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Tuesday, May 26, 2009

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.


John said...


What is the implication for equities should this "Krakatoa" occur?



Tord Steiro said...

It's fair chance they will get tainted by sulphur oxides, covered by massive amounts of ash, hit by repeating tsunamies, and buried below the ocean floor.

Or money drawn out of treasuries could, theoratically, feed the mother of all equity rallies.

Whatever you want to believe...

suek said...

I'm economically an ignorant person, reading this blog - among others - with the hope of getting a grasp of what's happening in the US economy. I ran across this post, and offer it for your consideration. I have no idea of its value - if any. Still given the possibility of out and out corruption in the Chrysler dealership closings, I consider this a real possibility. If the government is involving itself in the market in order to manipulate it, we really are in deep doodoo. IM uneducated O.

My verification word is "horse". Think that means we're regressing?? Is that a transportation clue?

Vijay said...

Great to have you back Ben!

To add more depth to what's happening checkout this article in the WSJSadly for politicians the Treasury market is so obviously massive and liquid that they can't blame evil speculators and hedge funds. If the treasury market explodes there's only one place to point: Uncle Sam.

"The very fact that a Fed regional bank president has to raise this issue is not very comforting. It conjures up images of Argentina. And as Mr. Fisher explains, he's not the only one worrying about it. He has just returned from a trip to China, where "senior officials of the Chinese government grill[ed] me about whether or not we are going to monetize the actions of our legislature." He adds, "I must have been asked about that a hundred times in China."

Ben Bittrolff said...


The whole world can't simultaneously go into massive budget deficits. There just aren't enough citizens saving to finance that kind of demand...

We may be hitting that crucial point of no return.

Tschäff said...
This comment has been removed by the author.
Tschäff said...

You're a talented trader but you're way off on this one.

Government's borrowing for now has given the enormous savings glut a place to go. It is a process which expands demand in the economy, thus GDP. All the world's governments can go into deficit spending and it won't crowd out private spending until the excess savings have been absorbed, which is the same as to say it can go on as long as countries are in a liquidity trap.

Comon Ben, you're getting mentally lazy.

DiverCity said...

Yeah, those Americans sure have been penny pinching savers for the past 10 years of so, Tschaff. And if you're referring to all those dollars held by foreign sovereigns as "savings," that's the point. If they decide to use those dollars to buy other assets, such as commodities, watch out. Private buyers aren't buying -- hence, the rising yield which becomes necessary to attract those "savings." And if the yield gets high enough to pull in privates, then it surely will crowd out investments in actual productive endeavors.

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