Bond Market Dislocation?

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pir8don's picture
pir8don
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Bond Market Dislocation?

I read this term on Denninger but didn't understand it so I have been educating myself. It seems this last week has seen so called 'Bond Vigilantes' embark on a challenge.

http://market-ticker.denninger.net/

http://www.bloomberg.com/apps/news?pid=20601087&sid=a6eMpGVUDeeE&refer=home


bloomberg wrote:

Bond Vigilantes Confront Obama as Housing Falters (Update3) By Liz Capo McCormick and Daniel Kruger
May 29 (Bloomberg) -- They’re back.
For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.

more on link

Don

________________________________

too big to fail, too big to fix, too big to care

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pir8don
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Re: Bond Market Dislocation?

More

Mortgage Market Dislocation Shows How Heavily Mortgages Rely on Fed

http://seekingalpha.com/article/140388-u-s-economy-there-are-limits-to-k...

Don

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Re: Bond Market Dislocation?

This is a good article (and if the video loads) and video from Financial Times on the bond market spreads and their effect on the economy:

Short View: Bond market

By John Authers, Investment Editor

Published: May 28 2009 19:04 | Last updated: May 28 2009 19:04

Is the bond market the great stabiliser of the world economy or the territory of vigilantes determined to extract a price for governmental profligacy?

Either reading of the sharp rise in 10-year Treasury bond yields and in mortgage rates, only partially reversed on Thursday, is possible.

The 10-year yield, at about 3.7 per cent, is far below the 5 per cent it hit two years ago, when a bond scare triggered the credit crisis. By historical standards, yields are very low, consistent with a trend that has persisted for a quarter of a century. They are not high enough to derail an economic revival.

A rise in yields, barely 2 per cent when the US Federal Reserve unveiled its plan to buy bonds, could be an overdue return to normality. Investors are no longer making flights to safety and are selling bonds.

It can also be argued that bond yields will not rise enough to halt recovery. If they did, growth would fall and people would buy bonds, pushing yields down.

Yet there is another view, also rooted in common sense. The global economy came out of its freefall thanks to the spending of piles of government money. That must be financed. The bond market could prove to be a crucial bottleneck.

Mortgage rates are critical. They need to stay at artificially low levels, not at historical norms, if the plan to revive US housing and banks’ balance sheets is to work.

Mortgage rates had stayed low only thanks to historically low spreads compared with Treasuries. They have now snapped. The latest US mortgage delinquency figures are horrendous, with more than 6 per cent of prime mortgages in arrears – more than double the long-term norm. A quarter of subprime loans are delinquent.

Even if the bond market is merely normalising, vigilantes could have no effect. The US needs bond yields to be much less than normal for a while.

[email protected]

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Re: Bond Market Dislocation?

Darn it - video didn't load.  Anyway, here is the link:  http://www.ft.com/cms/s/0/7b375846-4bb0-11de-b827-00144feabdc0.html

Almost Chris-Martenson-grade explanation and nice graphs to boot.

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Re: Bond Market Dislocation?

An accompanying articlee from FT:  http://www.ft.com/cms/s/2/724e1170-4b06-11de-87c2-00144feabdc0.html

 

Treasury sell-off

Published: May 27 2009 22:49 | Last updated: May 28 2009 09:40

So that is what happens when you try to take on the bond market. On Wednesday the US authorities must have been looking on in horror as long-term bond yields spiked. Markets were already wobbling last week. Now it looks like someone is hitting the panic button. Yields on 10-year Treasuries, for example, jumped more than 20 basis points in an hour and now stand at 3.7 per cent. Earlier this month, yields were 3.1 per cent.

The risk of rattling the bond market was always there. A government cannot go around dropping the odd trillion dollars and expect no one to notice. Equally, the ballooning of the Federal Reserve’s balance sheet has worried many, while the start of quantitative easing was an open invitation for investors to test the Fed’s hand. So far it is proving limp. This week, for example, the Treasury has issued another $100bn-worth of bonds. The Fed, meanwhile, has purchased less than a 10th of that.

Of the three things spooking investors, one is real, while the others are overplayed. That yields on 30-year Fannie Mae mortgage bonds leapt about 45 basis points on Wednesday to 4.7 per cent is a genuine problem. If Americans cannot be coaxed into taking out mortgages or if refinancing cash vanishes from consumers’ pockets, forget about green shoots. Mortgage applications fell 14 per cent last week versus the week before, according to the Mortgage Bankers Association.

That the yield curve has steepened so dramatically highlights the two other fears, namely that the Fed may lose control of prices in future and that America’s bulletproof credit rating may be under threat. Here investors should heed Japan’s experience and relax a little. The downgrading of its sovereign debt in 2001 did not prevent authorities from keeping interest rates low nor did loose monetary policy and rising government debt lead to inflation.

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Re: Bond Market Dislocation?
 
 

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Federal Reserve puzzled by yield curve steepening

Sun May 31, 2009 3:48pm EDT

By Alister Bull - Analysis

WASHINGTON (Reuters) - The Federal Reserve is studying significant moves in the U.S. government bond market last week that could have big implications for the central bank's strategy to combat the country's recession.

But the Fed is not really sure what is driving the sharp rise in long-dated bond yields, and especially a widening gap between short and long term yields.

Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit? If so, there might be less need for the Fed to expand the money supply by buying more U.S. Treasuries.

Or does the steepening yield curve mean investors are worried about the deterioration in the U.S. fiscal outlook, or the potential for a collapse in the U.S. dollar as the Fed floods the world with newly minted currency as part of its quantitative easing program. This might be an argument to augment to step up asset purchases.

Another possibility is that China, the largest foreign holder of U.S. Treasury debt, has decided to refocus its portfolio by leaning more heavily on shorter-term maturities.

With officials still grappling to divine the factors steepening the yield curve, a speedy decision on whether to ramp up the Treasury debt purchase program or the related plan to snap up mortgage-related debt seems unlikely.

"I'm in wait-and-see mode," said one Fed official who spoke on the condition of anonymity. "We laid out the asset purchase plan and we're following it. That is going to have some affect on various interest rates, but together with a hundred other things. So I don't think we should be chasing a long-term interest rate," the official said.

BERNANKE

An important clue could come on when Fed Chairman Ben Bernanke testifies about the economy to U.S. lawmakers on Wednesday morning.

After lowering short term interest rates to near zero in 2008, the Federal Reserve said at its March meeting that it would buy up to $300 billion in longer-term Treasury securities over six months as part of its efforts to increase the money supply and ease the credit crunch of the past two years. So far, the Fed has bought $130.5 billion or about 44 percent of that $300 billion.

The Fed also has a goal of buying up to $1.25 trillion of mortgage backed securities (MBS) and $200 billion of debt issued by agencies like Fannie Mae and Freddie Mac. The Fed purchases of agency MBS total $507.075 billion so far in 2009.

But last week the benchmark 10-year U.S. Treasury bond yield jumped to a six month high around 3.75 pct, while the spread between 2-year and 10-year bond yields widened to a record 2.75 percentage points.

Economists at Barclays Capital in New York have argued that the Fed should announce plans to increase its planned purchases of longer-dated Treasuries to $1 trillion from $300 billion to drive yields back down, lower home mortgage rates again, and support the embryonic economic recovery.

They warn the Fed cannot afford to hold fire until its next scheduled policy meeting on June 23-24.

But the Fed is not so sure, and officials note that corporate bond spreads have narrowed over U.S. Treasuries, and that although mortgage rates have risen, they are still low.

An obvious culprit for the move in bond yields is the country's record fiscal deficit, which will generate a massive amount of new government issuance.

The U.S. Treasury must sell a record net $2 trillion in new debt in 2009 to fund a $1.8 trillion projected fiscal deficit, resulting from falling tax revenues, an economic stimulus package and sundry bank bailouts.

Investors began to worry this could erode the United States' cherished triple-A sovereign credit rating when Standard and Poors's on May 21 revised its outlook for Britain's triple-A status to negative from stable, blaming higher government debt.

The International Monetary Fund estimates that gross U.S. debt will reach 97.5 percent of the country's GDP in 2010, versus 72.7 percent of GDP for the United Kingdom.

But other Fed insiders said they have a problem blaming the steepening of the yield curve just on the extra supply of new Treasury debt.

While there has been a sharp deterioration in the U.S. fiscal outlook, this has been evident for months and the dramatic steepening of the curve only occurred this week.

Fed officials also believe that some better-than-expected economic data recently has encouraged investors to believe there is less need for the safe-haven of government bonds and more risk of inflation.

Dallas Federal Reserve Bank President Richard Fisher said on Thursday that the yield curve often steepens after a period of flatness heralding an economic recovery, but in this case is it likely a combination of factors.

"Obviously, there is a lot of supply of debt. Another way to interpret the steepening of the yield curve is ... confidence in the economy going forward," he told reporters in Washington after delivering a speech.

(Reporting by Alister Bull)

(Additional reporting by John Parry and Lynn Adler in New York, and Ros Krasny in Chicago; editing by Carol Bishopric)

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Re: Bond Market Dislocation?
Quote:

Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit? If so, there might be less need for the Fed to expand the money supply by buying more U.S. Treasuries.

How could they even consider this question?  A steepening yield curve in a recovering/growing economy is due to credit demand in the private market going up.  How in the heck could credit demand be going up at a time like this?  Is the US consumer out buying new homes, cars, and appliances all of a sudden?  Are companies investing in new factories, infrastructure, offshore platforms, mines?  No, no, no and no.  None of the other economic data remotely suggest so, that's for sure.

Quote:

But other Fed insiders said they have a problem blaming the steepening of the yield curve just on the extra supply of new Treasury debt.

While there has been a sharp deterioration in the U.S. fiscal outlook, this has been evident for months and the dramatic steepening of the curve only occurred this week.

Yeah, but the Fed has now bought 50% of the $300 billion of treasuries they threatened to purchase.  Looks like they're blowing through that pile pretty quickly and everyone is taking notice.

Quote:

Fed officials also believe that some better-than-expected economic data recently has encouraged investors to believe there is less need for the safe-haven of government bonds and more risk of inflation.

Dallas Federal Reserve Bank President Richard Fisher said on Thursday that the yield curve often steepens after a period of flatness heralding an economic recovery, but in this case is it likely a combination of factors.

"Obviously, there is a lot of supply of debt. Another way to interpret the steepening of the yield curve is ... confidence in the economy going forward," he told reporters in Washington after delivering a speech.

They just can't keep themselves from invoking the "green shoots" theory, even when the sky is falling.  They're nothing if not self-delusional I suppose.

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pir8don
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Re: Bond Market Dislocation?

Um urr thanks Patrick - I think. I now know far more (or less) than I ever thought I would want to on this subject. It all seems to amount to 'something might be afoot in the bonds market' and whatever it is it isn't what the fed want.

Don

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