The Bond Market Has it Wrong
Aug 18, 2006
Perhaps Abraham Lincoln would never have devised his famous adage
about fooling all the people all the time if he had a chance
to observe the current bond market's complete obedience to Fed
propaganda. In an exercise in mass hypnosis that would have made
Orson Wells jealous, the Fed has managed to convinced bond investors
that inflation no longer matters. This is like convincing major
league managers that batting average no longer matters. It was
a long process, but for now at least, the Fed should celebrate
their communications victory, at least until the actual carnage
becomes too heavy to ignore.
In an article earlier this week in the Wall Street Journal, as
in many other recent media reports, a professional bond investor
says that he is no longer focusing very intently on CPI
reports. After all, says the bond trader, the Fed has said that
growth is the thing to watch now and that any current signs of
rising inflation are backward looking. As a result, at a time
when even the most watered down data reveal that inflation is
running at its fastest pace since the early 1980's, Treasury
yields have remained significantly below the current 5.25% Fed
funds rate. How could this have happened? How could professional
bond investors speed through these stop signs at 75 mph? It happened
step by step.
The first step was convincing the markets that hedonic adjustments
were okay. Next came the legitimization of substitution bias.
Then the Fed convinced everybody to ignore monthly increases
in food and energy. When that wasn't enough, it got everybody
to ignore yearly increases in food and energy. Finally, when
even all these tricks were not enough to conceal the growth of
inflation, the Fed finally played its trump card by telling the
markets that inflation is the poor step-child of its much more
import parent, GDP growth.
This week, when the government reported better then expected
PPI and CPI, data, the bond market went ballistic, as traders
took the government's bait hook, line and sinker. Equities went
along for the ride, and a good time was had by all. Lost in
the shuffle was the renewed weakness in dollar, which has lost
about 2% of its value relative to other currencies over the past
month. The Fed pause has given currency traders the "all
clear" to sell the dollar. Combine that with a poor technical
outlook and I look for the dollar to meet with some intense seller
pressure in the coming months.
Since the value of the dollar is the single biggest determinate
of prices, it is amazing that Wall Street can celebrate a victory
over inflation based solely on one month's data despite the poor
monthly performance of the dollar itself.. If the dollar continues
to lose value, it's only a matter of time before sellers demand
more of them in exchange for their wares. If they fail to raise
their prices, the net effect is that they suffer a price reduction.
So while Wall Street looks to the bond market as evidence that
inflation is well contained, the smart money looks at the forex
markets to realize just how much worse inflation is likely to
get. Remember, bond yields do not reflect what future inflation
actually will be, only what bond investor think it will be.
Action in the currency markets will reveal just how wrong these
bets are likely to be.
Place your bets now before the rest of the world figures out
the truth. Protect
your wealth and preserve your purchasing power before it's too
late. Discover the best way to buy gold at www.goldyoucanfold.com, download my free
research report on the powerful case for investing in foreign
equities available at www.researchreportone.com, and subscribe to
my free, on-line investment newsletter at http://www.europac.net/newsletter/newsletter.asp.
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.