Monday, January 26, 2009

More on the Bond Market…

The long end of the curve continued down again today. I’ve been writing about the bond market recently, here are my two latest articles that you can find here:

Bond Market Hide & Seek – A Domed House & 3 Peaks...
And here:
Another Expert Weighs in on Bonds...

Now another expert, Martin Weiss, weighs in with this enlightening piece that spells out the effects of the rapid move in recent days:

5 Years of Interest Destroyed in 6 Weeks!

by Martin D. Weiss, Ph.D.

Last month, investors from all over the world — spooked by the debt crisis — flocked to buy long-term U.S. Treasury bonds.

They bought U.S. bonds with money earned from China's export boom. They scooped up bonds with money gleaned from the savings of millions of Japanese families ... with government money ... oil money ... even drug money.

Investors large and small, haughty and humble — Asian central bankers, mid-East sheiks, and retired Americans living on fixed income — all piled into Treasury bonds at the same time.

And they all had a similar goal: To escape the terrifying dangers ... find what they thought was a safe haven ... and grasp for something — anything — better than the near-zero yields on short-term Treasury bills.

Many reached out as far as they possibly could in maturity, buying the longest Treasury bond in existence — the 4.5% "long bond" expiring May 15, 2038.

But as the Treasury bond buying frenzy reached a crescendo on December 18 of last year, they didn't get the coupon yield of 4.5%.

Instead, they had to pay such a high price for the bond, they wound up locked into the lowest Treasury-bond yield in history: A meager 2.52%!

That was bad enough.

But the saga of woes does not end there. The real disaster came with the events that have ensued since...

For each $10,000 in face value bonds, they paid an exorbitant $14,091. And now, the value of that bond has plunged to only $12,200, delivering a shocking loss of $1,890.

The summary of these results reads like a fixed-income horror story:

Annual yield: A meager 2.52%
Market loss: 12.85%
Years of interest lost: 12.85/2.52 = 5.3
Time elapsed: 6 weeks

Conclusion: They lost the equivalent of more than FIVE YEARS OF INTEREST in just SIX weeks.

It was easily among the most disastrous Treasury bond investments of all time! Meanwhile, investors who followed our recommendation to buy strictly short-term Treasury bills didn't lose a penny.

Now do you understand why we've been warning you not to touch long-term bonds with a ten-foot pole? And now do you see why we've been working so hard to find other, alternative, depression-proof sources of income and profits for you?
That’s quite a move in 6 weeks – 12.85%! And TLT (20 year bonds) went down anther .87% today.

Then this afternoon we learn that the Treasury had difficulty with their latest TIPS auction as Mike Larson spells out at his blog, Interest Rate Roundup:
Stinko 20-year TIPS auction

The Treasury just sold $8 billion of 20-year TIPS at what looks like a stinko auction. The notes were sold at a yield of 2.5% versus pre-auction talk for a yield of 2.37% (per Bloomberg). The bid-to-cover ratio came in at 1.92, compared with an average of 1.98 for the past five sales. Indirect bidders bought 54% of the notes issued, below the five-auction average of 57.2%.

Long bond futures fell on the news, recently down 31/32 to a price of 128 20/32. Ten-year yields are up about 5 basis points. Next up: $40 billion in 2-year notes tomorrow and $30 billion in 5-years on the 29th.
So, they are having trouble selling 20 year TIPS and that’s producing higher interest rates and lower yields… Darn that old supply and demand! See, Bernanke believes that he can flood the entire globe with supply and that he can just buy all our own debt back ourselves – a great parlor trick that has, unfortunately, never worked before in the history of mankind – although it most certainly has been tried.

But they do know there are ramifications of their action, at least some people do, just not the ones in charge. Their game is to give lip service to reporters in hopes that their words will get investors to front-run their buying so that they don’t have to! Well, the insiders aren’t buying the bull:

Bloomberg article:
Bernanke Risks ‘Very Unstable’ Market as He Weighs Buying Bonds

By Rich Miller

Jan. 26 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke and his colleagues may try once again to cure the aftermath of a bubble in one kind of asset by overheating the market for another.

Fed policy makers meeting tomorrow and the day after are exploring the purchase of longer-dated Treasury securities in an effort to push up their price and bring down their yield. Behind the potential move: a desire to reduce long-term borrowing costs at a time when the Fed can’t lower short-term interest rates any further because they are effectively at zero.

The risk is that central bankers will end up distorting the Treasury market, triggering wild swings in prices -- and long-term interest rates -- as investors react to what they say and do. “It sets forth a speculative dynamic that is very unstable,” says William Poole, former president of the Federal Reserve Bank of St. Louis and now a senior fellow at the Cato Institute in Washington.

The Treasury market has “some bubble characteristics,” Bill Gross, the manager of Newport Beach, California-based Pacific Investment Management Co.’s $132 billion Total Return Fund, said in December on Bloomberg Television. He echoed that sentiment last week.

“I will say, and I have said for the past three months, the governments are very overvalued,” Gross said in a Jan. 20 interview. Treasuries last year returned 14 percent, according to Merrill Lynch & Co.’s Treasury Master Index, their best performance since 1995.

Inflated Prices
Recent history shows the economic danger of inflating asset prices. After a stock-market bubble burst in 2000, the Fed slashed interest rates to as low as 1 percent and in the process helped inflate the housing market. The collapse of that bubble is what eventually helped drive the U.S. into the current recession, the worst in a generation.

Faced with the danger of a deflationary decline in output, prices and wages, the Fed is considering steps to revive the moribund economy. On the table besides bond purchases: firming up a pledge to keep short-term interest rates low for an extended period and adopting some type of inflation target to underscore the Fed’s determination to avoid deflation.

The central bank has been buying long-term Treasury debt off and on for years as part of its day-to-day management of reserves in the banking system. Yet it has always gone out of its way to avoid influencing prices. What it’s discussing now, says former Fed Governor Laurence Meyer, is deliberately trying to push long rates below where they otherwise might be.

Fed Purchases
Bernanke raised this possibility in a speech on Dec. 1. While he didn’t specify what maturities the Fed might buy, in the past he has suggested that purchases might include securities with three- to six-year terms.

Investors immediately took notice, with the yield on the 10-year note falling to 2.73 percent from 2.92 percent the day before. Yields fell further on Dec. 16, dropping to 2.26 percent from 2.51 percent the previous day, after the central bank’s policy-making Federal Open Market Committee said it was studying the issue.

“Every time they mention it, the market reacts,” says Stephen Stanley, chief economist at RBS Greenwich Capital Markets in Greenwich, Connecticut.

Yields have since risen, with the 10-year note ending last week at 2.62 percent. Behind the reversal: expectations of massive fresh supplies of Treasuries as the government is forced to finance an $825 billion economic-stimulus package and a possible new bank-bailout plan. This week alone, the Treasury is scheduled to auction $135 billion worth of securities.

Jump in Yields
David Rosenberg, chief North American economist for Merrill Lynch in New York, says the jump in yields may prompt the Fed to go ahead with Treasury purchases.
This isn’t the first time Bernanke and the Fed have discussed buying longer-dated securities and ended up roiling the market. Bernanke touted the idea as a tool to fight deflation in speeches in November 2002 and May 2003.

Egged on by his comments -- and later remarks by then-Fed Chairman Alan Greenspan that the central bank needed to build a “firewall” against deflation -- many investors became convinced the central bank was poised to buy bonds. The yield on the 10-year Treasury note fell to 3.11 percent in June 2003 from 3.81 percent at the start of the year.
Traders quickly reversed course as it became clear the Fed had no such intentions, sending the 10-year Treasury yield soaring to 4.6 percent just three months later, on Sept. 2.

Poole, who was then at the St. Louis Fed, was critical at the time of what he called the central bank’s “miscommunication.” He now sees the Fed making the same mistake with its latest suggestions that it might buy longer- dated securities.

“If they do it, it’s going to be disruptive to the market,” says Poole, who is a contributor to Bloomberg News. “If they don’t do it, it will impair the Fed’s credibility and erode the confidence the market has in the statements that the Fed makes.”

Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers, says the Fed should, and probably will, go ahead with purchases as a way to lower borrowing costs. “The story is stop talking and start buying,” he says.

Still, he notes that not everyone at the Fed is enthusiastic about the idea. One concern: Foreign central banks and sovereign-wealth funds, which are big holders of Treasuries, might cool to buying many more if they believe prices are artificially high.

Undermine the Dollar
That may undermine the dollar. “There’s no guarantee that international investors would switch to other dollar- denominated debt if flushed from the Treasury market,” says Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

Tony Crescenzi, chief bond-market strategist at Miller Tabak & Co. in New York, says foreign investors might also get spooked if they conclude that the Fed is monetizing the government’s debt -- in effect, printing money -- by buying Treasuries.

Bernanke himself, in his 2003 speech, said monetization of the debt risked faster inflation -- something bond investors, foreign or domestic, wouldn’t like.

Some economists argue the Fed would help the economy more if it bought other types of debt. Even after their recent rise, 10-year Treasury yields are still well below the 4.02 percent level at the start of last year.

Corporate Bonds
Yields on investment-grade corporate bonds, in contrast, stood at 8.24 percent on Jan. 22, the latest date for which information is available, compared with 6.45 percent at the start of 2008, according to data compiled by the Fed.
So, the question is, can Bernanke buy all the debt across the entire yield curve to drive rates down? They already have short term rates (IRX) at zero, does anyone really believe that they can buy up enough of the long end spectrum to drive rates down and keep them there? I don’t.

No, once parabolic collapses begin, the government cannot stop it... their best hope is to slow the tide by using lip service, and that's exactly what they're doing.


If you hold a lot of long dated bonds and haven't been checking the markets lately, well... when you open up your next statement there might be tears to shed:

Roy Orbison – Crying: