Well, this one really is a conundrum as Sir Alan would say.
Don't think anybody has the complete picture. So much for the gurus. But a couple of thoughts:
Basically, 10 year rates are a series of 10 1 year rates. What Mr. Market is telling us is that short term rates (e.g., 1yr rates) are going to continue to stay low for 10 years. That is to say -- no inflation.
Bill Gross has for months been arguing that we have been traversing a tightrope between the forces of deflation and the forces of reflation. Wouldn't take much to tip us either way. Just recently he has basically said that the forces of defaltion have won this tug of war. He sees no inflation and low interest rates for the next 3 to 5 years.
Bill Gross has not always been right. This may be wishfull thinking on his part. After all he does have a $475 billion bond portfolio to worry about.
We here in the U.S. don't have a real good grasp of what is going on in the rest of the world. From what I can gather, Europe appears to be a basket case with low growth and all of our problems, only magnified. European Union looks like it is going up in smoke. Japan still has near 0% interest rates -- Japanese mired in a never ending slump. Chinese -- we know about -- don't consume and save 40% of income-- lend it to us to buy junk. Bottom line of all this---lots and lots of idle capital and beaucoup liquidity floating in the international system. And the U.S. looks positively energetic and robust to foreigners. A great place to invest relative to their own miserable investment options. May be a lot of betting that the Dollar has been beaten up enough. One way for foreigners to bet on the Dollar is to buy U.S. Treasuries. Go figure.
Greenspan and the Fed are in a really interesting situation right now. If Bill Gross is right and there is no inflation and the forces of deflation have won, then continuing to increase interest rates could have a suicidal impact on the economy. But if they do call a halt at this point it is an admission that the economy is stalling out. The whole theory of "measured pace", predictability transparency and telegraphing policy well in advance is coming into question. IMO Greenspan has been stalling and playing for time with his monetary policy for the past year. He is now out of time. Its now damned if he does raise interest rates or damned if he doesn't. Don't think he can temporize his way with the investment community any longer. Events are beginning to force his hand to reveal the Fed's true intentions. My guess-- he will declare victory and announce arrival at the infamous neutral zone -- not too hot ,not too cold-- time for a pause to evaluate things. The whole thing is beginning to stink. Not good.
Seems to me we are getting two conflicting signals on investor preference for risk.
On the one hand we have the stock market with its relatively high P/E and convresely low capitalization rates telling us the economy, earnings and dividends are going to continue to grow at robust rates and justify the current very high prices investors are willing to pay for equities.
On the other hand the bond market is signaling perhaps a flight to safety and a growing conviction that much of the world, maybe including us, is headed for a deflationary recession.
So what is going on? Time will tell.
Donner