With the Federal Reserve announcing their new quantitative easing program we now have all of the information we need to paint a picture of the medium term economic picture. That the central banks made the moves they did makes it very clear that the global economic picture is far worse than the headlines make it out to be. It has become the role of the central banks to use the media to talk the markets into submission. We have seen that since last summer when the European debt crisis began in earnest, necessitating the action by the Swiss central bank to peg the franc to the euro.
And interestingly, looking at the U.S. Treasury International Capital report we see a number of things that clear up the picture. In August 2011 just before they announced that they would be pegging the franc to the euro, the Swiss purchased $39.1 billion in U.S. Treasuries, nearly single-handedly avoiding a third month in a row where the total stock of foreign held U.S. Treasuries would have fallen. The global monetary system depends on the U.S. Treasury's ability to find buyers for their debt and the intervention by the Swiss first to prop up the U.S. bond market and second attempt to halt capital flows into their currency by weakening the franc was their first opportunity to save the system.
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The chart also shows the last two years' worth of T.I.C. data which makes it clear that since that day the central banks have been coordinating how they will hold the U.S. Treasury market together, adding to their stock at around 1% per month. In the past few months, however, and the T.I.C. data has two months' of lag built in, the rate of growth has slowed. The chart is a third-order fit of the data going back to August 2010. The trend line plotted here peaks out towards the end of 2014. A parabolic fit of the data has much lower correlation (R2 = 0.97) and a 4th order fit has the world dumping U.S. Treasuries en masse in December 2012 though the correlation is higher (R2 <0.99). I don't place much stock in either model.
What is important to note is that this situation has an end. At some point the U.S. bond market will be seen as a detriment to global economic growth. And the dumping of U.S. Treasuries will begin on a net basis. Even a slowing of the growth rate from 1.0% per month to July's 0.7% per month leads to a catastrophic failure sooner rather than later, absent a massive intervention.
The central bankers have made it clear that maintaining the current stasis, however ugly it may be, will be their course of action. The problem for the U.S. and its allies in Europe, however, is that the country with the biggest trade surplus with the U.S., China, has stopped buying U.S. Treasuries.
In December 2011, China dumped $103.6 billion in U.S. Treasuries which got absorbed by other countries. The total outstanding barely moved, down $1 billion, but Ireland (+$28 B), Luxembourg (+$20.5 B), Switzerland (+$16.2 B), and Norway ($16.4 B) and others picked up the demand. This brought China's total holdings down to $1151.9 billion. At the end of July the total was $1149.6 billion. In 2011 China ran a $299 billion trade surplus with the U.S. Pro-rating that out so far that means that ~$175 billion in trade surplus has been used to buy things other than U.S. Treasury bonds. So, while a big stink was made about China having direct access to the U.S. Treasury to buy securities the data shows they are not using this in any significant way.
This means, of course, that the rest of the world has to continue buying U.S. Treasury debt in order to keep the bond market from completely collapsing. This is why the Fed had to announce another round of QE, they need to swap the Mortgage-Backed Securities clogging up their primary dealer banks like JPMorgan (JPM) and Bank of America (BAC) for the next round of Treasuries that the Fed does not want to openly monetize without alarming people that this is, in fact, what they are doing. The banks will do well in this environment as the Fed will buy off their worthless assets and continue to funnel them Tier 1 capital to bet with and lend at good spreads.
In the past two months the Swiss have bought $35.2 billion in U.S. debt while also maintaining their peg to the Euro. There will always be buyers for U.S. bonds as long as either the real yield on them is positive or the price keeps going up, which has happened for most of this past year. But, the announcement of open-ended QE has changed things. The 30 year bond closed last week at 3.09%, a preliminary technically bearish event. The fundamentals of the U.S. bond market are awful and bonds are extremely over-priced. Since the Euro bottomed on July 23rd and the markets turned on a dime off of that moment we've seen steadily rising bond yields for both of the safe-haven assets of the past 6 months, the U.S. and Japanese government bond.
The Bank of Japan's announcement that they would extend their existing QE program without adding to it means that they are going to print to oblivion at a slightly slower rate than either the E.C.B. or the Fed. So the Yen will likely continue its slow appreciation versus the Dollar once the turbulence settles down. And while the Fed is going to twist every arm they can to keep the markets stuffed to the gills with U.S. Treasury paper and artificially depress rates on the long-end of the curve it may run out of ammunition. The best estimates out there state a supply of around $650 billion in 10+ year paper. Once that supply is gone, what then?
If I were a holder of U.S. government bonds I would be selling them immediately and moving into assets with higher short-term yield. That means for those holding the iShares Barclays 20+ Year Treasury Bond ETF (TLT) sell it now at a profit and do not turn around. Even if rates somehow go down from here, say because of an Israeli attack on Iran, the long term outlook is bleak and there are better investments. The Sprott Physical Gold Trust (PHYS) is an excellent vehicle to play gold which will thrive in this environment. It is a closed-end fund holding physical metal for the long run.