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Monday, August 08, 2011

Bond and Market Vigilantes are Not the Same People

If Consumer Reports came out with a widely discussed report telling us they are lowering their rating on a particular type of car, what would you expect to happen to the price of that car? And, if you believe that markets are smarter than people, if the price goes up instead of down, what would the reaction say about the market's confidence in firm issuing the ratings?

The price of bonds went up today, not down:

Aaauuuggghhh! Market Commentary Edition, by Paul Krugman: Carnage in stock markets as I write — and all of the headlines I see attribute it to S&P’s downgrade.
They really are trying to make my head explode, aren’t they?
Once again: S&P declared that US debt is no longer a safe investment; yet investors are piling into US debt, not out of it, driving the 10-year interest rate below 2.4%. This amounts to a massive market rejection of S&P’s concerns.
The “signature” of debt concerns should be stock and bond prices both falling; what we actually see is those prices moving in opposite directions. And that’s normally the signature of concerns about a weak economy and deflation risk (see Japan, decline of).
What triggered economy fears? To some extent I think this is a Wile E. Coyote moment, with investors suddenly noticing just how weak the fundamentals are. Also, the mess in Europe.
And maybe, maybe there is an S&P story — but not the one you think. Arguably, that downgrade will bully policy makers into even more deflationary, contractionary policies than they would have undertaken otherwise, which has the perverse effect of making US debt more attractive, since the alternatives are worse.
But all the Very Serious People, having totally misdiagnosed our problems so far, will probably double down on that wrong diagnosis as markets fall.

Investors appear to be piling into Treasuries as a safe haven amid the turmoil.. That is, part of the story today is that people are getting out of stocks and moving into Treasuries. From the WSJ:

Treasury bonds proved again Monday that they are still a haven for global investors despite the first credit-rating downgrade on the U.S. in modern history from one of the big three firms.
Bond prices rallied broadly as investors fled risky assets including U.S. stocks, with the benchmark 10-year note's yield falling toward the lowest level since October. The two-year note's yield earlier hit a fresh record low of 0.232%, falling below the top end of zero-0.25% range for the Federal Reserve's key policy rate. ...
"Double-A plus is the de facto triple-A," said James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which manages $342 billion. "There is a lot of fear in the markets right now and Treasurys are still the place to go." ...

As noted above, that's much more consistent with a story involving fears of a weak economy than it is fears about default on the debt.

    Posted by on Monday, August 8, 2011 at 08:46 AM in Economics, Financial System | Permalink  Comments (18)


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