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Posts Tagged ‘government bond bubble’

The 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.


Mortgage Refi Activity Is Driving Rates Higher

Posted by Larry Doyle on May 26th, 2009 7:17 PM |

In Wall Street terms, the wheels are coming off the Treasury bus. What does that mean in layman’s terms? Interest rates on U.S. Treasury securities are ratcheting higher. Why? I have addressed the massive supply of global government bonds that will be issued in order to finance the exploding deficits. For newer readers, you can find my thoughts on this topic in Is The Government Bond Bubble Getting Ready To Burst? UPDATE #2.

The dynamics of the massive supply of bond issuance to fund global deficits will not change. To wit, our market needs to absorb $60 billion in 5yr and 7yr notes tomorrow and Thursday.  Long term interest rates in our U.S. Treasury market moved higher by another 10 basis points again today to a level of 3.55%.

Over and above that, though, there is another significant reason that is driving our bond market lower and interest rates higher. This reason is receiving little to no attention by the media or market analysts. In fact, the color allocated to this factor is strictly viewed as a positive. I am talking about the waves of mortgage refinancing precipitated by the Federal Reserve’s quantitative easing program. 

How could refinancing activity further pressure the government bond market driving interest rates higher? Well, let’s accept the premise that any government program is never risk free or cost free. The quantitative easing employed by the Federal Reserve to purchase government and mortgage-backed securities has very real costs. The extraordinary volume of purchases of newly issued mortgage-backed securities by the Federal Reserve has allowed millions of homeowners to lower their mortgage payments. This is great for those benefitting. What are the costs? (more…)

Is The Government Bond Bubble Getting Ready To Burst? UPDATE #2 >>

Posted by Larry Doyle on May 21st, 2009 2:41 PM |

With equities down 2-2.5% on the day, one might think the safety of U.S. Treasury debt would be in vogue. Well, not so. In fact, the Treasury market is BREAKING down as I write this. The 10yr U.S. Treasury note has backed up to a 3.36% rate, which is a full 16 basis points higher on the day. This is a very significant move. What’s happening?

Well, let’s revisit my original commentary on April 30th and my subsequent update on May 7th.

What has changed today from then? Very little aside from S&P putting U.K government debt on watch for potential downgrade. Can the U.S. be far behind?

The demand for credit by global governments is swamping the market. If equities go up, down or sideways, I think U.S. Treasury 10 year notes are headed to at least a 4% rate and potentially much higher. (They started the year at approximately 2%, so they have already gotten pummeled).

Please recall that U.S. Treasury funding needs this year will very likely exceed the debt issued in 2006, 2007, and 2008 combined!! As I see it, the overall delevering process – in which individuals, corporations, and governments need to pay down debt via asset sales or refinance the debt – continues unabated. On May 7th, I wrote:

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.

Having fewer banks on Wall Street means larger slices of the profit pie for those still standing. However, having fewer banks also means lessened liquidity and risk-taking overall. Bigger deficits mean higher rates which lead to a slower economy and longer recovery period. Turbo-Tim, Big Ben, and Barack need to factor that dynamic into their economic equations. Principles of Economics 101.


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