Sunday, January 09, 2005

PIMCO commentary

Here is the latest from PIMCO's Bill Gross. One interesting comment: It is PIMCO’s opinion that central bank purchases in 2004 were the primary force in lowering 10-year Treasury rates from 4.90% to nearly 4.0% in October, while the Fed was in the process of raising short rates by 125 basis points.  On the other hand I keep reading that China's central bank holdings are generally of short duration. I suppose the Japanese can afford to go out further on the yield curve: real interest rates in Japan are close to zero, so a 4.2% yield on 10y Treasurys doesn't look so bad. Also, the $700B in Treasurys they currently hold is only a small component of their national savings.

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14 comments:

Anonymous said...

steve.

There pretty clearly is foreign buying (i.e. CB buying) of at least the 5 year. here is some raw data on recorded purchases.

http://www.fms.treas.gov/bulletin/b44pdo4.doc

Some of the I-banks have published material suggesting that CBs are buying the longer end of the curve as well.

My general sense is that the MOF/ BOJ go for the shorter end of the curve (2 yrs). Their cheap cost of funding means that they don't have to worry too much about yield. They cover their costs even at the short-end, and they are reportedly relatively conservative, i.e. they manage their reserves as traditional reserves, not as investments ...

China a) has not been buying that many treasuries through recorded channels and b) seems interested in agencies (long duration). It would not surprise me if they were also buying longer maturity treasuries in the secondary market, perhaps through intermediaries. China's cost of funds are a bit higher than Japan's, so they have to worry a bit more about yield to avoid "fiscal" costs. Remember that the increase in China's treasury holdings in the TIC data this year lags their reserve increase in a big way -- so they clearly are doing something, we just don't know what. US data only picks up certain kinds of CB inflows (the BIS dollar reserves v. BEA official inflows data discrepency)

Then throw in US debt management -- which has kept the supply of 10 years limited/ met CB demand at other points on the curve -- and the response of US investors to the heavy CB demand at some points of the curve (they "pushed into the 10 yr), and I think Gross may well be right. Total foreign buying exceeded US net issuance by a big margin this year ...

brad

10:45 AM
Steve Hsu said...

Brad,

Very interesting comments. I've also heard that foreign CBs have been getting into agency debt. Right now everyone is in the same boat - how to find reasonable yields without taking on too much risk.

I've seen a lot of predictions that the dollar is oversold right now (at least in the short term) and will come back a bit. It looks like US interest rates are headed up, while in europe they are headed down, which should take a little pressure off.

Roach seems to be on the extreme end in predicting a dollar meltdown. Most other analysts seem to give it only a small probability. Somehow I can't see the PBOC, BOJ, BOK, BOT letting it happen. I suppose the euro could still go higher, though.

1:42 PM
Anonymous said...

Stephen Roach has long been of the no pain-no gain economic school. Frankly I do not recall him ever being enthuiastic about the economy, and has been regularly calling for austerity and asset price target measures for more than a decade. Always compelling to read, but I am cautious in heeding.

2:42 PM
Anonymous said...

The dollar certainly rallied last week.

But I have never quite understood the "$" is oversold argument in some deeper sense. tis true that the dollar fell sharply and fast v. a few currencies this fall, and thus some charts say it is due for a rebound. But the broad dollar remains well above its 1990-97 level -- and that was a level consistent with a stable trade deficit. Maybe falling back to that level with a much higher deficit than we had then will produce some small fall in the deficit, maybe it will produce (after a lag) a constant deficit -- but my gut combined with some experience with trade modelling tells me that a broad dollar in the 95 (fed scale) is not going to bring the trade deficit back down to sustainable levels if us growth continues on its current path.

Put differently, until the trade deficit falls back to sustainable levels, i have a hard time arguing that the overall dollar has overshot on the downside, though it may have fallen too far and too fast v some currencies and not enough (or not at all) v. others.

In any case, right now, I don't see any signs that the fall in the $ (or more accurately, the lagged impact of the dollar's big fall in 03) is reducing the trade deficit, or the US borrowing need. So in a sense, the dollar can only stay where it is if the PBOC, the BOJ, the BOK, the BOC (taiwan), the BOT (thailand) and the Bank Negara Malaysia, the BOI and the BOR combine to keep it where it is -- barring that, it has to fall to the point where private investors find the dollar and dollar assets cheap. It took something like $450-500 billion in intervention in 04 to keep the dollar from falling further. My sense is that it will take that much or in 05 to produce the same result. there are not enough 2 year treasuries to absorb that kind of intervention, so the money has to end up somewhere.

p.s. am working on a post on the $, so it is on my mind!

brad

2:42 PM
Anonymous said...

http://www.nytimes.com/2005/01/09/opinion/9sun2.html

A Divide China Must Conquer

To understand today's China, it is necessary to look beyond the unfathomable ebb and flow of 1.3 billion people. It is only by studying the few that it is possible to grasp what is happening to the overwhelming many - like Yu Jikui, a porter whose slight by a passer-by set off riots in Wanzhou; or the young Yang Shan, whose parents both work in distant cities; or the developer Zhang Yuchen, who built a castle fit for Marie Antoinette where 800 farmers once grew wheat.

Anne

2:43 PM
Anonymous said...

http://www.nytimes.com/2005/01/09/magazine/09COUNTERFEIT.html?pagewanted=all&position=

Manufaketure
By TED C. FISHMAN

Counterfeiting and pirating (that is, making knockoffs of what developed nations have created) are at the heart of the Chinese economic boom. As unethical or illegal as it might be, the Chinese government is not about to stop it.

Anne

2:44 PM
Anonymous said...

http://www.epinet.org/content.cfm/webfeatures_econindicators_jobspict_20050107

Relative to last December, the hourly wage is up 2.7%, likely below inflation, which was up 3.5% in the most recent data for November 2003 through November 2004. Wage growth started the year considerably slower than in 2003, and averaging over all of 2004, hourly earnings were up only 2.1%. This increase was well below inflation and marked the lowest growth rate for hourly earnings on record, going back to 1964.

...

Though the dollar has fallen in value and commodity prices have climbed, labor costs for employers have been constrained these last 5 years. Labor is easily the most expensive component of production, and as long as labor costs are constrained there seem little reason to expect much inflation. So, why not have low long term interest rates?

2:54 PM
Anonymous said...

http://www.nytimes.com/2005/01/09/national/09jobless.html?pagewanted=all&position=

For Unemployed, Wait for New Work Grows Longer
By JOHN LELAND

When Fabiola Quitiaquez lost her job in New York City last May, she moved to the Atlanta area, confident that she would easily find work there.

'I thought maybe it would take two or three months,' she said.

But after six months Ms. Quitiaquez was still unable to find a job, even cleaning houses or caring for the elderly. As her unemployment benefits ran out in November, she found herself at odds with news reports of economic recovery. 'I realized what all these people like me were going through,' she said.

Ms. Quitiaquez, 50, is one of about 3.6 million American workers who ran out of unemployment insurance benefits last year, the most in at least three decades, said Isaac Shapiro, a senior fellow at the Center on Budget and Policy Priorities, a research and advocacy group that supports extending unemployment benefits.

Anne

3:07 PM
Steve Hsu said...

Brad,

By "oversold" I meant in the short term (i.e., based on psychology of traders) - not that we are yet at a level where macro imbalances are affected. Long term I believe the dollar will go lower, particularly against the Asian currencies. The micro-mechanism for dollar moves involves traders taking positions against it, and my vague impression from various bank and analyst reports is that these guys are taking profits right now - long term they will be back at it until the macro issues resolve. (BTW, I'm looking forward to your upcoming post!)

Regarding the inflation numbers someone posted, I am less concerned about inflation than the Fed seems to be. The last jobs number of 170K is barely above the 150K or so we need each month just to absorb new entrants into the labot market (due to demographics). The percentage of working age people who have jobs is well below the late 90s number. I just don't see a lot of inflationary pressures other than perhaps commodity prices and perhaps the second order effects of dollar devaluation. Nevertheless it is probably wise for them to get short term rates above neutral, just in case.

Finally, the NYT piece on IP and piracy that Anne posted shows how much the Chinese are benefitting from the current trade regime - huge amounts of technology transfer. I believe that is why they are willing to accept dollars with an uncertain future as payment for their products. If you look at the Yen history I posted, the Japanese did the same, and suffered a huge devaluation of their dollar holdings after Plaza.

3:19 PM
Anonymous said...

Steve and Brad

Wonderful exchange. I posted the labor cost note and inflation argument, but as usual forgot to sign :) Steve's note on technology transfer is especially interesting.

Anne

3:44 PM
Anonymous said...

A while ago, I went through World Bank data on intellectual property accumulation. I was thinking to southern Africa, and how Africa might fare giving the quickly growing imbalance in such accumulation. China was in my mind, for China "asks" technology transfer as the price of business. But, what of Nigeria? What of Malawi? What of even South Africa? We must think about this.

3:52 PM
Anonymous said...

Anne, oh well :)

3:52 PM
Anonymous said...

Though the Yen strengthened against the dollar through the decades, and Japan built dollar reserves through the decades, I never heard the question asked whether development might not be worth the exchange losses. What we might ask however is whether the Plaza Accord would come to limit Japanese growth severely? China must be careful as the Yuan rises in value, and I am increasingly thinking China will be buying Treasury bonds for longer than we might guess from just looking at the exchange loss factor. Again, what a fine post and comments with Brad Setser.

Anne

6:11 PM
Anonymous said...

steve -- alas, i am still working on my broad dollar post; i broke it into two and put the less technical bit up. the remaining half probably is way too in the weeds of the moves in the broad dollar to be of general interest.

brad

7:40 PM

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