This story was originally published on RealMoney on June 20 at 9:59 a.m. EDT.
"I used to think if there was reincarnation, I wanted to come back as the president or the Pope or a .400 baseball hitter, but now I want to come back as the bond market. You can intimidate everybody."
-- James Carville
With the bond market throwing its weight around in the manner it has for the last year or so, I'm beginning to wonder whether it makes sense any longer to follow the
. Should I care about what monetary policy is trying to accomplish if the bond market pays no mind?
In the past year, the fed funds interest rate target has been boosted by 200 basis points. During that interval, the yield on 30-year Treasury bonds has fallen by 100 basis points. "Clearly without recent precedent," was Chairman Alan Greenspan's reaction as the bond market ignored his intentions: "The economic and financial world is changing in ways that we still do not fully comprehend."
Because of that lack of comprehension -- on Greenspan's part, on mine, and on the parts of other economists whose work I consult and who have been unable to clear up my confusion -- the "conundrum" of low long-term interest rates is all I'm able to think about lately.
Is it different this time? That question is often posed sarcastically, but in this case, it's a straight-up, sincere inquiry. If you've seen more than one business cycle, you know that, like television sitcoms and the grist from Hollywood's mills, they bear a strong family resemblance, one to another.
They may differ in certain particulars from cycle to cycle, but their shared genetics -- the fundamental dynamics of the business cycle -- tend to be dominant in determining outcomes. Obsessing over what's different this time is often a dangerous distraction.
Except, that is, in rare instances when obsessing over what's different can be critical. Examples? How about the so-called "reverse yield gap" that appeared in 1958? After almost 30 years during which the market required dividend yields on stocks to exceed bond yields, stock prices rose enough to push their yields through those of bonds. A raging sell signal, right, with nearly 30 years experience to back it up?
But it was different that time: America had finally recovered psychologically from the Great Depression; the market was once again willing to credit the idea that stocks, the risky asset, might return something, a growth element, in addition to their current yield. The rules that worked after 1958 were different than those before.
How about when Nixon closed the gold window in 1971? Cut loose from a golden anchor, the world's inflationary risks going forward would prove to be much greater than historical experience had prepared us for.
Later in the 1970s, the demise of Regulation Q interest rate ceilings was a critical difference, one that subsequent financial sector turmoil showed was not fully comprehended at the time. The collapse of the communist model in the early 1990s was another clear "different this time" development.
And today we have globalization. It is a more subtle, more diffuse difference than those just cited, but it may be more profound than any but communism's demise. With billions of new entrants effectively in our labor force and eager to climb the value ladder, the world has changed, as Greenspan says, in ways we do not fully comprehend.
One of the effects of those poorly understood changes has been the conundrum of persistently low long-term interest rates. Last week's newspapers were full of articles covering the global nature of this phenomenon and the global spread of hot house price appreciation that has developed as a result.
The tone of those articles, like so many concerning the indefatigable bond market, was one of wonder at the good fortune, and worry that it can't last and anxiety about the nature of the inevitable shakeout. I suppose that is very much like what investors must have felt in 1958 as they considered a stock market so pricey that its risky dividends couldn't match nice, safe bond yields.
Brakes Won't Grab? Bond Market Ignores the Fed
Looking ahead, I can see three distinct alternatives for the economic outlook. One is that it is not different this time, that familiar business cycle dynamics will eventually right the imbalances -- U.S. current account and federal budget deficits, U.S. savings shortfall -- that are now seen as unsustainable. The mileposts along this path include the possibility of much higher interest rates, financial crisis and recession.
Two is the Fed's basic case and that of the consensus: Economic growth continues along a 3% to 4% path while inflation remains muted and inflation expectations well anchored.
Three acknowledges that it
different this time, that all those billions of new entrants to the global labor force, with their cheap wages, mercantilist attitudes and excessive savings rates, have changed the business cycle from the dynamics we have been familiar with to something that we do not fully comprehend.
The second option is the consensus, but perhaps by default. If you propound No. 1, you're likely to be asked just when it is that today's imbalances will begin to right themselves. That's a question that may be impossible to answer before the fact. No. 3 is tempting because it does a fair job of explaining the world's imbalances and its ebullient bond markets, but because it's "clearly without recent precedent," it seems impetuous to adopt it, and besides, you're likely to get follow-up questions that you can't handle.
The Fed's base case -- the consensus -- may be the default option, but it strikes me that it is not a stable one. If indeed the economy can continue to grow steadily and inflation remains tame while the bond market ignores the Fed, then it really is different this time. The Fed can hike its short-term target rate all it likes but its effect will be muted if bond yields remain low and liquidity continues to slosh around the globe.
Eventually, in this case, equity investors will be forced to recognize that the market has to be bought. If indeed bond yields stay low as the consensus case unfolds, then the global nexus of cheap labor, good economic growth, low inflation and low bond yields will force investors to overcome their postcrash fear of stocks and, as in 1958, enter bravely into a new era.
Jim Griffin is economic consultant and portfolio adviser to ING Investment Management and its Hartford-based unit, ING Aeltus, which manages institutional investment accounts and acts as adviser to the ING Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to send comments on his column to