The 10-Year Yield Climbs a Bit: Whussup with That?

September 12th, 2014 at 7:09 pm

Like others, I’ve wondered why bond yields have remained so low in recent months. Yes, of course the Fed is in the game big time but what with the taper, the on-going recovery, and forward leaning expectations, I’ve been expecting yields to climb.

And so they have, with the yield on the 10 year up almost 30 basis points since late August (see chart). What explains the increase?

Since we’re looking at a long term bond, there’s a rising “term premium” in play. That’s the additional yield investors’ demand for holding longer-term securities as opposed to just rolling over a series of shorter term securities. If investors believe the economy is gaining steam, they incur “interest rate risk” when locking their money up in a long-term bond, as new issuances with higher yields come onto the market. The term premium is one way bond buyers try to insulate themselves from that risk.

There’s also evidence that all those asset purchases by the Fed reduced term premiums–that was their point–so as the Fed tapers off their assert buys, the term premium should rise.

Expected inflation can also push up yields. But I’m all in with Krugman on this one, as inflation expectations remain well-anchored, as per the Cleveland Fed’s monthly estimates.

That leaves, as noted above, the Fed themselves. We’ll know a bit more about the central bank’s thoughts on all this later next week, including new projections and the connect-the-dots graphs regarding the board’s thoughts about when to expect lift off on rates. But expectations have been a bit more hawkish and that too is nudging on yields.

So I think a rising term premium and expectations regarding higher short term rates as the era-of-zero winds down are pushing up the ten year, and while one never knows, and barring negative shocks, I expect that trend to at least mildly persist.

 

10yr_fri

Source: MarketWatch

Friday Musical Interlude: BBK!

September 12th, 2014 at 9:07 am

Could it be that I’ve never featured BB King in a musical interlude…unforgivable! Here’s the man gettin’ down to bizness with Lucille (that’s his guitar’s name) and here’s his great explanation as to why he sings the blues. Both of these are from an album–as in vinyl–that I got in 1969!…now get the hell off my lawn!

Whatever made us break up, baby, I don’t know til today
But if it was my fault, I swear I’ll change my ways!

What we would do if we wanted to reduce America’s excessive share repurchasing problem.

September 11th, 2014 at 6:14 pm

You’ve hopefully heard about, if not read, this revealing analysis by William Lazonick on the sharp rise in public corporations using their profits to boost their share price through stock buybacks as opposed to re-investment.

I won’t summarize the findings, as Harold Meyerson amply does so here. As he writes:

From the end of World War II through the late 1970s major U.S. corporations retained most of their earnings and reinvested them in business expansions, new or improved technologies, worker training and pay increases. Beginning in the early ’80s, however, they have devoted a steadily higher share of their profits to shareholders.

Lazonick looked at the 449 companies listed every year on the S&P 500 from 2003 to 2012. He found that they devoted 54 percent of their net earnings to buying back their stock on the open market…they devoted another 37 percent of those earnings to dividends. That’s a total of 91 percent of their profits that America’s leading corporations targeted to their shareholders, leaving a scant 9 percent for investments, research and development, expansions, cash reserves or, God forbid, raises.

What I wanted to tackle here is a question someone asked me the other day: what could be done about this significant problem of underinvestment in the long-term in the interest of boosting near-term share prices, stock options, and stock-based CEO pay?

Lazonick offers three ideas.

First, change back the SEC rule that facilitated the growth of stock repurchases. Back in the early 1980s the SEC gave corporate leaders the permission to repurchase large amounts of their companies’ outstanding shares, with only nominal oversight against stock price manipulation. Lazonick suggests the SEC change the rule back to sharply limit allowable repurchases.

Second, put some restrictions on stock-based compensation. For example, implement a six-month holding period for exercised stock options so executives can’t immediately flip shares when a buyback spikes the price.

Third, implement corporate governance changes that give some different stakeholders seats on the board, like worker representatives. This is a common German practice, and their corporations certainly plough more profits back into their companies than ours do (though this is but one of many difference in governance and corporate culture).

I’d add: do not provide government subsidies and tax breaks to companies that engage in large scale and frequent open market repurchases (as opposed to “tender offers,” which tend to be smaller, less frequent, and more benign). If the best use you can think of for your retained earnings is dividend payouts and share buybacks, why should the taxpayer subsidize your R&D or equipment purchases?

Pfizer and other American drug companies defend their patents and profits by saying how essential they are for research. Yet from 2003-12, they spent 146% (!) of their net income on dividends and buybacks. I should also note here that Pfizer paid 3% of its worldwide income in taxes in 2012. If reading that makes you feel like a tax-paying chump who neglected to get lawyered up, join the club.

Finally, the fact that tax rates on dividends and capital gains are lower than those on ordinary income exacerbates this problem.

And no, none of these sorts of changes are likely to occur anytime soon. But when you think about how these regulatory and tax issues have facilitated this short-sighted trend—one which exacerbates inequality and slows investment-led growth—you get an important insight into ways policy changes shape economic outcomes.

Hey, What’d I Miss? OTE 9/1-9/8

September 9th, 2014 at 2:44 am
  • On August’s jobs data, explaining why last month’s disappointing jobs numbers does not a new trend make.
  • On Labor Day, calling for the courage to call it like it is and rounding up some great articles on labor, unions, wages, and more.
  • Pointing to Elise Gould’s analysis of the role of the minimum wage at the bottom of the wage distribution.
  • Explaining the increasing prevalence of kitchen-sink econometrics.
  • Pondering Rep. John Delaney’s (MD-D) solutions for fixing Congressional dysfunction.
  • Reacting to Tom Edsall’s thoughts re a bipartisan solution to poverty.
  • Illustrating a simple picture of inequality from the new SCF survey.
  • Looking at US health care in an international context — the very picture of an outlier.
  • Arguing that this isn’t the right time to get too wound up about potential supply constraints.

Music et al: switching up this week’s musical interlude by adding observations, recipes, recommendations, and more.