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HomeThe Wheels Have Come Off Barack’s Bond Bus
Posted by Larry Doyle on May 27th, 2009 5:56 PM |
Despite what market analysts, media mavens, and government officials may assert, from an investment standpoint, the price action in the bond market can only be defined as “THEY’VE LOST CONTROL!!”
Who’s they? Bernanke, Geithner, Summers, Obama, and team. How so? The weight of the massive deficit spending along with the embedded costs of the Fed’s quantitative easing program are pressuring the bond market and driving interest rates dramatically higher. (10yr U.S. Treasury moved higher by almost 20 basis points today to 3.75%, a full 55 basis points higher over the last week. This is an ENORMOUS move.)
The knock on effect is increased anxiety in the equity markets (down 2% today) and a highly likely further slowing in the economy. I am not surprised. Given the programs and approach put forth by Obama, along with the economic turmoil, there was little doubt we would experience very high levels of deficit spending. Prior to the inauguration (January 4th to be precise), I surmised:
I also believe that despite the Fed and Treasury purchasing government and mortgage debt, these rates will end up much higher at the end of this year than they are now simply due to the growing deficit. A move higher in these rates will potentially cause further anguish within the equity markets.
I have tried to proactively highlight why I thought the government bond bubble was bursting (Is The Government Bond Bubble Getting Ready To Burst?) and just yesterday broached the negative impact on interest rates of all the mortgage refinancing activity (Mortgage Refi Activity Is Driving Rates Higher).
For those involved in trading or investing, successful calls are measured by direction, magnitude, and time. This call on rates has been a fairly patient development, but given the dramatic shift higher in rates over the last week, the implications of this move can now be embraced. Those implications include a revaluation of the equity markets (lower) and the economy (forestalled recovery). Beware of people who discount this move in interest rates. The fact is it has more to run. In my opinion, the move higher in rates is not only a reflection of the supply of bonds (both government and mortgage) but also an indication of further deterioration in our currency precipitating inflation.
Can the Federal Reserve do anything to defend the currency? Increase short term interest rates. Does anybody think our economy can afford an increase in short term rates at this juncture? NO WAY! There truly is very little the Fed or Treasury can do at this juncture. Thus, in my opinion, they’ve truly lost control as “the wheels have come off the bus.” Welcome to the Brave New World of the Uncle Sam economy 2009.
LD
Is the Government Bond Bubble Getting Ready to Burst? UPDATE>>
Posted by Larry Doyle on May 7th, 2009 2:59 PM |
I have tried to highlight my concerns on interest rates for the entire year. Despite the Federal Reserve “cutting checks” to buy hundreds of billions in U.S. Treasury bonds and mortgage-backed securities, the global demand for credit (meaning global governments, companies, and municipalities issuing MASSIVE supply of bonds) is driving rates higher.
As I wrote in my post from April 30th, the U.S. Treasury market has been faced with underwriting tens and now hundreds of billions in government debt on a regular basis. The 30yr government bond auction today was not well received and interest rates have moved higher by 10-20 basis points (.10 to .20%).
What are the implications of higher rates?
1. Increased cost of financing the deficit.
2. Upward pressure on other rates, primarily mortgage rates.
3. Longer time for economy to improve given higher interest costs.
4. Given the massive global government deficits, the access to credit for private enterprise is negatively impacted. This is known as crowding out.
As I referenced the other day, “We Still Have To Pay The Bill.”
Bloomberg reports, Treasuries Tumble as Bond Sale Draws Higher Than Forecast Yield.
From my piece at the end of April:
The equity markets have rebounded significantly over the last seven weeks. The Dow and S&P are now down approximately 4-6% on the year. The tech heavy Nasdaq has distinguished itself and is up approximately 10% on the year.
At this juncture, if the equity markets are implying that the economy will not slip into Depression, then the bill for the stability in equities is being transferred to participants in the bond market. Government bonds are facing an almost weekly avalanche of tremendous supply. This week the market is absorbing over $100 billion in 2yr, 5yr, and 7yr Treasury securites. Take a deep breath and next week the market is faced with over $75 billion in 3yr, 10yr, and 30yr government securities. The Treasury is likely going to sell 30yr government debt on a monthly basis!!
The Federal Reserve has been the biggest buyer of Treasury and mortgage-backed securities. The Fed’s balance sheet may be large but it is not endless. What have 10 yr. Treasury securities done on the year? Even in the face of massive buying of these securities by the Fed, the 10yr has backed up almost 1% to a current level of 3.1%. That rise in rates is very significant.
I have maintained and continue to maintain that interest rates will move higher given the overwhelming demand for funds by global governments to pay for deficit spending. Central banks around the world may try to hold the respective bond markets up and interest rates down but investors will continue to demand a higher rate of interest in the process.
As government rates move higher, mortgage rates, and other corporate rates will likely move higher as well. If we get a whiff of early signs of inflation which I believe is coming these rates could ratchet higher and the bubble in the government market would not merely burst but would actually explode.
LD
