Whether in my job as Elliott Wave International’s Senior Bonds Analyst or in these essays, I enjoy writing with a slightly cynical, tongue-in-cheek style. I believe that most of the time, humor is the best thing to get you out of a bad situation. However, there are certain times when a more sober assessment is needed.
EWI’s Interest Rates Specialty Service, which I edit, seeks to identify the future direction of global bond prices, present forecasts and opinions as an enjoyable read, and identify industry-specific and macro-economic social shifts that may have a material effect on fixed income markets.
In my Service, I have pounded home the ongoing risks of deflation the national and international economies have been facing. It is nice to be ahead of the curve, but now that we are in the grips of the deflationary cycle, it is difficult to see the outcome.
However, certain specific outcomes would seem obvious: the need for significant funding by the Fed to fulfill its promises on the bailouts (they will focus on short duration paper, but this will have an adverse effect on the long end); risk aversion throughout the financial community; and tighter (and, hopefully, streamlined) government regulation.
The frantic pace of capital destruction that we’ve seen is the hallmark of systemic deflation – which, although poorly understood, now has the undivided attention of the government, Wall Street and Main Street. Each, however, have their own needs of fulfillment.
Many in the government do not, will not and cannot understand the fundamentals of the over-leveraged credit unwind, but they want a painless (for voters) resolution – with heads to roll. Main Street may not understand all the intricacies of the crisis either, but they already know their taxpayer dollars have been committed to its “resolution.” They will accept a well-conceived, understandable and painful plan – if it allows stability in housing and jobs. Wall Street typically wants a painless solution, but with more than 100,000 jobs lost already, they are willing to accept a forced solution, as the alternative one is inconceivably painful.
The resolution, as always, will fall somewhere in-between.
Deflation is here and everybody knows it – even those who don’t yet call it by its name. And, as I and many others have suggested, structural and regulatory reforms are needed. An RFC (depression era) repository is forthcoming and more short-selling bans are likely. How do you stay ahead of these markets?
I’m not the smartest guy in the world (where is he when we need him?), so I look to price charts and macro trends for insight. What I see is an unfortunate transfer of private risk to socialized one in order to forestall a system-wide meltdown. We simply cannot let this much debt go bad, goes the current reasoning, because the U.S. dollar would cease to exist as a reliable mechanism of exchange. However, by the same token, the U.S. government, with all its trade, budget and outstanding deficits, must also quit borrowing, if this scheme – which I call the ‘Paulson Put’ – is to have any lasting effect.
Elliott wave patterns in bond price charts are telling us that deflation is here to stay. That means a lower standard of living over the foreseeable future – until Wall Street, Main Street and the U.S. government are willing to live within their means.
This essay originally appeared inside the September 19 daily forecast for the U.S. 30-year Treasury Bonds in Bill Fox's Interest Rates Specialty Service. (See full menu for EWI's Specialty Services here.)
Bill Fox is EWI's Senior Bonds Analyst. He has been involved in the markets since graduating in 1988 from Vanderbilt University. He joined EWI in 1994; most of his subscribers are professional bond traders spread around the globe.