A 'New Age' Slowdown Could Pop Treasury Bubble

A: No, I don't think this will be another Great Depression, with bread lines and 25% unemployment. But I also think that the term recession, as we know it, is too optimistic given the current environment. With peak credit past us, deflation upon us, perhaps this will be a 'new age' style of depression that isn't as dire as it was in the 30s, yet more economically painful than anything we have seen in decades. The shock alone of shifting from a wall street innovated credit system to a heavily regulated 'old world' banking system will be long, boring, and non-sexy. It will mark the end of an era where its back to basics as Americans start saving and cut down on excessive consumption, credit is vastly different from how we remember it, and housing is once again viewed as a 'place to live' and not a casino/atm. But the hidden danger lies in the after-effects of funding these rescue/bailout packages ---> with massive treasury issuance may come the inevitable popping of the treasury bubble, emphasis on the long end of the curve. Lets connect the dots.

First, lets take a look at how GDP changed from 1929-1933, in the beginning of the depression:


Courtesy of USStuckonStupid.com

Second, lets take a look at what unemployment did during this same period:


Courtesy of USStuckonStupid.com

So, GDP went from +3% or so all the way down to -13% or so during the first few years of The Great Depression. Unemployment went from about 3.5% to about 25% during this same period which clearly marked the worst times.

Fast forward to today and we currently have a 6.1% unemployment rate and a 2Q GDP of 2.8%. Do I see us nearing depression levels on these datasets? No! But, given the extraordinary set of macro forces at play right now around the globe and the furious actions taken by governments to catch up and slow this deflationary spiral, I don't think many have awaken to how bad the economic data is about to get; given the period of paralysis in the credit markets. By this time next year, many of us will be asking ourselves, "...man, when will this end!".

I have one force against me; tweaked BLS economic modeling compared to the 1930s whose design alone will make the data less painful. Even with this tinkering, I think the likelihood of 10% unemployment and far negative GDP numbers than what are currently expected, is rising fast. How will markets react?

Two differences between The Great Depression and today are:

a) the actions of the fed/treasury that led to the Great Depression and were taken in response to the event, as opposed to the global actions (fed/govt's) taken over the past 12 months

b) the use of credit/debt to get us out of the Great Depression, as opposed to the use of credit/debt for sustained excessive growth to get us into our current mess

As I noted in my Peak Credit discussion:

"The use of debt in the 1930s was a direct response to the Great Depression! We used debt to get us out of the depression. Recently, we used debt for an entirely different reason: TO SUSTAIN ECONOMIC GROWTH! My two questions are, who are we going to borrow from this time to get out of this mess + how are we going to service our current levels of debt?"

The upcoming massive treasury issuance to fund these rescue & recapitalization plans could mark the bubbly top to an arguable 20 year secular bull treasury market!

Very few are really discussing this! I'm always worried when there is massive supply coming to market and to boot, this is becoming a favorite trade of a few high profile investors.

Julian Robertson, featured here on this CNBC video states:

"My favorite trade right now, is something I did not even know about 15 months ago, is the Curve Steepener, and that in effect is a derivative that pays the movements in the difference between the 2 year interest rate, on government bonds, and the 10 year and 30 year. My thought is that the Federal Reserve will continue to be very accomodative, and they can help the 2 year rates a great deal, but they have no control over the 10 year and 30 year rates, and I think gradually people will shy away from those particular type of investments, particularly as the dollar continues to weaken, and so I think the curve steepener is the best hedge against inflation, and I think we are going to have some inflation..."

Jim Rodgers recently discussed his interest in shorting the long end of the curve on CNBC, but I can't find the video to get the exact quote (help from anyone finding this?)

I've discussed this treasury trade idea a few times here on UrbanDigs (here & here), and I don't think many people connect the dots and realize how this may ultimately affect the housing market's wished recovery. If the long end of the curve does pop, and treasury yields spike down the road, think about how that will affect borrowing costs for businesses and lending rates for homebuyers/consumers. This may be a side effect of the massive medicine we took to combat this new age slowdown, is a multi-year train of thought and yes, it is worth discussing on a real estate blog. It could be the 5th or 6th chapter of the nationwide housing slowdown as affordability restricts with higher borrowing costs. Time will tell.