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We're back to a familiar game in the U.S. Treasury bond market: How low can rates go?
As pessimism about the domestic economy has deepened in the last few weeks, the Treasury market has been the best indicator of that mood shift. The annualized yield on the 10-year T-note dived to 3.3% by the end of last week -- down from an eight-month high of 4% just a month earlier.
Traders were amazed by investors' appetite for the $104 billion of two-, five- and seven-year T-notes the government auctioned the week of June 22, and for the $65 billion of three-, 10- and 30-year Treasuries sold last week. Now it looks those buyers made the right bets -- even though they know Uncle Sam has plenty more to sell this year.
"All those 'green shoots' guys realize they were too optimistic" about the economy, said Tom Tucci, head of Treasury trading at RBC Capital Markets in New York. "The reality of 'lower for longer' [on Treasury yields] has caught investors offside."
 Indeed, the big trade of the spring -- sell Treasuries, buy stocks -- has flip-flopped. While the Standard & Poor's 500 stock index has fallen 7% since June 12, the iShares Barclays 20-plus-year Treasury Bond exchange-traded fund has risen 7% in the same period, to $96.23 a share as of Friday.
The dive in Treasury yields has been so abrupt that some bond market pros have been reluctant to recommend that clients jump in at this point, fearful of whiplash if Wall Street gets a few days' worth of upbeat economic reports.
But investors who believe there is no economic recovery on the horizon may be quite content with a 3.3% yield on a 10-year T-note -- if no recovery also means that the major threat is deflation, not inflation.
If the inflation rate is zero, the 3.3% "real" return on a current T-note would be rich by historical standards. And it comes with a principal guarantee, if you can hold to maturity.
In the near term -- the next week or so -- the Treasury market could just be powered by its own momentum. If the stock market worsens, institutional money exiting equities could pour into government bonds, pushing yields even lower. A rally to 3% would just return the 10-year T-note to its level of last winter.
The first leg of the latest bond rally "was just a reality check," said George Goncalves, fixed-income rate strategist at brokerage Cantor Fitzgerald in New York. If stocks keep sliding that could be the "death knell" for risk-taking, further boosting Treasuries' appeal, he said.
But then, don't underestimate the resolve of the Obama administration and the Federal Reserve to do whatever it takes to keep Wall Street believing in a recovery. Treasury Secretary Timothy F. Geithner says there's no point in talking about a second economic-stimulus program so soon -- but that could change in a heartbeat.
-- Tom Petruno
Treasury Secretary Timothy F. Geithner today sought to downplay the idea of a second economic stimulus plan, saying the need for another program is a decision the administration "can’t really make" now.
In an interview on CNN’s "Fareed Zakaria GPS," Geithner also was asked about reining in federal borrowing, whether tax increases would be needed and whether the administration should curb what critics say is its anti-business rhetoric.
Excerpts:
--- On whether a second stimulus plan is needed:
"I think all economists believe, and this was inherent in the design of the program, that the biggest thrust or force would start to take effect in the second half of this year. And we’re going to start to see that happen. But I don’t think that’s a judgment we need to make now, can’t really make it now prudently, responsibly."
--- On ballooning federal borrowing:
"It is very important both for the sustainability of recovery, for confidence, that the world understands, American people understand that this government will do what’s necessary to bring these deficits down to a sustainable level as soon as we’re confident we have a sustained recovery in place.
 "The president is absolutely committed [to] that. He deeply understands how important that is. His team . . . lived through a period where a remarkable period of fiscal discipline and response in the United States helped generate a long period of rising private investment, strong . . . growth, stronger dollar, lower interest rates, broad-based improvement in income standards. And so he understands deeply the importance of making sure we put in place a stronger foundation for recovery as a whole. And part of that will be our return to living within our means as a country."
--- But when asked whether "living within our means" will mean higher taxes to pare borrowing needs, Geithner gave a classic Washington non-answer:
"As a country, and there’s no mystery in this, we’re going to have to bring our resources and our commitments closer into balance. That is a necessary thing for us to do. And it’s going to be a hard thing for us to do. But it’s perfectly within our capacity as a country to do."
--- On whether the administration is beating up on business:
"If you listen to what the president says on this and of course I say this all the time, we, of course, deeply understand that the future of America -- the future strength of our economy -- depends on quality of innovation by business in the United States. On the judgments they make and their willingness to take risk again and put money at stake and building companies that are going to grow.
"There is no path on the road to the American economy that doesn't come with that. And of course the president deeply understands that."
-- Tom Petruno
Photo: Treasury Secretary Timothy F. Geithner. Credit: Jim Watson / AFP Getty Images
Amid the worst global economic decline since the 1930s, the leaders of the major industrialized nations met last week in Italy and decided . . . well, not much.
High Frequency Economics’ Carl Weinberg, who believes that governments' response to the deep recession hasn't been strong enough, wrote in his Friday newsletter on the Group of 8 summit's results -- or lack thereof:
"G-Whatever Heads of State may have agreed to push for a conclusion to the Doha round of trade talks, but that will affect nations’ terms of trade a decade from now, not next week or next quarter. Keeping global warming limited to two degrees -- if that can be done, since no one was willing to commit resources to make it happen -- is an agreement to accept limited failure to protect our planet, rather than a success.
" So our core story about the world economy remains unaffected by the goings-on in Italy. World trade imploded by 35% over the eight months ended in March. Summiteers did not even discuss this! World industrial output decreased by 20%-to-30%, depending upon which country you consider. Unmentioned! Prices and wages are slowing in most countries, and already falling in some. . . . Among the world's largest economies, only China continues to grow. The world economy is severely damaged and recovery is nowhere in sight."
Maybe the summiteers are confident that we're beginning to see an upturn in trade, as May data on U.S. exports hinted. Their statement on the economy cited "signs of stabilization," but added that "the situation remains uncertain and significant risks remain to economic and financial stability."
Weinberg believes that major countries should be doing more specifically to re-stimulate trade, the revival of which is "a precondition to a return to global prosperity," he asserts.
Although slumping consumer spending in the developed world obviously explains much of the slide in trade, Weinberg believes there's more to it than that. He suspects that a big problem is a lack of financing for importers and exporters, a side-effect of the credit crunch. To fix that, "All that would be needed are public sector guarantees of trade credits written by any private sector bank," Weinberg writes. "This ought not to be a big leap for governments that have already guaranteed so much lending to shaky institutions around the globe."
-- Tom Petruno
Photo: French President Nicolas Sarkozy, Russian President Dimitri Medvedev and President Obama at last week's summit of world leaders. Credit: Vincenzo Pinto / AFP Getty Images
Not that anyone in California should need more sobering-up about the state's economic outlook, but the scenario painted by blogger Gregor Macdonald, who describes himself as a veteran oil analyst and energy investor, is particularly stark.
In a summary of his piece titled "The Scholarship of Collapse," he writes:
"Without the two industries that characterized post-war growth in the U.S., housing and automobiles (and the financial industry that squatted on top of these) it’s hard to see how California -- and the U.S. by extension -- does not become a permanently smaller economy.
"I now foresee zero net physical infrastructure or housing growth in California for at least another 5 years. If housing units go up somewhere in California, they’ll be bulldozed someplace else. If new roads or highways are erected, they’ll be discontinued or dismantled somewhere else. Without California, there will be no sustainable U.S. GDP growth."
I’m not convinced that the U.S. can’t grow without growth in California. Texans probably had similar thoughts when their mini-Depression began in the mid-1980s, with the collapse of oil prices and real estate values. But obviously the long workout ahead for California will weigh on U.S. growth.
In a broader view, Macdonald sees California as emblematic of the tipping point faced by the U.S. economy overall:
"The United States, just like California, now sits astride massive, gargantuan post-war infrastructure that was built with cheap energy and leveraged with cheap energy, for over 50 years. . . . To make matters worse, the federal government is in the midst of one of the largest policy mistakes in U.S. history as it has chosen to make enormous new investments in car companies, cars, biofuels, roads, and highways to the exclusion of public transport. This is a classic, textbook example of the sunk cost effect in decision making and is a hallmark of the collapsed societies of antiquity."
-- Tom Petruno
Warren Buffett has come up with an interesting analogy for the shortcomings of the Obama administration's $787-billion economic stimulus plan, which Congress approved in February.
"Our first stimulus bill . . . was sort of like taking half a tablet of Viagra and having also a bunch of candy mixed in . . . as if everybody was putting in enough for their own constituents," the billionaire investor said on ABC’s "Good Morning America" today.
He reiterated his support for another stimulus program, saying of the economy, "We are not in a freefall, but we are not in a recovery either."
 "I think that a second one may well be called for," Buffett said, adding, "You hope it doesn't get watered down in many ways."
He also took aim at the Treasury’s program to partner with major investment firms and buy up rotting mortgage-backed bonds from banks and other financial institutions. The Treasury on Wednesday named nine firms as its initial partners, including BlackRock Inc., TCW Group and Oaktree Capital Management.
By offering cheap loans to the buyers, the government structured the program to increase private firms’ likelihood of profiting from the purchases in the long run, even if mortgage defaults continue to surge.
"I do not like the idea of any kind of a plan involving the government where Wall Street makes a lot of money," Buffett said. "I just think that Wall Street owes the American people one at this point."
-- Tom Petruno
Photo: Warren Buffett. Credit: Nati Harnik / Associated Press
Oil prices are down for a sixth straight session today, the longest losing streak since mid-December, on the triple-whammy of economic fears, rising gasoline supplies and growing calls to rein in speculators in futures markets.
Near-term crude futures were down $1.77, or 2.8%, to $61.16 a barrel at about 11 a.m. PDT. The price now has tumbled 16% since reaching $72.68 on June 11, and is the lowest in seven weeks.
Gasoline futures also are plummeting, down 6.3 cents, or 3.6%, to $1.67 a gallon. The price peaked at $2.07 on June 16.
From Bloomberg News:
Gasoline stockpiles climbed 1.9 million barrels to 213.1 million in the week ended July 3, more than twice the increase forecast in a Bloomberg News survey, the Energy Department said. Inventories of distillate fuel, a category that includes heating oil and diesel, rose to the highest since 1985 as consumption dropped to a 10-year low.
"The market is starting to focus on the weak fundamentals," said Antoine Halff, head of energy research at Newedge USA in New York. "The deterioration of the fundamentals should continue in the weeks ahead. The drop in prices has yet to run its course."
Traders took no comfort in data showing that U.S. oil inventories fell last week. Supplies still are 7.4% higher than the five-year average for this point in the year.
Commodity prices have been slumping in tandem with the stock market over the last week as investors has lost faith in an economic rebound in the second half. That sentiment ballooned after the dismal June employment report last Thursday.
The U.S., British and French governments also may be spooking players in the oil market by threatening to limit what they view as excessive speculation.
The Commodity Futures Trading Commission on Tuesday said it would hold hearings on whether to impose limits on the dollar value of bets that a single speculator could make via commodity futures.
Separately, British Prime Minister Gordon Brown and French President Nicolas Sarkozy used the op-ed page of the Wall Street Journal today to call for steps to reduce "damaging speculation" in the oil market.
"Governments can no longer stand idle," they wrote. "Volatility damages both consumers and producers."
They weren’t specific about what to do -- other than calling for greater "transparency and supervision" of futures trading -- but in a falling market they’re giving oil speculators another excuse to exit.
-- Tom Petruno
Pope Benedict XVI is offering a solution for what ails the global economy: a "true world political authority" to manage it all.
In a so-called encyclical published today -- just as leaders of the world’s biggest economies gather in central Italy for a summit -- Benedict mostly focuses on his ideas for achieving "justice and the common good" in the modern economy.
His basic themes are well-traveled, including fairness to workers, the evils of "excessive" wealth disparities and regard for the environment.
But then he ventures onto controversial turf, suggesting that the authority to fix all of this be vested in global governing bodies, including the United Nations.
The pope writes:
In the face of the unrelenting growth of global interdependence, there is a strongly felt need, even in the midst of a global recession, for a reform of the United Nations Organization, and likewise of economic institutions and international finance, so that the concept of the family of nations can acquire real teeth.
 To manage the global economy; to revive economies hit by the crisis; to avoid any deterioration of the present crisis and the greater imbalances that would result; to bring about integral and timely disarmament, food security and peace; to guarantee the protection of the environment and to regulate migration: for all this, there is urgent need of a true world political authority, as my predecessor Blessed John XXIII indicated some years ago.
Such an authority would need to be regulated by law, to observe consistently the principles of subsidiarity and solidarity, to seek to establish the common good, and to make a commitment to securing authentic integral human development inspired by the values of charity in truth.
Many of Benedict’s ideas might have been viewed as roadblocks to progress during the global economy’s boom years, but his message no doubt will resonate today with many people worldwide who believe that unbridled capitalism has been ruinous.
He has choice words for the world’s financiers:
Finance, therefore -- through the renewed structures and operating methods that have to be designed after its misuse, which wreaked such havoc on the real economy -- now needs to go back to being an instrument directed towards improved wealth creation and development. Insofar as they are instruments, the entire economy and finance, not just certain sectors, must be used in an ethical way so as to create suitable conditions for human development and for the development of peoples.
Financiers must rediscover the genuinely ethical foundation of their activity, so as not to abuse the sophisticated instruments which can serve to betray the interests of savers.
-- Tom Petruno
Photo: Pope Benedict XVI. Credit: Pier Paolo Cito / Associated Press
Laura Tyson is adding her voice to those calling for more economic stimulus spending.
The UC Berkeley economics professor, a member of President Obama’s Economic Recovery Advisory Board, said in Singapore today that the $787-billion plan Congress passed in February "will have a positive effect, but the real economy is a sicker patient."
The plan turned out to be "a bit too small," she said.
From Bloomberg News:
 "The economy is worse than we forecast on which the stimulus program was based," Tyson told the Nomura Equity Forum. "We probably have already 2.5 million more job losses than anticipated."
"The money is just really starting to come out in more significant amounts now," Tyson said. "The stimulus is performing close to expectations but not in timing."
Billionaire Warren Buffett also recently suggested that the U.S. may need more stimulus spending.
"It looks like we’re going to need more medicine, not less," Buffett said June 24 in a Bloomberg TV interview. "We’re going to have more unemployment. The recovery really hasn’t got going."
The administration so far has rejected calls for more spending, saying the current plan needs time to work.
But as long as the Treasury has no trouble selling mountains of new debt, the temptation to launch another stimulus plan may well grow.
Government bond yields have declined in recent weeks from eight-month highs despite Uncle Sam’s continued record borrowing.
Today, however, bidding was weaker than expected at an auction of $35 billion in new three-year notes. The notes were sold at an annualized yield of 1.52%, higher than the 1.49% forecast in a Bloomberg survey of bond dealers.
The Treasury will sell $19 billion in 10-year notes on Wednesday and $11 billion in 30-year bonds on Thursday.
-- Tom Petruno
Photo: Andrea Tyson. Credit: Munshi Ahmed / Bloomberg News
Wall Street opens this week less confident that a turning point for the economy is on the near horizon, after last Thursday's report that the U.S. lost a net 467,000 jobs in June.
But as I noted in my weekend column in The Times, many stock market bulls are sticking with the view that the employment situation isn't a good indicator of where stocks are headed. Investors, the bulls point out, know that the job market always is the last thing to recover, and so are more likely to take their cues from other economic signposts in deciding whether stocks deserve higher prices.
Pimco CEO Mohamed El-Erian, however, takes issue with the idea that unemployment is a lagging indicator in the current recession.
He writes on Pimco's website:
"The unemployment rate is traditionally characterized as a lagging indicator and, as such, is viewed as having limited forward-looking information. After all, unemployment is a reflection of decisions taken earlier in the cycle so the rate always lags behind the realities on the ground – or so says conventional wisdom.
"This conventional wisdom is valid most, but not all of the time. There are rare occasions, such as today, when we should think of the unemployment rate as much more than a lagging indicator; it has the potential to influence future economic behaviors and outlooks.
"Today’s broader interpretation is warranted by two factors: the speed and extent of the recent rise in the unemployment rate; and, the likelihood that it will persist at high levels for a prolonged period of time. As a result, the unemployment rate will increasingly disrupt an economy that, hitherto, has been influenced mainly by large-scale dislocations in the financial system."
Pimco, of course, is mainly a bond investor, so stock bulls will accuse El-Erian of talking his book. Bill Gross, El-Erian's co-chief investment officer at Pimco, also has been arguing for some time that the economy's structural challenges (too much debt, too little savings, etc.) will mean very slow growth, at best, in any recovery -- an environment that could favor many fixed-income investments over stocks.
But then, almost nobody expects a strong rebound for the U.S. economy this time around. The question is whether, despite high unemployment, many companies will be able to get their earnings back on a growth track with even a very modest increase in demand (which might well come from places outside the U.S.). Reviving earnings, after all, is what all the corporate cost-cutting of the last nine months has been about. And it's the expectation of rising earnings that draws investors back to stocks.
The market's spring rally was built on the assumption that the economy was no longer in a free fall, and that some kind of recovery was on the way -- a reason to hope.
After the dismal June employment report, two big tests now loom for Wall Street: Will other data this month support the optimists' view that the worst has passed for the economy overall, if not for jobs? And will companies in their second-quarter earnings reports provide guidance for the rest of the year that offers enough incentive to investors to stick around for better times?
-- Tom Petruno
Even counting last Thursday's slump, the U.S. stock market as a whole hasn't given much ground since the big rally began on March 10 -- frustrating sidelined investors who've been hoping for a pullback.
But under the surface there has been plenty of bloodletting among industry sectors and individual stocks over the last month or more. If buyers are still interested (a big if, it seems), they can already find a lot of issues marked down from their spring highs.
Though the Standard & Poor's 500 index was off just 5.3% through Thursday from its spring closing peak of 946.21 reached on June 12, four of the 10 main industry sectors in the index already are in "correction" mode, meaning they're down at least 10% from their highs.
 The biggest loser among the 10 sectors: financial stocks, which had led the rebound from the market's winter low. The S&P 500 finance sub-index was down 12.7% through Thursday from its spring peak reached May 8.
More surprising, perhaps, is how much energy stocks have been hit since topping out in mid-June. The S&P energy sub-index was off 12.5% through Thursday from its June 11 high. Crude oil futures, which also peaked June 11, were down 8.2% through Thursday, to $66.73 a barrel.
The other two S&P sectors down more than 10% from their spring highs: materials, off 11.5%, and industrials, off 10.2%. The softness in those stocks suggests doubts about how soon the recession will end. In the industrial group, General Electric, at $11.46 on Thursday, was down 21% from its May 8 high of $14.53. (GE, of course, also has a huge financial business.) Farm machinery giant Deere & Co. has fallen 18% since May 6, to $38.53.
At the other end of the spectrum, the S&P sectors that have held up the best so far are consumer staples, off just 2.9% through Thursday from their spring high reached June 2; health care, off 3% since peaking on June 29; and technology, also off 3% from its high set on June 11.
Consumer staples (toiletries, packaged foods, etc.) and health care are considered classic "defensive" sectors, meaning places to hide in a lousy economy. Technology's relative strength, by contrast, signals that investors are counting on tech firms to lead the way if the economy is on the verge of reviving -- a view that will be tested soon by second-quarter earnings reports.
-- Tom Petruno
Photo: The statue of George Washington near the New York Stock Exchange. Credit: Andrew Harrer / Bloomberg News
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Tom Petruno
Tom Petruno has been chronicling financial markets' highs and lows since 1979, and has been the Times' financial columnist since 1990. He writes on markets, corporate finance and the economy, and how it all ties in to individual investors' portfolios.
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