Bear Steepening of the Yield Curve

FN: A quick follow up to yesterday's post With Each Interest Rate Tick Higher Another "Green Shoot" Dies.

Rates continued to rocket higher yesterday and an interesting post from Across the Curve, an excellent fixed income blog I follow regularly.

Bond Market Close May 26 2009: "Why is the market crashing and why is the curve so steep?

We are drowning under the weight of near term supply for sure but I guess I think something else is afoot here.

Look at the breakeven spread on the 10 year TIPS bond. That spread is currently 185 basis points. I do not believe that we have been that wide since the advent of the financial crisis in 2007. I think that investors are uttering a gigantic and collective nyet regarding the implementation of monetary policy and fiscal policy in the US.That is why the curve is steepening so dramatically.

Foreign central banks continue to intervene, buying dollars and selling their local currencies. The names most mentioned in that endeavor are Russia and Brazil. Sources tell me that the fruits of the intervention are parked in 2 year notes and 3 year notes. There is a dearth of central bank interest in the longer maturities.

Some cite the very strong 2 year note auction today as a sign of the market’s health. I think not. The issue is propped up by the prospect of a very low funds rate for an extened period of time. The carry and ride down the curve profits are seductive.

Central banks bought over 54 percent of the issue. I would submit that while that is great for the 2 year note it is a less than festive sign for the 5 year note and the 7 year note which will auction over the balance of this week, The money in the 2 year note is money that will not be invested in the 5 year note and the 7 year note. The treasury should organize a posse to search for marginal dollars for the 5 year and 7 year. If one wishes to observe bond market panic I think it would develop quickly if the 5 year note or the 7 year note auctioned with long tails as we observed in the Bond auction earlier in May.

A long tail in a bond auction with its attendant risk is one thing. If that were to occur in a shorter maturity in would be a sign that investors are in full retreat from longer dated US assets.

Maybe the final climactic event is upon us. Maybe the final bubble to burst is the US Treasury market and maybe we are on the verge of a financial Krakatoa which will realign financial markets.

Whatever the case it feels like the calm before the storm and we are about to embark on another interesting expedition."

FN: I couldn't agree more. These are ominous developments that aren't getting the attention and scrutiny they deserve.

In Gold: Massive Catalyst Required I argued that something big and bad had to happen for Gold to crack $1000 and go higher. The implosion of the sovereign bond market would be just such a catalyst.