How Bad Was It?

After I posted this yesterday at about 3PM EDST, the S&P 500 fell another 10 points in the last hour of trading and the yield on the 10-year Treasury fell another several basis points.  Lars Christensen, in his comment, tried to put a better face on things by suggesting that implied inflation expectations as measured by the TIPS spread had not really moved very much.  That was true on Friday and Monday, but yesterday they dropped sharply.  I use the TIPS spread on the 10-year constant maturity Treasury Bond, which I can only get from the St. Louis Fed with a one-day lag.  However Bloomberg reports the TIPS spread on two and five year Treasuries.  And they both dropped steeply yesterday.  So, despite Lars’s attempt to cheer me up, I am still worried.

16 Responses to “How Bad Was It?”

  1. 1 Lars Christensen August 3, 2011 at 5:54 am

    David, no reason to become all gloomy here;-)

    Yes, we have had a bit of volatility in TIPS inflation expectations this week, but inflation expectations (5y) are now just around 2% down (up and down 10-15bp this week) and well above the lows of the year in June. Furthermore, there are no signs of a downtrend in inflation expectations and inflation expectations are much higher than in September 2010 when inflation expectations was down to around 1%. So as much as I hate saying that FDR did it in 1933 I think Ben has done it: Inflation expectations have been stabilised. This of course demonstrates that if the Fed had a price level target or a NGDP target the crisis would likely be history already.


  2. 2 David Glasner August 3, 2011 at 9:30 am

    Lars, I agree with you until last Friday. But I am afraid that there could have been a shock to the system, and that even the current anemic recovery path may no longer be sustainable without a significant monetary boost. So I am worried, but we shall have to see how this plays out in the coming days.


  3. 3 jj August 3, 2011 at 10:57 am

    What’s the difference between the TIPS spreads you linked to and the N-year breakeven?

    The 10-year breakeven is available:

    The definition in the link is: “The rates are United States breakeven inflation rates. They are calculated by subtracting the real yield of the inflation linked maturity curve from the yield of the closest nominal Treasury maturity. The result is the implied inflation rate for the term of the stated maturity.”


  4. 4 Luis H Arroyo August 3, 2011 at 11:11 am

    not rule out a negative influence of the euro problem (more and more involved) in the U.S. markets.
    This would lower bond yields and stocks. Yields of Spain are increasingly alarming: two days in 400 bp above Germany.


  5. 5 David Glasner August 3, 2011 at 11:34 am

    Luis, I have not been giving enough thought to the Euro situation. You are right that what is happening there could be another factor in upsetting US markets.


  6. 6 Lars Christensen August 3, 2011 at 11:39 am

    Luis, I completely agree. To me the situation in the European fixed income markets are much, much more worrying than the US situation and most of what we see in the US markets reflect the European worries – as I also stressed below. Fed has reestablished deflation fighting credibility but the ECB has not.


  7. 7 Luis H Arroyo August 3, 2011 at 12:38 pm

    i think (I´ve posted about recently) that the risk of an implosion of the euro is rising and weighting a lot in markets. I don´t understand why you, american economist, neglet this factor. You have analysed the problem quite in extense, but not the splash, that could be terrorific.


  8. 8 Lars Christensen August 3, 2011 at 12:53 pm

    Today we have seen a bit of stabilisation in the US markets – helped by better than expected ADP numbers and a Swiss rate cut that have curbed the sharp appreciation of the Swiss franc.

    And see this story from Bloomberg:

    The headline in the Bloomberg story “Stocks Erase Losses on Stimulus Bets” is pretty telling of the point I am trying to make. Market participants are starting to bet on QE3 even without the Fed have been out with any comments. Gold prices also continue to spike – another indication that inflation expectations in facts are on the rise. Hence, I think that it is pretty clear that the Fed has regained some credibility and that is surely good news.

    So yes, I am trying to put a positive spin of events over the last couple of days, but I think it is important to make the argument for “easier” monetary policy based on the right arguments rather than on a few macroeconomic data.

    Furthermore, I think there is a very strong case for the Federal Reserve to announce a clear rule (preferably price level or NGDP level targeting) rather having no rule. QE2 is has to some extent created an expectation in the market that the Fed will target inflation around 2 1/2%. A level target would have been preferable, but I think at least the implicit inflation target that the markets now seems to think the Fed has helps stabilise the markets.

    Is the debt deal good or bad news? Well, I am fiscally conservative in the sense that budgets have to be stabilised over the cycle and I clear prefer expenditure cuts to tax hikes. Further, I don’t think fiscal policy is an effective instrument to spur domestic demand so I would welcome any political action to reduce the budget deficit. My only worry is however that enough is not done in this regard. That said, if for example an NGDP target was implemented by the Fed then the budget problems obviously would be reduced significantly. But that’s another story…


  9. 9 Lars Christensen August 3, 2011 at 1:39 pm

    Luis, the question is rather should US policy makers worry about a possible euro collapse? Obviously, but if a proper monetary policy regime was in place – for example NGDP level targeting then that would significantly reduce the potential for a wider impact on the US economy and markets from a euro crash -and yeah David, Scott is on vacation so I am the sub;-)


  10. 10 Luis H Arroyo August 3, 2011 at 2:54 pm

    Well, Lars, I agree with you on your opinion on fiscal policy. And also in that the only arms disposable for US is MP in the case of a Sutnami from Europe. But i insist that this problem is weighting a lot in global markets… And it will follow wighting: I don´t be able of seeing a solution for it.


  11. 11 Benjamin Cole August 3, 2011 at 3:11 pm

    I suspect interest rates go even lower, ala Japan. Not sure about equities markets. The p/e’s are okay, and earnings are rising. They did rally today.

    The soft spot may be real estate.

    Man, oh man, we need some juice from the Fed.

    The Us needs to run tighter fiscal budgets and print money like Zimbabawe–okay, not that much, but a lot.


  12. 12 David Glasner August 3, 2011 at 8:23 pm

    Luis and Lars, Thanks for your input. Obviously, Lars, you could be right about what markets are expecting now. I think there are probably a lot of people now trying to figure out what just what we are discussing and making bets accordingly. And for everyone’s sake I hope that your view is the correct one. Sorry, Luis, but we Americans often do tend to be a little bit too insular in our view of the world, and I should be better informed than I am about developments in Europe, I will try to catch up. Fortunately, both the Swiss and the Japanese are taking steps to curb the appreciation of their currencies which is good for them and international economy.

    Benjamin, Maybe now the Japanese will learn how to conduct an expansionary monetary policy. Wouldn’t that be nice? Then we could send the Chairman of the Fed there to take lessons.


  13. 13 David Pearson August 4, 2011 at 7:32 am

    I would be careful interpreting moves in the bond market here. Markets are weighing the possibility of the Fed buying out longer on the curve. Financial repression eliminates the bond market as a signal of anything but the Fed’s perceived bond buying strategy. The prospect of more QE, on a global scale, is likely what is holding up the inflation spread in the face of sinking bond yields.

    The promise of long term deficit monetization — whether direct or indirect — is a proven source of steeply rising inflation expectations. Unfortunately, it is also a source of volatility and chronically low private investment. It leads to actors’ focus on hedging behavior (forward buying, commodity hoarding, shortening duration, capital flight) that effectively reduces AS over time.


  14. 14 Lars Christensen August 4, 2011 at 8:47 am

    Today it is really, really bad. And there is no doubt – this is an European problem getting out of control.


  15. 15 Mark C August 4, 2011 at 8:54 am


    The situation now is kinda worse than you fear, TIPS market’s kinda freezed up now, everyone is a seller in the TIPS market, even the ‘pricemakers’ wouldn’t want to buy.


  16. 16 David Glasner August 6, 2011 at 9:26 pm

    David, Well, the prospect of QE3 doesn’t seem to have held up the inflation spread, though there was a bit of a recovery on Friday. I agree, at least in part, with your characterization of the effect of expected inflation. However, expected inflation doesn’t have the same effect under all circumstances. In my paper on the Fisher Effect, I found that expected inflation generally has little or no effect on stock prices. Since 2008, however, it has been strongly associated with increased stock values.

    Lars, Yes it did get bad. I agree that European issues are part of the mix, but I think that the US situation is also scary.

    Mark, It was quite amazing to watch even from a distance.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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