Bond Expert: Monday Outlook

Prices of Treasury coupon securities have sagged in overnight trading and the yields on most of the benchmark issues have risen 4 basis points. The motivating factor behind the move is angst about central bank monetary policy and the possibility that the US central bank might drain liquidity via reverse repos.

On Friday, rumors of an emergency Fed meeting about reverse repos traveled through the market. The report said that the Fed was talking with dealers about balance sheet capacity to absorb the (large I suppose ) operation.

The weekend press magnified the story as Barron’s ran a story calling for the Federal Reserve to hike rates. I reiterate the stance I have taken here many times. Maybe I am being stubborn, but it is inconceivable to me that the FOMC would initiate a policy to reduce liquidity when the unemployment rate is nearly 10 percent. The FOMC in it s most recently released minutes specifically related its concerns about the labor market and saw it as a persistent headwind well into the future.

About this time one year ago, the financial system was in the midst of a global nervous breakdown. We barely avoided the abyss. The Federal Reserve is run by a man who spent his academic career studying the Great Depression. His background and experience would make it very difficult for him to do anything other than leave rates very low for a very long time. I do not believe that he will drain liquidity until that is a clear and unambiguous choice and that time is not now.

The yield on the 2 year note increased 4 basis points to 0.99 percent. The yield on the 3 year note climbed 4 basis points to 1.54 percent. The 5 year note also experienced a 4 basis point rate hike to 2.39 percent. The 7 year note and the 10 year note each rose 4 basis points in yield to 3.03 percent and 3.45 percent, respectively. The yield on the Long Bond bucked the trend and climbed 3 basis points to 4.27 percent.

The 2 year/10 year spread is 246 basis points.

The 10 year/30 year spread is 82 basis points.

The 2 year/5 year/30 year spread is 48 basis points.

On Thursday supply will become a factor as the Treasury will announce the monthly ration of 2s, 5s and 7s. That package will be in the $110 to $ 15 billion zone. For those inhabiting a spot on the grassy knoll this will be the first batch of issuance since the springtime in which the Federal Reserve will not be the deus ex machina for owners of this paper.

Comments

[Macro_Man:]

The massive liquidity is going more into asset bubbles than the real economy. Are we simply kicking the can down the road once again? This time it will be harder because the dollar is starting from a weaker position and commodities are much higher.

The risk of $100 oil and higher grain and metals prices is much higher now. Not sure if continued excess liquidity is the magic bullet. So, Ben doesnt repeat the mistakes of the past..he just figures out new mistakes to make.

The U.S. economy is like someone who has binged and led a hedonistic life for quite some time. the only solution is diet and exercise and moderation. Taking some easy medicine to party longer, just means the inevitable adjustment will be all the more painful. Also, the pain will fall more on the innocent than the sinners.

All the Fed has done is give Wall Street an easy pass out of its pain, but in doing so, has increased the pain on Main Street.

Oct 19 08:59 AM

[Macro_Man:]

John: Question for you...If the dollar's weakness continues...when does it start affecting the U.S. rates? At some point overseas holders have to reevaluate their U.S. assets versus dollar depreciation. And, if does cause overseas holders to start selling Treasuries, which part of the curve gets affected more on a relative basis? Meaning, if you hold T Bills, you earn nothing and lose a few % on dollar depreciation. If you hold the long bond, you earn some interest to offset currency loss...but, of course the risk is higher

Oct 19 09:07 AM

[phdinsuntan...:]

John, I join Macro Man concerns. Has been nasty time for foreign US fixed income holders same as for US expats living on it, unemployment is not related to liquidity in this cycle. Looking Asia and lat Am crisis, the debt adjustments take days and no months and the new balance is a few 100s % up for the local against harder currencies, even if the government plays confetti games.

Oct 19 10:20 AM

[The Simple ...:]

Macro Man's point regarding the interests of foreign holders of US assets is well taken.

It seems also that the US authorities are beginning to take notice that whileethe super easy monetary policy has helped the financial economy to avoid total catastrophe, it has not done so much for the real economy.

Unchecked dollar depreciation + liquidity fueled speculation in commodity prices = further misery for the growing legion of the un/under-employed. Perhaps the authorities are planning real -as opposed to rhetorical - support for the dollar in hopes of heading off a disgruntled electorate at the mid term? (Yes, I do understand that the Fed is independent of political motivation).

Oct 19 10:28 AM

[mloren:]

I think you are right on about the Fed and keeping rates low. I just saw an article critical of the cash infusions used to prop up bank reserves as though everything is fine and running on all cylinders. Our banking system is only making money with these artificially low interest rates. With low rates in CD's, bonds, money markets, it appears that there is no place to run other than stocks. Sometimes we need to be patient and just wait.

Oct 19 03:10 PM