Is the Bond Market Cooked, as Endgame Starts Early?
A: Hmm, tough call but I honestly don't think so - especially when the fed can talk up purchases of treasuries and change investor sentiment on a dime. This doesn't change my longer term thoughts on the bond market though. Remember that nothing goes in a straight line, but if a market is about to roll over (like oil, dot com tech stocks, etc..) you will see bids disappear real fast as the initial plunge is always both surprising & shocking. Longer time readers of this site caught my multiple mentions of endgame, and the likely reversal of the secular bond market rally that has lasted about 27 years. While consumers, corporate exec's, and traders cry for bailouts so that their stocks would rise faster, few out there talk about the unintended consequences of the path our decision markers are putting us on. The latest comes from the stimulus package's 'Buy American' talk and new Treasury Secretary Tim Geithner's 'fightin' words against China!
With the treasury about to embark on a major fund raising campaign via bond sales to help pay for all this stimulus, I'm not sure now is the time to:
1) have the latest stimulus package include a 'Buy American' order
2) have our new Treasury Secretary / President pick a fight with China, claiming manipulation of currency
...whether or not these are the things that both should happen and have been happening, is another issue. Bonds already had a big rally, and now it seems to be reversing:
You don't start a fight or place protectionist trade barriers with the people who have been funding our debt for so long, hold tons of treasuries, and who we hope to continue funding our debt moving forward! Is this just me here? Are they trying to pop the treasury bubble and send rates skyrocketing? Do they not understand the unintended consequence of these actions? Somebody help me, please!
Now, to understand the worry here you need to understand the situation we are in. Since the beginning of this debt-deflation adjustment, money has come out of stocks & commodities and went into treasuries as a safe haven play.
Today, we are about to pass an enormous $827,000,000,000.00 stimulus package to deal with this severe recession, we hope to raise these funds by selling bonds! The bond market capped off a 27 year secular bull rally with an amazing bubble like run to close out 2008. As stocks plunged and fear rose in the 4th quarter, more money poured into treasuries sending rates uber low and bond prices surging. But what if this money starts to pour OUT of treasuries, right before the massive supply to fund the stimulus package is about to hit the market? What if our friendly funders, become not so friendly anymore and do the unthinkable to deal with their own crisis - what if they sell their treasuries? What if the bond market rolls over?
I may not be right all the time, but at least I'm asking the right questions! Now, I don't think this is going to happen just yet and I think the latest bond selloff will ease a bit; but in this market, you just never know what could happen!
If the bond market does roll over, we will see a mad rush for the exits as everyone that is long treasuries with the expectation of holding the asset for a trade, sells out. This will send yields surging. And if yields surge, the cost of money will surge. Think about how any future recovery may be affected if the bond market rolls over, and borrowing costs skyrocket!
The WSJ Marketbeat blog is calling it 'The Geithner Bond Selloff':
“He came right out and said Obama believes China is manipulating their currency,” says Maryann Hurley, bond market strategist at D.A. Davidson, who notes that China’s economy is slowing as well. “It’s very easy to pick another country to be your whipping boy. In an era where we’re looking at deficits as far as the eye can see all we don’t need is somebody starting to dump our debt.”I also discussed this in Stage 10 of my piece, 'Stages of the Slowdown / End Game?", back in October:China is the largest foreign holder of U.S. Treasury securities, although data for November (the most recent available) showed that the country reduced its long-term holdings, though short-term holdings rose
STAGE 10 (Yet To Come, End Game) - Treasury Market?: massive treasury issuance to fund bailouts, nearing the end of rate cut cycle which is yet to come (I'll bet on 75-100 more bps of easing), stabilizing economic data which is far off, unwinding or slowing of treasury purchases by foreigners, rolling over of treasuries, selling of widely owned treasuries for this slowdown, and most of the damage done to equities already may all contribute to the selling of treasuries. The treasury market is arguably at the tail end of a 20 year secular bull market. What will treasury buyers demand in yields 12-24 months from now? Will treasuries still be in huge demand, as they are today, right in the center of the crisis? The end game may bring with it the end to the secular bull market in treasuries and higher yields; especially in the longer end of the curve! How will lenders and businesses adapt to higher borrowing costs should this occur and drag credit rates with it?You hear talk of how fed policy and trade policy can turn a severe recession like this one, into a depression. And at the heart of a statement like that, lies the unintended consequences of policy taken in times of distress. This post helps explain just HOW and WHY it could happen. Its the $25 TRILLION of US bond market debt, as estimated by Wikipedia in 2006, that could drive the next phase of this slowdown! It takes about $1.2 Trillion alone to fund our deficits, and that is sure to rise more and assumes things don't deteriorate further! At some point we are talking about real money here.
Let me guess in advance, they will ultimately blame any bond market selloff on the short sellers! I can see it already.
Comments (11)
Semi-on-topic.
Geithner's comments were foolish. Just about everyone I've spoken to agrees that he exercised horrible judgment by making that comment. Reportedly the administration scrambled to do damage control.
Personally, I don't think Geithner's long for the job. Haven't been at all impressed by him, and he really seems to be over his head. My guess is that (i) he got a bit of a spanking following the China comment and (ii) that Summers and/or Volcker are on him like a blanket and controlling his every move.
The only reason he may survive beyond a year is the fact that Obama has already been embarrassed by his cabinet nominees, and it would be too soon for another black eye.
Posted by faustus | February 8, 2009 10:52 AM
Semi-on-topic.
Geithner's comments were foolish. Just about everyone I've spoken to agrees that he exercised horrible judgment by making that comment. Reportedly the administration scrambled to do damage control.
Personally, I don't think Geithner's long for the job. Haven't been at all impressed by him, and he really seems to be in over his head. My guess is that (i) he got a bit of a spanking following the China comment and (ii) that Summers and/or Volcker are on him like a blanket and controlling his every move.
The only reason he may survive beyond a year is the fact that Obama has already been embarrassed by his cabinet nominees, and it would be too soon for another black eye.
Posted by faustus | February 8, 2009 10:52 AM
whoops - sorry for dp
Posted by faustus | February 8, 2009 10:54 AM
faustus - ridiculously foolish, I would say. Honestly, Im mixed on Geithner. And I think Volcker has more of an upcoming role than most think right now. I cant see Volcker being used only in 'an advisory' capacity.
I think the fact that he was Pres of NY Fed, shows the caution of bringing on any outsider, whether it be because they needed someone familiar with everything going on at the time or something deeper.
Im not a conspiracy theorist by any means, but those in control of the fed have way more power/control/influence than most think. Its out of control. Paulson was temp damage assessment and control, and even he could only do so well.
Posted by Noah | February 8, 2009 11:04 AM
Bonds got out of equilibrium in the
flight to quality.
Fair value is still 4% for the 10 year.
If that makes a difference to the RE bubble?
RE landlords borrow at Libor+400 to 600 depending on leverage.
Their funding rate is consistant with a 10% caprate on RE.
So, less that 10% of the RE price depends on
the 10 year being 3% or 4%.
Nothing can stop this bubble from deflating unless
The Fed prints money. That will bring a
run on the dollar and hyperinflation.
Pay now or pay later -- pick your poison.
Bear
Posted by bear | February 8, 2009 11:37 AM
Bear wrote:
"Nothing can stop this bubble from deflating unless The Fed prints money. That will bring a
run on the dollar and hyperinflation."
And that has always been my biggest fear (print money). Faced with hard choices, the Fed (and US Government) will take (already are taking) what appears to be the easy route only to lead us to ruin.
I listen to these politicians (new head of HUD over the weekend) and this idiot states that the reason we are in this mess is housing. He is representative of all the dopes in Congress.
The reason we are in this situation is because of credit... too much... too lax, which manifested itself in housing in the final stages of the credit bubble. So instead of attacking the real source of the problem (too much debt) our politicians are hell bent on spending more to support an unsupportable market.
I think we are doomed. The only saving grace that I see is that every Central Bank seems to be following the same insane policies so the pain maybe mitigated through a defacto worldwide sharing mechanism.
Posted by lars | February 8, 2009 12:12 PM
Geithner is a moron.
It would be wise to recall that Protectionism deepened and lengthened the Great Depression.
Also, as Noah says: don't piss-off your Main Creditor.
Old saying goes:
"The U.S. created a lovely house on the hill...but the Chinese hold the Mortgage."
Posted by Eastvillboy | February 8, 2009 1:47 PM
"I think we are doomed. The only saving grace that I see is that every Central Bank seems to be following the same insane policies so the pain maybe mitigated through a defacto worldwide sharing mechanism."
I think this is a huge saving grace. It's certainly the reason why there really haven't been violent currency swings against the dollar. And also probably why there won't. Could the dollar weaken? Absolutely. Will we see a complete collapse? Highly unlikely.
I recently heard a group of economists (take with a grain of salt) talking about the prospect for inflation. These were all very smart guys/women, and none of them seemed particularly concerned about inflation at all, near-, medium- or long-term. They did say there was a risk down the road, but they also pointed out that, unlike deflation, inflation can be seen coming well in advance and can be actively and relatively easily managed. Not saying it's not a risk, but it's an addressable risk.
Posted by faustus | February 8, 2009 3:33 PM
As far as Geithner, I strongly believe that Summers was Obama's #1 choice for treasury secreatary, but he did not pick him because he said a bunch of stupid things back when he was president of Harvard, which would make for a nasty confirmation process.
Posted by Donald | February 8, 2009 4:57 PM
Noah, first you offered a great education on the Goldbug argument, and now you offer one for the Treasury bubble. I have a question based on your post.
It is my understanding that a large reason for the flight to Treasuries, particularly over the past year, was a flight to safety and a desire to preserve cash. To what extent do you believe that the rise in Treasuries reflects a greater confidence in other asset classes that offer higher yields. I have been keeping most of my money in short term treasury funds (yielding close to 0%) based upon a lack of confidence in other investments. Do you believe that investors will no longer view treasuries as safe, or do you think rates will rise because money will be flowing to other assets that appear to offer a greater yield or a greater chance at appreciation.
Thanks
Posted by mh23 | February 8, 2009 9:08 PM
Bonds soared last fall b/c of a combination of flight to safety and the game playing by Bernanke in the repo market. Failures to deliver were increasingly common as the primary credit dealers delayed deliveries in order to show that they were well capitalized. Well, that game might be coming to an end soon w/the rush of new issuances this spring. Just look at what gold's price is predicting.
Posted by jp | February 13, 2009 5:21 PM