How the Fed Will Ease Rates

The Treasury is soon to make a stunning announcement.

In my post from April 19th, Stormy Weather, I noted that the Fed can drive rates lower by driving Treasuries higher.

This outlier move in Treasuries has been a central theme in these pages. Except for one thing. I never revealed the catalyst. What will be the catalyst? The quantitative easing they announced in their 300 billion Treasury buy back plan has been shrugged at. To you, my readers, I will now reveal the catalyst.

Often when I explain what a catalyst will be, I do it by taking a page, out of our history. This article from November 2001 from the New York times talks of what the Treasury Department was up to way back in 2001. History doesn't repeat, but it often rhymes.

The Treasury Department's decision to stop selling 30-year bonds could help push longer-term rates lower for reasons that have less to do with the economy than with the mechanics of the bond market. With no new 30-year bonds, more investors who want to own long-term bonds backed by the government will buy the Treasury's 10-year note, which influences the interest rates on home mortgages. The added demand will push the price of the 10-year bond higher, and the yield, which moves in the opposite direction, lower. With the 10-year rate and related rates falling, mortgage rates will fall, too.

The Treasury Department will stop selling the 30-year, which will push up demand for the 10-year, driving rates lower. Is the strength in the housing index anticipating this? Driving mortgage rates even lower would allow a massive refinancing and write down cycle in residential mortgages. Just what the economy needs, to finally take flight again. Then what happens? They’ll do what they did then. Offer the 30-year for sale again. Same cycles, different players.

I wonder when they'll announce it? During the market? After? Before? Who knows? Whenever they do, it will be a shock to everybody. Everybody but those who read me.

Disclosure: Long IEF calls, Long Treasury Futures calls

Comments

[John Polomny:]

So maybe they get a short term reduction in rates. Long term there are structural debt problems that cannot be solved with nonsense like this suggestion of terminating the sale of 30 year bonds. I guess if you want a trade this will work. Long term all roads lead to inflation in a social democracy.

Apr 23 10:25 AM

[Prospector4:]

Interesting idea, "scarce-ifying" the long end. So who holds the bag if foreign holders sell and buy shorter denominations? There is a risk is that the market becomes so dislocated, no?

Apr 23 10:56 AM

[User 143167:]

The Fed is doomed to be a loser on this. Why? It is because the Fed is pretty much fighting against itself on this front.

Apr 23 12:06 PM

[whidbey:]

You are playing the Treasuries' game, manipulation of the curve to affect consumer behavior.?

But, like a bag of monkeys it is almost impossible to predict what the kick to the bag will elicit. There are many LT holders who will not move to the TNX if TYN is discontinued. There are choices and some of them are not what the Fed or Treasury would desire. We are living in a market where there is too much calculation by half. What is next investment controls?

Apr 23 02:14 PM

[altaman:]

This is a really terrible idea, leading to more uncertainty, volitility and risk in the Treasury market, and therefore I think it has a good chance of it happening under these clowns. However, what if people just stop buying the 10 year and/or find some other instruments that are more to their liking. Checkmate?

Apr 23 02:19 PM

[schlumpf:]

who buy this junk, never this will be payed !!

Apr 23 06:57 PM

[Gedankonomist:]

Perhaps to encourage everyone to spend, spend, spend! The FED will set negative interest rates. That is, when banks borrow, the FED pays them interest!

No joke, this has been proposed by an Ivy-League economist (see tinyurl.com/c9ja6b), making a 6-figure salary no doubt.

Apr 24 02:33 PM

[Richard Woon:]

All road lead to Rome.

Apr 28 02:33 PM