US Treasuries: Now What?

FN: Yesterday 10 year yields briefly printed 4.0% after the auction. Equities didn't like it and immediately sold. Things stabilized by the end of the day, with a yield below 4.0% and equities levitated off their lows.

But now what?

Treasury 10-Year Notes Yield 4% for First Time Since October: " Treasury 10-year note yields reached 4 percent for the first time since October on concern surging budget deficits and a falling dollar will prompt investors to reduce holdings of U.S. debt as issuance climbs to a record.

Treasuries tumbled 6.5 percent so far this year, the worst performance since Merrill Lynch & Co. began tracking returns in 1978, as so-called bond vigilantes drove up yields to punish President Barack Obama for quadrupling the budget shortfall to $1.85 trillion and raising the risk of inflation.

“People are increasingly concerned about supply,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee. “The government running a deficit of 12 or 13 percent is not something we’ve seen since World War II. It’s very hard to digest.”"

FN: The deficits are set. Government debt supply won't decrease for years. Therefore the only part of the equation left to tamper with is demand. To prevent yields from spiking much higher and crushing an already crippled economy, a bid must be manufactured for treasuries.

Somehow liquidity must be coaxed out of risky assets, such as equities and commodities and funneled into treasuries to push yields down. The simplest way to do this is to inspire a "Safe Haven Bid". To achieve this outcome something somewhere has to be allowed to die... Lehman style. Perhaps the sacrifice of a few small Baltic states, such as Latvia, would do the trick.

Sure it sounds far fetched... but stranger things have happened. Somehow rising yields must be stopped. So how will "they" do it?

Latvia’s Woes Look Like Argentina All Over Again, Roubini Says: "Latvia's troubles resembles those Argentina faced early in the decade, said Nouriel Roubini, an economist at New York University.

Writing in the Financial Times, he said the Baltic nation faces a deep recession triggered by a global financial crisis, a sudden cessation of capital inflows and the need to cut an external deficit worsened by a greatly overvalued currency.

The Latvian authorities, backed by the International Monetary Fund, have set their faces against devaluing the lat, but foreign-exchange reserves are melting away at a frightening speed and the policy has to be reversed, Roubini said.

Without a depreciation of the lat, an adjustment of relative prices could occur only by means of deflation and a drop in nominal wages that would take too long and worsen the recession, he said.

The large foreign liabilities of Latvian households, banks and companies are in foreign currency, so a devaluation would lead to a sharp increase in the value of such debts expressed in lats and, possibly, to a surge in defaults; that would be damaging for Swedish banks that own the Latvian ones, he said.

Still, devaluation seems inevitable and the IMF's policy, which rules it out, is mistaken, Roubini argued."