Committee for a Responsible Federal Budget


Aug 6, 2010 | Economics

Today’s disappointing employment report (unexpectedly, June was revised downward and July was weak) prompted a Treasury rally, attributed by the financial press to safe haven flight once again. Deflation concerns however may have also driven investors. With prices rising for the benchmark 10-year note (and for most maturities), yields headed even lower on Friday after drifting downward most of the week. The unemployment news also resulted in stock market losses and a weakening of the dollar (as the prospect of lower interest rates in the US drove investors to seek higher returns elsewhere.)

The weak employment data appears to have increased downside risk concerns of market players. But, it is still early and there is a lot more July data to come. Another important signal about the outlook and policy stance may come next week when the Fed’s monetary policy setting body (the FOMC, or Federal Open Market Committee) meets (August 10).

Market players are focused on many of the same burning questions as the American taxpayer and our policymakers. In a nutshell, what is the outlook for the economy? Are we firmly entering recovery territory, will we go back into recession, or will we see positive but subpar growth (in earlier years, the term “growth recession” was used)? Are the risks on the side of deflation, inflation or neither? And what about persistent high unemployment and the still troubled housing market? When will our financial system get back to “normal”?

And what should policymakers do: should there be more fiscal stimulus (Zandi, Blinder, and Stiglitz have been making the case) or less (consider the debt, near peacetime highs as a share of the economy); can the two fiscal positions be reconciled; should there be additional monetary stimulus, possibly through more quantitative easing – or an unwinding of the Fed’s positions (newspaper leaks in the run-up to next week’s FOMC meeting suggest there may be a debate on precisely this question within the Fed)?

Treasury auctions may also be affected by diminishing supply over time. The Treasury Department has announced that it is gradually downsizing the amount of notes and bonds offered in its quarterly refunding auctions based on its economic projections. According to Treasury officials, future borrowing forecasts will also be based on the assumption that the 2001 upper tax bracket cuts will be allowed to expire as scheduled (President Obama’s budget proposals). Based on borrowing projections, Treasury does not expect to hit the debt ceiling limit (always controversial) until the first or second quarter 2011.