first majestic silver

Forces In Yield Curve Inversion

December 28, 2005

The US Treasury yield curve has finally inverted. The actual point of inversion is the 5-year TNote, which at this moment is 4.31% versus the other barbell endpoints. The 2-yr and 10-yr TNote yields are near 4.36% and almost equal to each other. Remarkably, the entire maturity curve has come down in yields, as the long end and short end and belly have declined in the last month. A great debate has been sparked on its meaning. Initial debate is on calling the curve as "flat" and not "inverted" yet, nothing but a minimization of the unfavorable signal indicated. No single answer seems adequate. This holiday memorandum touches on a few key relevant points. To my surprise, the media has succeeded in putting before us several major issues toward the debate. The surprise owes to the competent coverage. Little has been overlooked, however, the denial of economic distress seems almost totally dismissed. The real economy is hurting, even as the bubblicious financial sector is showing fatigue. The debate will be covered more comprehensively in the January Hat Trick Letter.

Two weeks ago, the US Federal Reserve hiked the Fed Funds short-term interest rate target to 4.25%, up 25 basis points. Since that time, the bond market has seen fit to signal slower weaker economic activity, a slap in the USFed face, a contradiction to the "all is well" mantra promoted. The 10-year Treasury Note yield has fallen from the 4.5+% range to the 4.3+% range. Is Greenspan watching? Are USFed governors aware? Will these clown hack economists continue the tightening process? The futures market thinks YES. With each mindless rate hike comes another wet blanket atop the fragile USEconomy, hidden from view. While oldline pundits and professionals laud the USFed for its measured pace and prudent management, it is hard to conclude the monetary tightening which has taken us from 1.0% to 4.25% so far is anything but restrictive. Our financial sphere depends upon bond arbitrage, speculation, and spread trades so heavily. Our commerce centers require cheap credit, if not vendor financing. We all are taught of a significantly detrimental lagged effect from numerous rate hikes. Well, the time is here & now.

This is not the 1970 decade or the 1980 decade or the 1990 decade. Low interest rates power commerce throughout the system in a highly perverse fashion. In past decades, nowhere was 0% financing available to purchase an automobile, an expensive home entertainment system, a jacuzzi, large furniture items, or home improvement projects. Nowhere were ongoing assaults, nay bombardments, delivered in the daily mailbox for 0% credit card loans and low "life of loan" similar revolving credit loans. The explosion of home equity extractions, bill consolidation loans, and other sizeable borrowings depend on cheap money. That money is getting more costly. The USEconomy depends heavily upon it, more than so-called experts gauge.

Never expect Wall Street to regard signals as anything but positive, promising, optimistic, and bullish. These whore charlatan carnival barkers have never spotted a signal clear in its negative tone. They now point to lower long-term bond yields and the high valuations (price earnings ratios) they justify. Wow! So severe economic slowdown and correspondingly low long-term interest rates would be a good signal then, right? Well, we have strong robust vibrant Gross Domestic Product data to counter any hint of slowdown, right? Sure, if you accept the falsified GDP, permit price inflation to be labeled as growth via suppressed deflator series, and compound the error propagated in the chain weighting technique. This has been a theme repeated frequently, vigorously, loudly, and emphatically for the last few months. The United States economy is in a stall, fully masked by the housing boom, which itself is stalling.

The bond yield curve might sniff out a soft housing market, whose critical measures signal some distress, whose available spendable equity is critical to the retail shopping malls serving as our economic foundation. It has been estimated that up to 50% of all recent growth in our national economy has been derived from the housing boom. Let's call a spade a spade. The housing boom is actually an inflated bubble, engineered with full premeditation by Chairman Greenspan since 2001. In the summer and autumn months of that year when the USFed began its easing process on rates, Greenspan almost desperately (and very unprofessionally) urged long-term interest rates to come down, for mortgage rates to come down, even killing the 30-yr TBond auction sales. The long dated securities did witness a rally, with the good Mr Magoo cheerleading all along the path. With no 30-yr TBonds for sale, the demand was ushered into the 10-yr TNote, which serves as the hedged foundation for the entire mortgage finance industry. Somewhere between $600 and $700 billion was pulled from home equity in 2005. Anyone who ignores this as a key driver to economic growth is a pure hack, naïve to the reality that debt drives the engines whereby households pay for routine expenses as well as the frivolous garbage bought on a daily basis. My joke with several (mostly female) friends revolves around buying "stupid junk stuff" in order to relieve boredom if not depression, to feel good about a new toy to play with, or article of clothing to wear, or silly item to adorn the wall, or a strange utensil sure to end up idle in a drawer. Isn't it absurd how we are told that lower energy costs (gasoline mainly) will not force non-productive spending this autumn, sure to permit more purchases of essentials? From my vantage point, the great majority of retail spending is noway essential, but pure garbage, hardly productive, if not mostly destructive. Where do we see the masses buying books or training software? The only training visible is for abuse of debt, relief of debt, bankruptcy restructuring, refinanced mortgages, reverse mortgages, and the grab of structured settlements.

Would somebody please stand up and define what inflation is? Nowhere is it seen, yet we are told the bond market has priced in lower rates due to pervasive low inflation expectations. Take a gander at the Producer Price Index. Take a glance at energy costs (gasoline, diesel, heating oil, natural gas, electricity) and tell me where the lower costs lie. As long as the amateur magicians on Wall Street and the USGovt put forth official statistics with core rates stressed so much, the public will continue to accept the distracted numbers heralded by the adept conjurers. We all eat and burn fuel. We all require food and transportation. If the core is stable in price, yet the extra essentials are all more costly, what have we gained? In my book we have gained a profit squeeze! The big dirty secret in the investment community is that S&P500 index appreciation in 2005 came from the energy sector by a 30% component. Energy drove the mainstream stock market. In the process, hard assets like gold, silver, copper, zinc, tin, lead, cobalt, strontium, vanadium, molybdenum, platinum, palladium, coal, oil, natural gas, steel, cement, lumber, scrap (metal, plastic, fiberboard) have come to the fore. Certain key items among this long list have emerged as an asset class unto themselves. This paradigm shift screams of cost inflation. What lower inflation expectations? It is more like low profit expectations. Claims of grander corporate profits are actually derived from lower capital expenditures and lower depreciation. We have monster cost inflation, not offset by either pricing power or growing worker wages. Hack economists point to lower inflation expectations without the skill to define the term or understand the implications of the nasty mixture of rising costs.

My old buddy Kurt Richebächer harped repeated during my memorable week on the French Riviera in Aug2003 that "as the national car industry goes, so goes its economy." These are harsh words, a dire warning. Since early in 2004, echoed numerous times throughout 2005, my pen has screeched the upcoming death knell of the US car industry. We have seen it with GM this summer in unmistakably clear fashion, as sales have declined, labor unions keep plants operating, pensions are undercut, product recalls persist, and debt downgrades shame Detroit. As credit default swaps are killed without mercy, USTBonds are rebought to unwind the spread trade deployed by hedge funds. The Treasury market rallied widely. My perspective has been stated to my subscribers. Whatever happens to GM this year, it happens to Ford next year. The bond market reveals the ugly games behind the scenes played by the hedge fund spread traders. Chairman Greenspan admires them for offloading risk, but they might be described as planters of incendiary bombs in the financial marketplace akin to terrorist bombers.

Hey, stop! Let's bring some reality into the title!

This is such a crazy absurd nutty deceptive rationalized piece of propaganda which plays not only on Wall Street and in Chicago, but also on Main Street and in Peoria. The carnival barkers (primary promotional pumpers) wish to portray the general picture as full of strength, rather than focusing upon our weakness. Instead they reframe it as Asian strength replete with savings from robust industrial development, widespread Western partnerships, enormous business investment, grand trade surpluses, rapidly growing foreign reserves held in central banks, and general prosperity. Those who wish to describe the picture more realistically must direct attention to the gargantuan (and still expanding) US trade deficit now approaching $70 billion per month. It is funded by a credit explosion never seen before in humankind, founded upon a monstrous housing bubble, drawn mainly off home equity borrowed, wasted on unproductive retail consumption. This represents a bonafide capital hemorrhage, much more than an Asian juggernaut. To be certain, China and the more developed economies in the Far East are experiencing enervated economies. However, their domestic demand is sorely lacking, enough to raise a red flag. Western demand and Eastern production has made for strange bedfellows. The debts of the former make for the savings for the latter. Whether savings or capital hemorrhage, the stark reality is that Asian central banks from 2001 to the early months of 2005 have pushed down the 10-yr TNote yield by perhaps 0.75% or 75 basis points. This is undeniable.

What Wall Street and CNBC seems unwilling to acknowledge is that China and Japan have added to USTBond holdings almost nothingsince May2005. We are fully capable to warn of dire times if Asia withdraws from our Treasury support. They have done just that in the last seven months. So has OPEC pulled back in Treasury support. This is hardly mentioned by our intrepid lapdog press & media, undoubtedly the worst and least competent in the Western world. In fact, the biggest recent TBond support comes from the Royal Bank of Canada, which is avidly trying to forestall a quick dangerous rise in the most powerful currency on earth, the CANADIAN DOLLAR. For four years, rampant USTBond monetization has been indirect in its path from USDollar creation. New money was hatched in big banks, hedge funds, and mortgage agencies. That money originated in its funding from Asia. Since the summertime, that money might be more directly funded by the US Federal Reserve in more secretive purchases, monetization which bypasses Asia, since they have halted direct subsidy support.

A flat (if not inverted) Treasury yield curve at least signals an economic slowdown. Wage growth is near nonexistent. We spend more than we earn, thus negative savings. Job security is near nonexistent. Pensions are under siege. The inversion tells me that the troublesome real economy, where jobs are exported to Asia, is undergoing continued distress. But now, with this new signal, the financial sector is about to lose its pressurized bubble, only to give off gaseous vapors. PLEASE DON'T INSULT MY INTELLIGENCE BY TALKING ABOUT A SOFT LANDING. We have not seen a soft landing under the aegis of Chairman Greenspan ever!!! So should a sane person anticipate one here in 2006? Is it different this time? Don't look now, but the secular deflation scenario might soon unfold. The USFed had better end its tightening and renew its easing process. The USFed has clearly targeted the housing industry. But we all know that industry is the golden goose who laid the eggs we have been eating for five years. The USFed is attacking the pillars to the USEconomy. The USFed is relying upon falsified economic statistics, each and every one gravely corrupted and polluted.

The imbalances cry loud in geopolitical tension. Resolution toward a stable equilibrium seems an impossibility. If a move in the next couple years toward market balance is anticipated without major conflict, then we surely have a break from reality with some sort of psychotic viewpoint. In my view, the vast differential has set the stage for explosive outcomes, full of trade war, battles for scarce resources, currency warfare, large scale subsidies of critical industries, blackmail usage of foreign reserves, powerful new commercial & military alliances, and worse. By "worse" is meant military war and tectonic shifts to the political framework which we operate under on the major continents. That stink in the air, it is either from the putrid winds of war or acidic rise of state power. The loser has been the free market, far too controlled and manipulated in the last few years. Expect more control and "management" of the Treasury bond market under the new wet-behind-the-ears Chairman Bernanke.

The implications to debts, bankruptcies, interest rates, foreign support, currencies, gold, commodities, and energy are fully addressed in the monthly newsletter.


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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at For personal questions about subscriptions, contact him at [email protected]

Jim Willie

Jim Willie

Jim Willie CB, also known as the “Golden Jackass”, is an insightful and forward-thinking writer and analyst of today's events, the economy and markets. In 2004 he launched the popular website that offers his articles of original “out of the box” thinking as well as content from top analysts and authors. He also has a popular and affordable subscription-based newsletter service, The Hat Trick Letter, which you can learn more about here.  

Jim Willie Background

Jim Willie has experience in three fields of statistical practice during 23 industry years after earning a Statistics PhD at Carnegie Mellon University. The career began at Digital Equipment Corp in Metro Boston, where two positions involved quality control procedures used worldwide and marketing research for the computer industry. An engineering spec was authored, and my group worked through a transition with UNIX. The next post was at Staples HQ in Metro Boston, where work focused on forecasting and sales analysis for their retail business amidst tremendous growth.

Jim's career continues to make waves in the financial editorial world, free from the limitations of economic credentials.

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