Bond Investors Call Fed’s Bluff

Even a casual market observer like your humble blogger has noticed the dramatic increase in Treasury bond yields from 2.5% on the 30 year bond to over 3.5% in a bit more than a month. I had assumed that the Fed, at its last FOMC meeting, would shed a bit of light on its December statement, when it said it would use all available means to free up credit markets and was considering buying Treasuries. The latter was particularly credible, since Bernanke has discussed the idea in some of his academic work.

The long bond, which had fallen from its peak (remember lower prices mean higher yields) but stabilized and rallied a bit right before the January Fed meeting. Not only did the announcement fail to clarify how a Treasury program might work, but the language suggested an intent to focus on instruments other than Treasuries. This seems odd, for as long as the benchmark rate continues to rise, trying to control spreads over it can achieve only so much.

Or maybe the truth has dawned on the Fed: the market is bigger than it is. Even so, it had better learn to bluff better, since Treasury investors, discouraged by the latest announcement, are demanding higher yields.

Ambrose Evans-Pritchard of the Telegraph gives us a typically verging-on-apocalyptic but nevertheless informative piece, starting with the Fed and then looking at the pretty alarming data from other economies. However, since IMF managing director Dominique Strauss-Kahn said last week that advanced economies are already in a depression, Evans-Pritchard in increasingly in line with consensus reality. That alone should get readers worried.

From the Telegraph:

The yield on 10-year US Treasury bonds – the world’s benchmark cost of capital – has jumped from 2pc to 3pc since Christmas despite efforts to talk the rate down.

This level will asphyxiate the US economy if allowed to persist… The US is already in deflation. Core prices – stripping out energy – fell at an annual rate of 2pc in the fourth quarter. Wages are following. IBM, Chrysler, General Motors, and YRC, have all begun to cut pay.

The “real” cost of capital is rising as the slump deepens. This is textbook debt deflation. It was not supposed to happen. The Bernanke doctrine assumes that the Fed can bring down the whole structure of interest costs, first by slashing the Fed Funds rate to zero, and then by making a “credible threat” to buy Treasuries outright with printed money.

Mr Bernanke has been repeating this threat since early December. But talk is cheap. As the Fed hesitates, real yields climb ever higher. Plainly, the markets do not regard Fed rhetoric as “credible” at all.

Who can blame bond vigilantes for going on strike? Nobody wants to be left holding the bag if and when the global monetary blitz succeeds in stoking inflation. Governments are borrowing frantically to fund their bail-outs and cover a collapse in tax revenue. The US Treasury alone needs to raise $2 trillion in 2009.

Where is the money to come from? China, the Pacific tigers and the commodity powers are no longer amassing foreign reserves ($7.6 trillion). Their exports have collapsed. Instead of buying a trillion dollars of extra bonds each year, they have become net sellers. In aggregate, they dumped $190bn over the last fifteen weeks.

The Fed has stepped into the breach, up to a point. It has bought $350bn of commercial paper, and begun to buy $600bn of mortgage bonds. That helps. But still it recoils from buying Treasuries, perhaps fearing that any move to “monetise” Washington’s deficit starts a slippery slope towards an Argentine fate. Or perhaps Bernanke doesn’t believe his own assurances that the Fed can extract itself easily from emergency policies when the cycle turns.

As they dither, the world is falling apart. Events in Japan have turned deeply alarming. Exports fell 35pc in December. Industrial output fell 9.6pc. The economy is contracting at an annual rate of 12pc….

The[ [Japanese central] bank is already targeting equities on the Tokyo bourse. That is not enough for restive politicians. One bloc led by Senator Koutaro Tamura wants to create $330bn in scrip currency for an industrial blitz. “We are facing hyper-deflation, so we need a policy to create hyper-inflation,” he said.

This has echoes of 1932, when the US Congress took charge of monetary policy…

German orders fells 25pc year-on-year in December. French house prices collapsed 9.9pc in the fourth quarter, the steepest since data began in 1936….

Spain’s unemployment has jumped to 3.3m – or 14.4pc – and will hit 19pc next year, on Brussels data. The labour minister said yesterday that Spain’s economy could not “tolerate” immigrants any longer after suffering “hurricane devastation”. You can see where this is going.

Ireland lost 36,500 jobs in January – equal to a monthly loss of 2.3m in the US. As the budget deficit surges to 12pc of GDP, Dublin is cutting wages, disguised as a pension levy. It has announced “Rooseveltian measures” to rescue the foundering companies…

Meanwhile, Eastern Europe is imploding. Industrial output fell 27pc in Ukraine and 10pc in Russia in December. Latvia’s GDP contracted at a 29pc annual rate in the fourth quarter. Polish homeowners have had the shock from Hell. Some 60pc of mortgages are in Swiss francs. The zloty has halved against the franc since July.

Readers have berated me for a piece last week – “Glimmers of Hope” – that hinted at recovery. Let me stress, I was wearing my reporter’s hat, not expressing an opinion. My own view, sadly, is that there is no hope at all of stabilizing the world economy on current policies.

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  1. alexblack

    Yeah, Ambrose. That “Glimmers of Hope” column last week was just bizarre. I realize you were at the big party in Davos and probably imbibing substances to make you loopy and happy, but take the week off when you indulge that way.
    Nice to have you back.

  2. doc holiday

    New poop: American downturn reflects 1970s crisis
    America’s latest job data reinforces the comparison with the economic crisis of 1973-75, according to Lombard Street Research, an economics consultancy.
    In January the American unemployment rate rose to 7.6% from 7.6% in December, the Bureau of Labor Statistics reports. The economy lost 598,000 more jobs last month as companies are convinced that the worldwide economic downturn will be severe and ongoing.

  3. Jim in MN

    The Fed’s belief in wielding interest rates as a magic wand has no end. At least in The Sorcerer’s Apprentice, Mickey Mouse at some point realizes the water is rising faster the more he bails without sweat (magic rather than actual work).

    The Obama Administration had better figure out that the path of salvation probably runs through the point of maximum political (small ‘p’, i.e. angry elite) pain.

    1. ‘Surgical’ or ‘micro’ nationalization: Put public agents behind lending desks and write YES on the lending memos to ordinary businesses. Do not otherwise nationalize banks.

    2. Progressive bond haircuts: Write down/off everything, but allow bondholders with incomes under $500,000 to apply for special tax refunds, appropriately graduated by income.

    3. Strengthen social safety nets and spend a bunch on infrastructure, ‘green jobs’ etc.

    How hard is this really? The rich are too greedy to let their bonds get written down–especially the foreign rich–after living high on the borrowed teat for a generation. Boo hoo.

    Word Verification: ‘Shear.’ Can apply to either the rich bondholders, or to the taxpayer. Given this, the worst of all policy worlds, will apply to both.

  4. alexblack

    Anyone who would lend the US government money for 30 years at 2.5% interest was insane. Or 3%. Or 3.5%. Or 4%. I’ll stop shorting the 30-yr bond at 5%, but only out of cowardice.

  5. Anonymous

    I am hoping there is a Treasuries expert out there who could explain the following to me: Why, if the Fed really started buying Treasuries, wouldn’t the FCBs jump for joy and say “sold to you”? I mean, if the Fed is going to backstop this market, wouldn’t this take a lot of the risk out of “diversifying”?

  6. bg

    long term treasuries in December were either signaling 10 years or deflation, a sharp drop in the dollar, or excess demand (inefficiency) for safe treasuries. Since 10 years of deflation would be an extreme view, and the dollar has remained strong, there was nowhere else for the long bond to go.

    “On strike” implies the current behavior is the inefficient one, waiting for the government to respond. The current level is more rational.

    As for “this was not supposed to happen”, per Ambrose, I suspect the only way to get the so called expected result is to debase the current, which means printing more money than the banks are unprinting through deleveraging.

  7. FairEconomist

    The yield on 10-year US Treasury bonds – the world’s benchmark cost of capital – has jumped from 2pc to 3pc since Christmas despite efforts to talk the rate down.

    This level will asphyxiate the US economy if allowed to persist…

    3% 10 year rates will “asphyxiate” the economy? That rates very high on the “Oh please”-ometer.

  8. Anonymous

    Its only looking back a few weeks, when yields were at record lows.

    The search for tier one assets to hold through the end of the calendar year might have had something to do with the run up in prices.

    Just thoughts, and yes, way too high on the “Oh please”-meter

    Call me when they get above 5, or what most consider neutral.

  9. Stevie b.

    Americans and Brits (and whoever else you care to think of) have got used to a lifestyle that has been unearned for at least a decade. Average Western wage levels have been stagnant and will now decline to a global average over time. The politicians can/will NEVER accept this reality and tell the people that IT’S OVER! Therefore they will assuredly screw EVERYONE in an assinine attempt to pretend that the good old days can return and to bail-out those who mindlessly abused the system and who for some unfathomable reason must not be allowed to face the reality of the consequences.

  10. "DoctoRx"

    Yves: typo in para 4, line 4: first “in” should be “is”.

    You’ve been quite prolific! Thanks . . .

  11. Dan Duncan

    To those registering new highs on the “Oh Pleaseo-Meter” in regards to 3% “asphyxiating the US economy if allowed to persist…”

    The statement does appear to typical Ambrose-Evans hyperbole, but then consider:

    If you think the coming wave of Option Arms and Alt-A resets this summer is going to be devastating unless we get a massive wave of refinances….

    And when you consider that in this latest refi “boom”, when Treasuries were at 2pc there was a lot of activity, but with the increase, the refis just are not happening…

    Ambrose-Evans claim is not that ridiculous.

    We need A LOT more refinances before these mortgages reset, and they just aren’t happening to the level needed. A combination of a loss of jobs, poor appraisals and the increase in rates over the last month have left this refi wave underwhelming to say the least.

    I understand that Ambrose-Evans was referring to the economy as a whole (for some reason, “economy as a hole” seems more appropriate), and not just the real estate market, but nevertheless his statement is not that absurd.

    This Debt Monster that is our Government-Economy is like that big blood-sucking venus fly trap in Little Shop of Horrors: When it’s not spewing bullshit in order to get its thorny clamps on our unsuspecting jugulars, it is frantically waving its limbs, crying “Feed me Taxpayers! Feed me!”

  12. Anarchus

    Regarding: “If you think the coming wave of Option Arms and Alt-A resets this summer is going to be devastating unless we get a massive wave of refinances….”, most ARMs are tied to short term rates such as LIBOR, a 1-yr constant maturity treasury index or the 11th district COFI.

    The one year constant maturity treasury index (my ARM rate, yippee!) this January is at 0.44%, down from 2.71% in January 2008.

    Now, the 1-year LIBOR and 11th district COFI are hanging up there in the low-to-mid 2% range, but are still coming down and NOT going up in sympathy with 30-year or 10-year treasuries.

  13. john bougearel


    You forget the intentional manipulation of treasury yields in Q4 08 by the powers that be.

    Bernanke kicked the can on Dec 1 when he made declaration of intent to buy 30 year treasuries. Then the President dragged his feet for the next few weeks on the automaker crisis. These actions caused a safe haven bid in treasuries into year end. This served to intentionally (though I can’t prove it, I just know it)help the zombie banks holding treasuries on their balance sheets.

    Note the sell-off began immediately at the onset of the new year. These zombie banks have no desire to hold that crappy paper with no yield attached to it.

    Bernanke has been talking about buying treasuries since Nov 2002 as far as I know, so you would think there was substance in his words. But with some fancy footwork, and rewording of the FOMC statement, he was able to back out of supporting treasuries anytime soon.

    Now, the 30 year is collapsing to a point below where it was on Dec 1 when Bernanke first made that statement of intent. In short the market has round-tripped.

    Guess what this allows to happen. The banks get to do the whole 4th qtr trade over again at some point in 2009 (I suspect the re-run will begin in second half of Feb). And I do believe that Ben will buy some treasuries along with the agencies he is currently buying.

    Yes, you are right, the Fed knows its omnipotence has been reduced in recent years. In fact, all close mkt observers know this. That is why we reference the Fed as just another trader in the marketplace.

    Yes, I noted the story that the BOJ is buying equities last week. An interesting story that one can imagine was helpful in propping up equity mkts last week as investors try to front run BOJ orders.

    And finally, I have to agree entirely with Evans Pritchard that “there is no hope at all of stabilizing the world economy on current policies.”

    Great tagline from Pritchard, we ought to help promote it. In fact I think I will do just that on my blog later this week when I get it up and running again.

  14. haljett

    Stuff I’m seeing is that the bond market is a bubble that’s leaking and about to burst.

    It’s really starting to look like the dollar is toast in the long term. One of the reasons I’m keeping close eye on gold (I’m using the widget ExactPrice)

    Silver is another hedge that I think will perform well and is doing so right now.

    I see a lot of others like Schiff and Grandrich who are looking to juniors in the metal markets as a place to invest. Schiff’s even suggesting to get out of the dollar as much as one can.

  15. Lockstep

    Let’s clear up the discussion here.

    There are two camps on this board, one that thinks the Fed can keep up the balancing act for the “foreseeable future” (read as at least six more months) and those who believe inflating treasury prices will lead to imminent doom. I am of the former, and challenge any of the latter (Peter Schiff minions especially) to put together a roadmap to the end of the cliff that we are about to fall off. I think if you walk through all the things the Fed can do over the first half of 2008, I think you will join the “Fed will control the yield curve for the foreseeable future camp”

    Also, it was said previously that the 30 year does not matter in mortage rates. That is absolutely false. Option ARMs may be tied to LIBOR and the like, but the refinancing binge has happened and who is selling those now? What is most important is how 30 year fixed mortgages are prices and that is altogether linked to the 30 yield treasury. A fixed mortgage is probably the goal of any modification plan worth it’s weight in salt anyway.

  16. Anonymous

    Third camp here …

    This is textbook (being written as we speak) global financial coup – say bye bye to the world middle class and ‘expendable’ world population and hello to two tier ruler and ruled world with a new law enforcement overseer.

    We all need to listen more to people that have tested the system (illusion) and had their life changing ‘catalytic’ events. Catherine Austin Fitts is such a person;


    “February 2, 2009 at 11:02 pm
    Financial Coup d’Etat

    In the fall of 2001 I attended a private investment conference in London to give a paper, The Myth of the Rule of Law or How the Money Works: The Destruction of Hamilton Securities Group.

    The presentation documented my experience with a Washington-Wall Street partnership that had:

    * Engineered a fraudulent housing and debt bubble;
    * Illegally shifted vast amounts of capital out of the U.S.;
    * Used “privitization” as form or piracy – a pretext to move government assets to private investors at below-market prices and then shift private liabilities back to government at no cost to the private liability holder.”

    Take the time to read the pdf entitled; “The Myth of the Rule of Law or How the Money Works: The Destruction of Hamilton Securities Group.”

    Deception is the strongest political force on the planet.

    i on the ball patriot

  17. Juan

    Lockstep, would a crisis of external funding alter your perspective? Yes, in theory the Fed/Treasury could internalize such but seems to me that would only knock down the currency and exacerbate from another angle.

  18. Iconoclast421

    The Fed will start dropping money from helicopters soon enough. They are obviously just waiting for a bigger crisis to hit, to get the pitchforks pointed away from the bankers. Where is bin laden when they need him?

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