10 Year Bond Yields

[rb]

Even putting politics aside, it seems like it's still supply/demand. As supply of t-bills goes up there has to be equal demand for rates to stay the same. Otherwise rates have to increase to stimulate demand. Foreign governments have a choice of investing in the US (via t-bills) or investing in their own countries.

Like with companies, being dependent on outside financing seems risky because you're tied to the whims of those investors. T-bills are a complicated market though, that I'm far from an expert in. We'll see.

That is not really correct.

[JayGatsby]

Even putting politics aside, it seems like it's still supply/demand. As supply of t-bills goes up there has to be equal demand for rates to stay the same. Otherwise rates have to increase to stimulate demand. Foreign governments have a choice of investing in the US (via t-bills) or investing in their own countries.

Like with companies, being dependent on outside financing seems risky because you're tied to the whims of those investors. T-bills are a complicated market though, that I'm far from an expert in. We'll see.

That is not really correct.

Why not?

[rb]

Even putting politics aside, it seems like it's still supply/demand. As supply of t-bills goes up there has to be equal demand for rates to stay the same. Otherwise rates have to increase to stimulate demand. Foreign governments have a choice of investing in the US (via t-bills) or investing in their own countries.

Like with companies, being dependent on outside financing seems risky because you're tied to the whims of those investors. T-bills are a complicated market though, that I'm far from an expert in. We'll see.

That is not really correct.

Why not?

For a whole host of reasons capital flows are a reverse of trade flows. Country A has T bills because it ran a trade surplus with the US the you had reverse capital flow. That money went back to the US and bought T-bills. Country A can trade their T-bills to country B with which they run a trade deficit. But then country B has to hold the T-bills. Either way someone will hold those T-bills. But country A cannot choose to use the trade surplus to invest in their own country. That surplus MUST be invested back in the US one way or another.

 

What can be different is the type of investment country A makes into the US. They don't need to hold T-bills. They can do FDI (like building factories in the US), they can put it in stocks, property, etc. They just choose to have a lot of bonds: T-bills and mortgage bonds.

[JayGatsby]

For a whole host of reasons capital flows are a reverse of trade flows. Country A has T bills because it ran a trade surplus with the US the you had reverse capital flow. That money went back to the US and bought T-bills. Country A can trade their T-bills to country B with which they run a trade deficit. But then country B has to hold the T-bills. Either way someone will hold those T-bills. But country A cannot choose to use the trade surplus to invest in their own country. That surplus MUST be invested back in the US one way or another.

 

What can be different is the type of investment country A makes into the US. They don't need to hold T-bills. They can do FDI (like building factories in the US), they can put it in stocks, property, etc. They just choose to have a lot of bonds: T-bills and mortgage bonds.

Agree with all that. Two things though:

1. The US budget deficit (~$1T) is bigger than the trade deficit (~$500B). So doesn't that create a need for true outside investment in t-bills?

2. Country B still has the option of holding onto those T-bills or selling them. So if Country B has been in the market selling their peddling $500B of T-bills and now all of a sudden the treasury is also selling $500B of t-bills (math may be wrong.. not sure how much the deficit increased) because US taxpayers are no longer funding that $500B, all else equal shouldn't that increase in supply result in a decrease in price (increase in yield)?

 

Japan seems to be the classic example of a country that has debt financed itself for a long time. The difference I've heard (haven't confirmed statistics on this) is that the buyers of Japanese debt are largely Japanese citizens. Not sure what the long-term implications of that are if the population declines and becomes net sellers, but at least for the last 20 to 30 years it's worked.

 

Interesting stuff. I've never understood all of the fund flows with this money printing as well as I'd like. I've been one of the people saying inflation would go crazy since 2010.

[rb]

The idea here is that your foreign creditors do not have a choice in selling your bonds or not lend you money. In the past it you may have heard things like "oh what if china decides to not led the US money anymore". Basically China doesn't have a choice. They NEED to hold US bonds because they've ran trade surpluses with the US.

 

It's the same thing with Japan. Japan didn't finance their debt domestically by accident. Japan HAD to finance their debt domestically because for the most part they were running trade surpluses. This wasn't a problem for them because the Japanese have high savings and generally low propensities to consume.

 

In the US the numbers are large. But I don't think they'll have problems financing the deficit domestically. The situation is different from Japan. Americans have a high propensity to consume. But the deficits mainly come from tax policies that favor the rich which have low marginal propensities to consume. So you can picture it like this: the federal government gives a $100 tax cut to some guy who doesn't need anything. The government deficit goes up by $100. Then the guy uses his extra $100 to buy a government bond and that finances the deficit. So there won't really be a problem to finance the deficit domestically.

 

The real problem comes when deficit financing has to compete with consumption and investment that's when yields have to spike. But then the government can also raise taxes which lowers the deficit. Those can also lower consumption and eliminate the competition. Look at it this way, you will be hard pressed to find a government debt crisis in a country with a functioning economy that borrows in its own currency.

[gary17]

The idea here is that your foreign creditors do not have a choice in selling your bonds or not lend you money. In the past it you may have heard things like "oh what if china decides to not led the US money anymore". Basically China doesn't have a choice. They NEED to hold US bonds because they've ran trade surpluses with the US.

 

It's the same thing with Japan. Japan didn't finance their debt domestically by accident. Japan HAD to finance their debt domestically because for the most part they were running trade surpluses. This wasn't a problem for them because the Japanese have high savings and generally low propensities to consume.

 

In the US the numbers are large. But I don't think they'll have problems financing the deficit domestically. The situation is different from Japan. Americans have a high propensity to consume. But the deficits mainly come from tax policies that favor the rich which have low marginal propensities to consume. So you can picture it like this: the federal government gives a $100 tax cut to some guy who doesn't need anything. The government deficit goes up by $100. Then the guy uses his extra $100 to buy a government bond and that finances the deficit. So there won't really be a problem to finance the deficit domestically.

 

The real problem comes when deficit financing has to compete with consumption and investment that's when yields have to spike. But then the government can also raise taxes which lowers the deficit. Those can also lower consumption and eliminate the competition. Look at it this way, you will be hard pressed to find a government debt crisis in a country with a functioning economy that borrows in its own currency.

 

rb

can you explain for those without economics degree why when China runs trade surplus they need to buy T bills?

thanks

[rb]

rb

can you explain for those without economics degree why when China runs trade surplus they need to buy T bills?

thanks

Like I said in a previous post, they don't need to buy/hold T bills but they need to buy some type of capital asset of yours.

 

It's not easy to explain/understand this stuff without econ concepts but I'll give it a shot. I saying this I'm not trying to be arrogant but because I'm afraid I'm going to do a poor job at explaining it. If need be, please feel free to ask follow up question. I'll do my best to answer them.

 

Ok here we go. Think of it like this. The reason that you have a trade surplus with me is because I consumed more than I produced. You supplied the goods I consumed in excess of my production. My production is my income. So I've spent more than I made. For our transactions to happen you either have to extend me credit or I have to dip into my savings to pay you - this means I have to hand you over a capital asset of mine. So if you run a trade deficit with me you have to accumulate my capital whether in terms of real assets or my debt. You don't have a choice.

 

To make this more complicated this ties into another macro aspect which is that the real source of trade surpluses is the savings rate. Basically the reason why you have a trade surplus with me is because you consumed less than you've produced and sold me the rest. This means you have positive savings because your production is your income and consumption your expenditure. This is also why you can lend me money to buy your goods. You're lending me your savings.

 

I hope this makes sense.

[LC]

Interest rates represent the cost to rent capital. And capital here represents all forms: human capital, machines, factoreies, aka anything productive. Interest rates represent the average cost of productivity.

 

So the question is how do you price productivity?

[rb]

Interest rates represent the cost to rent capital. And capital here represents all forms: human capital, machines, factoreies, aka anything productive. Interest rates represent the average cost of productivity.

 

So the question is how do you price productivity?

Sorry, but not true at all.

 

First of all, there's no such thing as human capital. That's just a term invested by HR departments. It's labour and it's a completely different thing.

 

Second, interest rates are the cost of money. It can be related to the cost of capital, but not always so you want to be careful about that.

 

Third, if you're thinking about productivity, an increase in productivity will lead to lower interest rates.

[LC]

Labor, human capital, call it whatever you want. This is semantics.

 

Interest rates are the cost of money insomuch as money represents earnings. Earnings are the result of productivity. If "money" has no intrinsic value then the cost of money is also intrinsically invaluable.

 

Where do you see a difference between cost of capital and cost of money?

 

Yes an increase in productivity results in lower rates. Less resources needed to produce the same output. This assumes "output" doesnt change. My theory is the rate of change in output has been declining, causing the relative increase of overall productivity, hence lower-than-"average" interest rates.

[rb]

I'm sorry it's not semantics. Labour and capital are completely different things.

 

Money does not represent earnings.

 

Your last paragraph is both wrong and confusing. Why would output not change? Why would resources be left idle? That doesn't happen. Furthermore why would an increase in productivity lead to a decreasing rate of change in output? That's not how it goes. An increase in productivity leads to both and increase in output and lower rates.

[Cigarbutt]

@gary17

"rb

can you explain for those without economics degree why when China runs trade surplus they need to buy T bills?"

 

rb's answer is the classical answer and quite satisfactory.

 

If you're looking for something more "visual", you may want to try:

https://www.khanacademy.org/economics-finance-domain/macroeconomics/forex-trade-topic/current-capital-account/v/why-current-and-capital-accounts-net-out

 

If you aim for a more "folksy" answer:

http://archive.fortune.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm

 

A certain investor said that "a solution must come" as he saw an unfavorable trend. The article was written in 2003.

 

In macro, it may take a long time to find an explanation or for an explanation to find you. :)

 

 

[LC]

Why would output not change? Technological stagnation. Incremental improvements are not as groundbreaking as previous improvements. Take automobiles or farming for example.

 

Why would resources be left idle? As a result of the above. We get so good at building a car, eventually that activity requires less and less resources. The hope is that idle resources are re-allocated elsewhere.

 

Furthermore why would an increase in productivity lead to a decreasing rate of change in output? Again, just the nature of technological improvements. Eventually the activity reaches a level of production right around the cost curve. Only when something truly disruptive emerges does that change.

 

An increase in productivity leads to both and increase in output and lower rates.

To a certain point. The market got really great at churning out horse and buggys at one point

[rb]

That doesn't happen. Furthermore why would an increase in productivity lead to a decreasing rate of change in output? That's not how it goes. An increase in productivity leads to both and increase in output and lower rates.

Why would output not change? Technological stagnation. Incremental improvements are not as groundbreaking as previous improvements. Take automobiles or farming for example.

 

Why would resources be left idle? As a result of the above. We get so good at building a car, eventually

Yes, we got really good at farming. We don't need a lot of farmers. But we don't have a huge bunch of idle farmers. Those people got to doing other things and we have higher output.

[LC]

Output for commoditiy products is determined by the demand curve though. Well, mostly (aside from non-market incentives i.e. gov't subsidies).

 

My question is what happens when those ex-farmers are not able to be re-allocated. What happens when we become so productive? Why would capital costs remain high?

[rb]

Output for commoditiy products is determined by the demand curve though. Well, mostly (aside from non-market incentives i.e. gov't subsidies).

 

My question is what happens when those ex-farmers are not able to be re-allocated. What happens when we become so productive? Why would capital costs remain high?

Output is determined by demand in the short run. In the long run output is determined by supply.

[LC]

We can argue about that (Keynes would disagree) but my question remains. What happens if  we become so productive at 'current' activities, and there are no breakthrough technologies to demand additional resources and force re-allocation? I.e. a situation of long-term idle resources/capital. Why would capital costs remain high?

[rb]

We can argue about that (Keynes would disagree) but my question remains. What happens if  we become so productive at 'current' activities, and there are no breakthrough technologies to demand additional resources and force re-allocation? I.e. a situation of long-term idle resources/capital. Why would capital costs remain high?

Ok first off, the fact that long term output is driven by supply is consistent with Keynes and IS-LM. I also said in a previous post that if you get an bump in productivity would lead to lower rates and higher output.

 

In your mythical example when people stop wanting to consume and stop working. That would translate into a decrease in long run supply and lead to higher rates. But if we spend time talking about mythical scenarios we should start debating what will happen to the 10 year treasury yield once unicorns start working in auto manufacturing and elves take over investment banking.

[LC]

Keynes was the guy turning supply side economics on its head, saying it was increased demand which spurs supply increases. When cars were invented, why didn't the horse-and-buggy industry just ramp up supply to increase demand? Regardless, supply vs. demand driven economies is a different discussion...which economists far smarter than us still argue over.

 

I'm not talking about a slowdown in consumption or "wanting" to work. I'm saying, what happens to all the truckers/drivers when we build self-driving cars. Historically they work elsewhere. Because historically there have always been other opportunities for human labor. My question is what if those opportunities slowly dry up? Furthermore, is there evidence that those opportunities are drying up? I can see the argument for 'yes' to the latter question.

[Viking]

CNBC had an 8 minute interview with Nancy Davis of Quadratic.

 

At about the 4:30 minute mark she discussed how QE and rising bond yields are disrupting the volatility trade.

 

My key takeaway is the impacts are not over and they are going to be significant and nobody understands how it will play out. Very interesting discussion (most of the other panelists simply said nothing as it was clear the discussion was over their head).

 

https://www.cnbc.com/video/2018/02/13/chief-investment-officer-breaks-down-how-to-trade-volatility.html

 

[John Hjorth]

Lecture by Lars Christensen: Low bond yields are here to stay.

 

Lars Christensen is a Danish macro economist. He is a fundamental monetarist, in the camp of Milton Friedman - his favorite economist. I've started following him for a while.

The video is of questionable quality. Please have patience, if you start listening to it. It gets better.

 

Like other fellow board members in this topic, I'm also struggling with this .[too!]

 

I haven't heard the whole lecture yet. [This is really dense matter to me.] I thought I would just share here.

[John Hjorth]

Federal Reserve FOMC Meeting Transcript is out.

 

The press conference will take place today at 2:30 PM ET.

[John Hjorth]

Here is the video of todays FOMC press conference.

[EdWatchesBoxing]

CNBC had an 8 minute interview with Nancy Davis of Quadratic.

 

At about the 4:30 minute mark she discussed how QE and rising bond yields are disrupting the volatility trade.

 

My key takeaway is the impacts are not over and they are going to be significant and nobody understands how it will play out. Very interesting discussion (most of the other panelists simply said nothing as it was clear the discussion was over their head).

 

https://www.cnbc.com/video/2018/02/13/chief-investment-officer-breaks-down-how-to-trade-volatility.html

 

I missed this when it was first posted. Nancy Davis seems to really know her stuff. Interesting to hear that she only uses options to implement her ideas. She mentioned that she is long gamma in the short end. I think this makes a lot of sense. She also mentioned market makers and delta hedging.

 

Is anyone familiar with option market makers? Focusing on SPX, I am guessing that institutions typically write puts and covered calls, making them short vol and short gamma. Are market makers generally long the straddle then (and use futures to delta hedge)? Is this the correct thinking? And if the market maker is short gamma, I am guessing they would want to bring it down to zero ASAP.

[John Hjorth]

Federal Reserve issues FOMC Statement [June 13^th 2018].

 

.