Uncle Al Update - Comments?

[mjkst27]

IMO, it's getting to be rock-and-a-hard-place time for Uncle Al. If he wants to keep the housing bubble afloat, he needs lower rates at the long end of the curve. The prior (current) strategy has been to try to cajole the long end (not in direct Fed control) lower by driving the short end (in Fed control as long as the T-Bills market doesn't get too ornery) lower. This game climaxed in June '03 with the blow-off low in yields. Since then the market psychology for the long end securities seems a bit damaged. There are some long-term inflationary fears rattling around out there, probably the voice of the old-timers, veterans of the 70's, who still have a degree of influence over the new brood.

 

At this point I'd suggest that if Al wants to try to maneuver the long end yields lower, he needs to raise rates at the short end. In other words, it's time to engineer a flatter yield curve. By raising short rates, he would ease up somewhat on the bond market's longer term inflationary fears, making long paper more attractive. Yes, there would be an unwinding of the carry trade, which would work at cross-purposes to the lowering of long-end yields. Maybe the long yields don't come down much - the curve gets flatter only because the short yields rise. Again, this is better than a rise in long yields, if your goal is to maximixe system-wide debt creation primarily via the housing trade.

 

Who loses in this scenario? Spread traders. Money center banks. Floating-rate debt holders. In other words, Al now has to throw the banks and big industrial corpses and ARMs holders under the bus if he wants to keep housing going even at the relatively meager rate (compared to June 03) that it is going now.

 

On second thought, this looks like a huge net loser. Al is toast. Look for him to retire within 6 months. Perhaps he falls ill, real or imagined, either one works. Deflation dead ahead.

[mjkst27]

Then again, Uncle "Famous" Willy Gross over at PIMCo is now suggesting that ARMs are the prudent way to reduce mortgage borrowing costs. No one lives in their house more than 5 years these days anyway right? Al has promised us the Fed Funds will still be 1% 5 years from now....right?