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U.S. Treasury Bond Bear Market Picking Up Steam?

Interest-Rates / US Bonds May 22, 2009 - 02:11 AM GMT

By: Michael_Pollaro


Best Financial Markets Analysis ArticleAt the risk of repeating myself, this author is bearish on long dated US Treasuries.  Yes, despite the best efforts of the Fed to monetize the federal government’s ballooning borrowing needs and hold long rates at bay, this author is bearish on long dated US Treasuries. 

It’s my belief that a multi-year bear market in long dated Treasuries commenced on December 18th 2008, when the 30-year Treasury bond yield hit a panic-driven spike low of 2.53%.  30-year Treasuries closed today at 4.31%, a new high on the move.

For those who haven’t seen my bearish case, below are my three prior posts on the subject:

Inflection Point in U.S. Treasury Bond Interest Rates Near?

Obama Says Short US Treasuries, an Update

For those looking for an executive summary, I’ll start with this quote from Bill Bonner:

If the government funds its deficits honestly - by borrowing from willing lenders - this huge extra demand for credit will force up yields... thereby lowering bond prices. Or, if the government resorts to "monetizing the debt" - that is, funding its debt with printing press money - investors will flee bonds, in fear of higher inflation. Either way, it will be bad news for bond prices.  Treasuries lose either way

Ballooning government bailout and spending programs as far as the eye can see.  A Fed able, willing and ready to monetize the mountain of debt to follow. That’s the underpinnings for a Treasury bear market.

So what new tidbits can I bring you in this bearish saga? 

First, on May 20th, the minutes from the last Fed meeting suggested the Fed was close to upping its Treasury long bond monetization commitment, from the current $300 billion.  The 30-year Treasury rallied all of 5 basis points on the news, and this when the stock market was down.  When the Fed announced its $300 billion purchase program back on March 18th, the 30-year rallied 50 basis points.  Granted, it’s not an actual announcement, but I say, where’s the mo?

Next, on May 21st we read this headline on MarketWatch:

Treasury yields hit highest level since November.
Fed buyback, auction news pressures prices

NEW YORK (Marketwatch) -- Treasury prices headed lower Thursday, with 10-year note yields rising to the highest since November, after the Federal Reserve bought a lower portion of U.S. debt offered to it in its latest buyback.

The Fed bought $7.398 billion in Treasurys on Thursday in its third such operation of the week.

Dealers submitted $45.694 billion in debt maturing from 2013 to 2016 to be bought, by far the most ever tendered for operations of any maturity range. See results on Fed's website.

The last time the Fed bought from this segment, on April 27, it purchased $7.025 billion, of about $23.4 billion offered.

Dealers wanted out of $46 billion in Treasuries, versus $23 billion in the last auction, and the same $7 billion bid from the Fed wasn’t cutting it.  Having already bought $100 billion of its promised $300 billion it looks like the Fed is going to have to keep stepping up to the plate in increasing size at each auction to keep rates at bay.

Tony Crescenzi, chief bond market strategist at Miller Tabak & Co., offers up this explanation for the failure of today’s buyback:

The Fed may have wanted to push back the dealer community after many concluded yesterday from the FOMC minutes that the Fed might either increase its Treasury purchases or be more aggressive with its purchases

I’m not so sure Mr. Crescenzi.  I’m thinking that maybe the Treasury market is getting a bit antsy, and looking to move out of its long term Treasury positions with a bit more urgency.  I’m thinking maybe the size of the submissions at today’s auction caught the Fed, indeed everyone, by surprise.  I’m thinking the Treasury market is getting increasingly worried about the consequences of all this debt? 

From the same MarketWatch headline, we get one reason why the market is getting increasingly worried:

With data and other news mostly done for a holiday-shortened week, traders' attention turned to preparing for the $101 billion in auctions the government has slated for next week.

For more in the worry department, there was this headline in the May 18th Financial Times:

Brazil and China eye plan to axe dollar

Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil’s central bank and aides to Luiz Inácio Lula da Silva, Brazil’s president.

The move follows recent Chinese challenges to the status of the dollar as the world’s leading international currency [read reserve currency]

You see, the other side of the US reserve currency status is a mountain of US Treasuries held by central banks around the world, to the tune of 48% of the US public debt.  What’s more, some 75% of US Treasury new issuance this decade has been bought by foreigners.  Now, these buyers, led by China, are looking elsewhere, at a time of the US’s greatest need.  Say the Treasury market, if not foreigners, than who is going to buy all these Treasuries?  Who’s going to pay for all these bailouts and spending programs?

If this wasn’t enough to worry about, we get this headline from the May 21st MarketWatch, smacking the Treasury market right between the eyes:

Standard & Poor's cuts U.K. outlook to negative from stable

LONDON (MarketWatch) -- Standard & Poor's on Thursday lowered its credit outlook on the U.K. to negative from stable for the first time ever in view of the country's swelling debt, which may expand even as the economy recovers.
The move by Standard & Poor's raises the prospect not only of a credit-rating downgrade in Britain but a lowering of the outlook in the U.S., which has taken a similar path of big spending and quantitative easing to escape the credit-led recession.

Let’s see, says the Treasury market.  Huge and growing government borrowing needs.  That means higher rates.  For years, foreigners sucked up US Treasuries, helping to keep rates low.  But if foreigners are backing away, that’s going to leave the Fed as buyer of last resort.  But then that means we end up like the UK, with a wreck of a balance sheet and the only way out, the printing press.  I’m thinking that Bill Bonner’s Fed can’t win this one no way no how may be coming into play about now, don’t you?

Want some confirmation that the pop in Treasury rates are for real.  Granted, it could be noise, but have you seen how well gold, you know the ultimate safe-haven and inflation worry wart, is doing?  It’s up $30 dollars this week to $950?  That’s $100 or 12% better than its price on December 18th, the day 30-year Treasuries bottomed.  And gold stocks, as measured by the XAU, have broken out to new highs on this move and are up some 35% from December 18th.  And the US dollar, its hit new lows on this move.

Treasury rates up, gold up and the US dollar down.  Signs of a Treasury bear market in the making.

You might say, wait a minute.  Risk aversion is waning.  The market is selling Treasuries and buying into the risk asset rally.  That’s the reason why Treasury rates are up from their December bottoms.  Well, that may have been partly true, early on in the risk asset rally.  But it’s not true of late.  The stock market for example is struggling yet the Treasury long bond rate has continued its upward march.

It’s not straight up from here for Treasuries rates.  Nothing moves in a straight line.  It’s even possible that on the next deflation scare (I think we may very well get one) long dated Treasuries may shine as a safe haven once more.  But even in the event of another deflation scare, I wouldn’t bet on a repeat of 2008’s stellar performance.  And I certainly wouldn’t bet on a return of the Treasury bull market, anytime soon. 

You see, this time around it’s not the private sector that’s trashing its balance sheet and putting itself in hoc.  It’s the government, the last one standing, and it’s got a printing press too boot.  And that means the Treasuries of the future will be nothing like the Treasuries of the past.

By Michael Pollaro


I am a retired Investment Banking professional, must recently Chief Operating Officer for the Bank's Equity Trading Division. I am also a passionate free market economist in the Austrian School tradition and private investor

    Copyright © 2009 Michael Pollaro - All Rights Reserved
    Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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