcomings (and revisions) a corrective to anecdotal speculation, but frequently become a basis for wilder economic extrapolations, economical with nuance and with fact alike. So I'm pet-peevishly returning to the yield curve and the shape of things to come, but first reprising some commentary over at FT's Long Room (a semi-private area of the FT Alphaville blog):
from early December:
First time as tragedy, second as farce
April 2010
1) Greece teeters on brink of default
2) SEC goes after financial misdealings in Goldman Sachs / hedge funds
3) Oil spill impacts offshore drilling
November 2010
1) Ireland totters on brink of default
2) FBI goes after financial misdealings in expert networks / hedge funds
3) Document spill impacts offshore dealing
to which I'll add: relief at results of Portugal's latest bond auction are reminiscent of Greece's a year ago ...
from September (back when double-dipping was all the rage):
The Mild Depression
What's in a name? Calling the latest contraction "The Great Recession" manages to both overstate and understate the case, and sets in place false expectations for the shape of recovery. I propose "The Mild Depression" as more appropriate to the circumstances.
The difference between recession and depression evolved through common usage. The term "recession" gained currency to differentiate from The Great Depression (itself a term one-termer Hoover popularized; in the last episode of similar magnitude to today, one deserving of the moniker "The Great Recession", Alfred Kahn's proposal for "banana" never quite gained traction). "Depression" has come to mean a GDP contraction on a massive scale, at the expense of useful qualitative and other quantitative distinctions, for example deflationary vs inflationary impact, employment levels, or duration of effects.
David Rosenberg's corrective assessment of our current economic malaise underscores how this episode differs from prior post-war experience, but is misleading in its implicit comparison to the inter-war one: as historical analogues go, the past decade or so more usefully viewed (at least from a financial economics standpoint) as a centennial historical re-enactment, the last 3 years (and the consequent ongoing rejiggering of the regulatory regime) corresponding to the 1907 Bankers' Panic (and to the establishment of the Federal Reserve System, trust companies being the shadow-bankers of the time). But ramifications were more local, as the US was not yet a leading player on the world stage. It's not merely a matter of getting the right metaphor, it's getting the metaphor right; pace Rogoff and Reinhart, not just this time, but every time, it's different.
But relative to what to measure the differences? Just as recent experience defies the prevailing economic frameworks, the historical analogues fail to account for substantive structural changes. The most severe past global contractions predate the consolidation of fiat currencies, multinational corporations (especially in finance), and the service economy. The lead political actors seem to understand that 'beggar thy neighbor' tactics ultimately boomerang, and that a lovely little world war is no longer a viable exit strategy; historically speaking, the degree of coordination among governments has been remarkable.
One place to look for guidance is in how recent recoveries have deviated from expectations. The inelasticity of the US jobless rate in the last two mild recessions does not augur well. The ultimate profitability[?] of Resolution Trust/Funding Corp., the government's excursion into cleaning up the S&L crisis, hits a brighter note (cf TARP), as does the fact that commercial real estate hasn't cratered. Still, the artificial floor that has been installed beneath the residential housing market indicates that it will be a long time before that becomes an engine of recovery in the US, meanwhile skewing CPI lower (in my book, statistics come after lies and damned lies, but before demographics), while consumer demand seems likewise on a lower growth path, and so with business investment, and so on.
Taking a more global perspective, the burgeoning of sovereign balance sheets is most important in a relative sense: it's not the absolute level so much as how much that level exceeds peers (pot, kettle, minstrel show). One silver lining is that the crisis in developed countries has served to better integrate into the global economy those emerging markets whose balance sheets had improved since the Asian contagion. The banks' balance sheets now have Basel III as benchmark, the long phase-in mitigated by more proximate market discipline. In the US it's the household balance sheet that weighs most heavily against potential growth (and not on average, given the rising Gini coefficient).
Economic theory, much maligned in the course of events, still seeks an elusive equilibrium, now to incorporate financial intermediaries as players rather than just facilitators. I suppose this is rational behavior, at least by their lights, but I note that economist jokes have lately overtaken lawyers in popularity. The economy's itself in a transitional state (when isn't it?), the myriad interventions clouding where it will find what will be called a new equilibrium, regardless of what fundamentalist IS-LMists may say. Statistically, the lesson to be drawn from recent events is to only listen to economists whose name begins with the letter 'R': Roubini, Rajan, Rogoff, Reinhart, Roach ... Rosenberg?
Yogi Berra once said, "It's tough to make predictions, especially about the future." Much of the current commentary seems not to have much of a grasp of the past, much less the present, distorted by focus on a preferred prospective state of affairs, making it much tougher to get right. But then Yogi also said "The future ain't what it used to be."
So, as I was saying ... I've been bemused by continuing economic commentary and forecasts relying upon the history of the 2yr-10yr spread in U.S.Gov't notes. In normal times this may be a fair characterization of the shape of the yield curve, but these are far from normal times and the curve is warped by ZIRP and quantitative easing. (And the last "inversion" in 2-10s was of negligible magnitude relative to its supposed effect, but I've been over that before.) This isn't to say that there aren't signals to be discerned from the curve: one positive sign is that the area of maximum slope has migrated back below the 5-year mark. More widely, the hold of the bipolar "risk-on / risk-off" trade on the markets has weakened, as have correlations between asset classes (good: differentiation may cause sectoral pain but is return to systemic health) and co-ordination between governments (not so good, although not necessarily dire).
So how are my predictions holding up? Pretty well: for the 7-yr note recommendation, with recent yield curve resteepening, change over the past 18 months in the 5-yr yield have been largest (-0.7%, or -1.4% with curve roll-down), while unannualized total return (including coupons & roll-down) has been 10% for 7- & 10-yr, vs 8% for 5- and 30-yr; compared to 6 months ago, the 7-yr held its overall return while everything longer lost value and everything shorter eked out tiny gains. As for the benchmark bond swap spread, I was low by 5 basis points on level but otherwise on-target: I said -10 to 0bp for 2-3 months, then 0-5bp; we had -5 to 5bp for 2 months, and, except for a month-long excursion into the low teens post-election, 5-10bp since.
But where do we go from here? I don't know, I'm not going there ... I'd say your guess is as good as mine, but it probably isn't. I leave regular econoblogging to those who think they know better. Oh, if only they did ... and by now you'd think they would.
posted by nnyhav | 00:16
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