Katrina has delivered a body blow to the State of Louisiana, but how much of an impact it will have on the national economy can not be known, yet. But our best indicator is the long bond yield which accelerated its recent swoon on the dismal news coming from the Big Easy. Perched just above the 4% level, the 10 year note has, in effect, tightened monetary policy, by reducing the spread between short and long rates by 40 basis points, half of which occurred in the last week. While this drop may be temporary, as the spike in gasoline prices likely will be, the flattening of the yield curve will prove to be a disincentive to further expansion. For example, the housebuilding stocks perked up in the last few days, in part due to the potential rebuilding demand, but I have to wonder how many mortgages will be written at current rates, when the spread which banks can earn from borrowing short and lending long has shrunk from 90 to 50 basis points in the last few weeks. At the very least, this would suggest that the volume of lending required to maintain profitability has just doubled, to say nothing of actually producing earnings growth. While I am sorry that I have sold my bonds, if this condition persists it will not be good for the financial stocks. The Fed's action or inaction in the coming weeks may turn out to be increasingly irrelevant if the bond bulls continue to control the market. Yield curve inversion would be fatal to our highly-leveraged economy. Indeed, with the stratospheric level of indebtedness, even current spreads may spell the death knell of the global finance economy.
So, while I anticipate a short-term rally for the housebuilders (very short term), ultimately they are shorts at these level and should provide healthy profits for speculators willing to short them over the next two years.
Meanwhile, our government, at all levels, fails its people once again. One might as well get used to this occurrence, because in a nutshell, the pols have promised more than they can possibly deliver. There is nothing new in this predicament, I am sure, since politicians of all ages have consistently overpromised, but the scale of the current indulgence nearly boggles the mind. Yet I am also convinced that the powers in control today are working late to see what else can possibly be piled upon our heap of unfunded obligations. I don't see the difference between telling the electorate not to worry about the overbuilt and undermaintained levee systems in this country and promising prescription drug benefits to seniors. Both are promises which will be quickly swept away when the "perfect storm" arrives. Fundamentally, they are both about deferring or outright abandonment of fundamental infrastructure maintenance for the sake of current consumption. And while we can rail about the ineptitude and corruption of our officials, elected and appointed alike, ultimately we must find the true culprit when we peer into the mirror. Let's cut taxes and increase spending, let's grant expensive new benefits to our seniors, further burdening an actuarially unsound system or let's launch an expensive foreign war with no end in sight, while maintaining sufficient National Guard troops to respond to domestic crises.
Never mind the winds that are blowing, because in the words of that one-hit-wonder Katrina and the Waves, "I'm walking on sunshine and don't it feel good!".
