"The secular bull market in Treasury bonds is over

[I AM NOT THAT GUY 5,715]

Bond Vigilantes Confront Obama as Housing Falters

For the first time since another Democrat occupied the White House, investors from Beijing to Zurich are challenging a president’s attempts to revive the economy with record deficit spending. Fifteen years after forcing Bill Clinton to abandon his own stimulus plans, the so-called bond vigilantes are punishing Barack Obama for quadrupling the budget shortfall to $1.85 trillion. By driving up yields on U.S. debt, they are also threatening to derail Federal Reserve Chairman Ben S. Bernanke’s efforts to cut borrowing costs for businesses and consumers.

The 1.4-percentage-point rise in 10-year Treasury yields this year pushed interest rates on 30-year fixed mortgages to above 5 percent for the first time since before Bernanke announced on March 18 that the central bank would start printing money to buy financial assets. Treasuries have lost 5.1 percent in their worst annual start since Merrill Lynch & Co. began its Treasury Master Index in 1977.

“The bond-market vigilantes are up in arms over the outlook for the federal deficit,” said Edward Yardeni, who coined the term in 1984 to describe investors who protest monetary or fiscal policies they consider inflationary by selling bonds. He now heads Yardeni Research Inc. in Great Neck, New York. “Ten trillion dollars over the next 10 years is just an indication that Washington is really out of control and that there is no fiscal discipline whatsoever.”

Investor Dread

What bond investors dread is accelerating inflation after the government and Fed agreed to lend, spend or commit $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s. The central bank also pledged to buy as much as $300 billion of Treasuries and $1.25 trillion of bonds backed by home loans.

For the moment, at least, inflation isn’t a cause for concern. During the past 12 months, consumer prices fell 0.7 percent, the biggest decline since 1955. Excluding food and energy, prices climbed 1.9 percent from April 2008, according to the Labor Department.

Bill Gross, the co-chief investment officer of Newport Beach, California-based Pacific Investment Management Co. and manager of the world’s largest bond fund, said all the cash flooding into the economy means inflation may accelerate to 3 percent to 4 percent in three years. The Fed’s preferred range is 1.7 percent to 2 percent.

“There’s becoming an embedded inflationary premium in the bond market that wasn’t there six months ago,” Gross said yesterday in an interview at a conference in Chicago.

Shrinking Economy

Bonds usually rally when the economy is in recession and inflation is subdued. Gross domestic product dropped at a 5.7 percent annual pace in the first quarter, after contracting at a 6.3 percent rate in the last three months of 2008, according to the Commerce Department.

This time it’s different because the Congressional Budget Office projects Obama’s spending plan will expand the deficit this year to about four times the previous record, and cause a $1.38 trillion shortfall in fiscal 2010. The U.S. will need to raise $3.25 trillion this year to finance its objectives, up from less than $1 trillion in 2008, according to Goldman Sachs Group Inc., one of 16 primary dealers of U.S. government securities that are obligated to bid at Treasury auctions.

“The deficit and funding the deficit has become front and center,” said Jim Bianco, president of Bianco Research LLC in Chicago. “The Fed is going to have to walk a fine line here and has to continue with a policy of printing money to buy Treasuries while at the same time convince the market that this isn’t going to end in tears with fits of inflation.”

‘Potential Benefits’

Ten-year note yields, which help determine rates on everything from mortgages to corporate bonds, rose as much as 1.71 percentage points from a record low of 2.035 percent on Dec. 18. That was two days after the Fed said it was “evaluating the potential benefits of purchasing longer-term Treasury securities” as a way to keep consumer borrowing costs from rising.

The yield on the 10-year note rose one basis point, or 0.01 percentage point, to 3.47 percent this week, according to BGCantor Market Data. The price of the 3.125 percent security maturing in May 2019 fell 3/32, or 94 cents per $1,000 face amount, to 97 4/32. The yield touched 3.748 percent yesterday, the highest since November.

The dollar has also begun to weaken against the majority of the world’s most actively traded currencies on concern about the value of U.S. assets. The dollar touched $1.4169 per euro today, the weakest level this year.

Bond Intimidation

Ten-year yields climbed from 5.2 percent in October 1993, about a year after Clinton was elected, to just over 8 percent in November 1994. Clinton then adopted policies to reduce the deficit, resulting in sustained economic growth that generated surpluses from his last four budgets and helped push the 10-year yield down to about 4 percent by November 1998.

Clinton political adviser James Carville said at the time that “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

The surpluses of the Clinton administration turned into record deficits as George W. Bush ramped up spending, including financing of the wars in Iraq and Afghanistan.

The bond vigilantes are being led by international investors, who own about 51 percent of the $6.36 trillion in marketable Treasuries outstanding, up from 35 percent in 2000, according to data compiled by the Treasury.

New Group

“The vigilante group is different this time around,” said Mark MacQueen, a partner and money manager at Austin, Texas- based Sage Advisory Services Ltd., which oversees $7.5 billion. “It’s major foreign creditors. This whole idea that we need to spend our way out of our problems is being questioned.”

MacQueen, who started in the bond business in 1981 at Merrill Lynch, has been selling Treasuries and moving into corporate and inflation-protected debt for the last few months.

Chinese Premier Wen Jiabao said in March that China was “worried” about its $767.9 billion investment and was looking for government assurances that the value of its holdings would be protected.

The nation bought $5.6 billion in bills and sold $964 million in U.S. notes and bonds in February, according to Treasury data released April 15. It was the first time since November that China purchased more securities due in a year or less than longer-maturity debt.

Obama’s Confidence

Treasury Secretary Timothy Geithner, who will travel to Beijing next week, will encourage China to boost domestic demand and maintain flexible markets, a Treasury spokesman said yesterday.

Obama spokesman Robert Gibbs said the president is confident that his budget and economic plans will cut the deficit and bring down the nation’s debt.

“The president feels very comfortable with the steps that the administration is taking to get our fiscal house in order and understands how important it is for our long-term growth,” Gibbs said.

Investors are also selling Treasuries as the economy shows signs of bottoming and credit and stock markets rebound, lessening the need for the relative safety of government debt. And while yields are rising, they are still below the average of 6.49 percent over the past 25 years.

‘Renewed Appreciation’

The world’s largest economy will begin to expand next quarter, according to 74 percent of economists in a National Association for Business Economics survey released this week. The Standard & Poor’s 500 has risen 36 percent since bottoming on March 9, while the London interbank offered rate, or Libor, that banks say they charge each other for three-month loans, fell to 0.66 percent today from 4.819 percent in October, according to the British Bankers’ Association.

Three-month Treasury bill rates have climbed to 0.13 percent after falling to minus 0.04 percent Dec. 4. That flight to safety helped U.S. debt rally 14 percent in 2008, the best year since gaining 18.5 percent in 1995, Merrill indexes show.

“Yes there’s been a big move, and you can argue the big move is driven by the renewed appreciation of the risks associated with holding long-term Treasury bonds,” said Brad Setser, a fellow for geoeconomics at the Council on Foreign Relations in New York.

Fed officials see several possible explanations for the rise in yields beyond investor concern about inflation. Among them: The supply of Treasuries for sale exceeds the Fed’s $300 billion purchase program, the economic outlook is improving and investors are selling government debt used as a hedge against mortgage securities.

Liquidity

Central bankers want to avoid appearing to react solely to market swings. Bernanke hasn’t formally asked policy makers to consider whether to increase Treasury purchases and may not do so before the Federal Open Market Committee’s next scheduled meeting June 23-24. Officials are confident they can mop up liquidity without gaining additional tools from Congress, such as the ability for the Fed to issue its own debt.

The Fed declined to comment for the story. Bernanke has an opportunity to discuss his views when he testifies June 3 before the House Budget Committee in Washington.

“We have daily reminders from bond vigilantes like Bill Gross about the prospect of losing our AAA rating,” Federal Reserve Bank of Dallas President Richard Fisher said in Washington yesterday. “This cannot be allowed to happen.”

Repair the Damage

The government and Fed are trying to repair the damage from the collapse of the subprime mortgage market in 2007, which caused credit markets to freeze, led to the collapse of Lehman Brothers Holdings Inc. in September and was responsible for $1.47 trillion of writedowns and losses at the world’s largest financial institutions, according to data compiled by Bloomberg.

The initial progress Bernanke made toward reducing the relative cost of credit is in jeopardy of being unwound by the work of the bond vigilantes.

The average rate on a typical 30-year fixed mortgage rose to 5.08 percent this week from 4.85 percent in April, according to North Palm Beach, Florida-based Bankrate.com. Credit card rates average 10.5 percentage points more than 1-month Libor, up from 7.19 percentage points in October.

“Longer term the danger is that the rise in yields disrupts the recovery or the rise in inflation expectations dislodges the Fed’s current complacency on inflation,” Credit Suisse Group AG interest-rate strategists Dominic Konstam, Carl Lantz and Michael Chang wrote in a May 22 report.

‘It’s Over’

Inflation expectations may best be reflected in the yield curve, or the difference between short- and long-term Treasury rates. The gap widened this week to 2.76 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003. Investors typically demand higher yields on longer-maturity debt when inflation, which erodes the value of fixed-income payments, accelerates.

“The yield spreads opening up imply that inflation premiums are rising,” said former Fed Chairman Alan Greenspan in a telephone interview from Washington on May 22. “If we try to do too much, too soon, we will end up with higher real long- term interest rates which will thwart the economic recovery.”

Other economists are more pointed. After falling from 16 percent in the early 1980s, 10-year yields have nowhere to go but up, according to Richard Hoey, the New York-based chief economist at Bank of New York Mellon Corp.

“The secular bull market in Treasury bonds is over,” Hoey said in a Bloomberg Television interview. “It ran a good 28 years. They’re never going lower. That’s it. It’s over.”

http://www.bloomberg.com/apps/news?pid=206...refer=worldwide

[scandal 951]

Good article, Mr. Bill

Here's some historical context for where we are on the yield curve.

As the article noted we set a record on Wed (May 27) when the curve widened to 2.75 (that's the difference between the 10year and 2year yields).

The bond market recovered a bit on Thurs/Fri such that by Friday (May 29) the spread was down to 2.55.

For historical context a year ago on May 29 2008 it was 1.41

And as recently as June 5 2007 we had an inverted curve with a spread of -0.01.

Data is from US Treasury website.

http://www.ustreas.gov/offices/domestic-fi...ate/yield.shtml

http://www.ustreas.gov/offices/domestic-fi...ical_2008.shtml

Date        1 mo     3 mo     6 mo     1 yr     2 yr     3 yr     5 yr     7 yr     10 yr     20 yr     30 yr
05/27/09     0.18     0.17     0.29     0.49     0.96     1.50     2.43     3.22     3.71     4.58     4.59

05/29/09     0.14     0.14     0.30     0.47     0.92     1.42     2.34     3.06     3.47     4.34     4.34

05/29/08     2.02     1.90     1.93     2.16     2.67     2.94     3.41     3.68     4.08     4.77     4.76

06/05/07     4.75     4.83     4.99     4.99     4.99     4.97     4.96     4.96     4.98     5.16     5.07

Spread on May 27/09 3.71-0.96 = 2.75

Spread on May 29/09 3.47-0.92 = 2.55

Spread on May 29/08 4.08-2.67 = 1.41

Spread on June 05/07 4.98-4.99= -0.01

[scandal 951]

For all the hand-wringing, USD is still the world's reserve currency and our treasury auctions show no sign of failing to attract buyers.

http://www.bloomberg.com/apps/news?pid=206...&refer=news

Treasuries, Dollar ‘Only Game in Town’ as China Buys

By Daniel Kruger and Susanne Walker

June 1 (Bloomberg) -- For all the hand-wringing over the dollar’s slide, the expanding U.S. deficit and the nation’s AAA credit rating, the bond market shows international demand for American financial assets is as high as ever.

The Federal Reserve’s holdings of Treasuries on behalf of central banks and institutions from China to Norway rose by $68.8 billion, or 3.3 percent, in May, the third most on record, data compiled by Bloomberg show. The Treasury said bidding from foreigners was above average at its $101 billion of note auctions last week.

U.S. government securities have tumbled 4.3 percent so far this year, the worst performance since Merrill Lynch & Co. began tracking returns in 1978, as so-called bond vigilantes drove up yields to punish President Barack Obama for quadrupling the budget shortfall to $1.85 trillion. The purchases by foreigners show that, at least for now, there’s little chance of buyers abandoning the U.S. or threatening the dollar’s status as the world’s reserve currency.

“The U.S. Treasury market is the widest, deepest, most actively traded market in the world,” said Jeffrey Caughron, an associate partner in Oklahoma City at The Baker Group Ltd., which advises community banks investing $20 billion of assets. “There’s really no other game in town.”

Concerns about international investors have grown as the U.S. Dollar Index weakened 8.6 percent since February and Obama and Fed Chairman Ben S. Bernanke committed $12.8 trillion to thaw frozen credit markets and snap the longest U.S. economic slump since the 1930s. About 51 percent of the $6.36 trillion in marketable Treasuries are held outside the U.S., up from 35 percent in 2000, according to data compiled by the government.

(article continues, follow link to Bloomberg site...)

[Economist 0]

For all the hand-wringing, USD is still the world's reserve currency and our treasury auctions show no sign of failing to attract buyers.

By Daniel Kruger and Susanne Walker

June 1 (Bloomberg) -- For all the hand-wringing over the dollar’s slide, the expanding U.S. deficit and the nation’s AAA credit rating, the bond market shows international demand for American financial assets is as high as ever.

The Federal Reserve’s holdings of Treasuries on behalf of central banks and institutions from China to Norway rose by $68.8 billion, or 3.3 percent, in May, the third most on record, data compiled by Bloomberg show. The Treasury said bidding from foreigners was above average at its $101 billion of note auctions last week.

I saw that news report today on CNBC asia. I was stunned that they spun that as a good thing! Do you know why china and our other "creditors" are buying treasuries? They are doing it to because they have TRILLIONS invested in us. They are pumping money into our treasuries so we can keep spending and their hopes are that we can dig ourselves out of the hole. But you cant spend your way to economic growth...you can spend your way to bankruptcy though. Ask anyone that has run their credit cards & debt so high that with their current wages they could not pay off their debt. This is what is happening in the US! Our GDP (basically our INCOME) is shrinking and we are spending more money. This is equivelant of your employer cutting your wages and then you deciding its a good time to start getting cash advances from your credit card and give loans to your irresponsible friends at near 0% interest rates because they dont know how to spend money either.

They are spinning bad news as good news in the hopes that everyone will get their faith back in the US dollar so we can keep the party going a few more years. I can tell you how its all going to end too. It will end one day with China saying "Ok, we have had enough, your people are not buying much of our cheap chinese made products anymore, so we are going to cut our losses and ask that you pay us in other currencies or gold now" knowing full well that they will never see that money (or at least the value that money held) again.

This is the same thing that England did to Germany in the 1920s They demanded that Germany pay them in gold or foreign currencies because germany was just printing money to pay everyone. In 1920 it was something like 60 marks to 1 dollar. When london gave the "ultimatum" in may of 1921, by Dec, it was 330 marks to the dollar. 1 year later in 1922 it was 8,000 marks to the dollar. By 1923 1 pound of bread cost 3 billion, 1 pound of meat: 36 billion, 1 glass of beer: 4 billion."

China is pumping more money into our economy because they feel there is a real risk that we will hyperinflate and end up paying them back their 2 trillion dollars worth of treasuries with a couple dozen loaves of bread.

And CNBC is spinning it like china is buying treasuries because they are a bargain or something....i mean come on...really? Treasuries are paying nothing in interest. China's economy is growing at something like 8% They could put that money into growing their economy even more, but we've conned them into believing that they need us to pay them 20 cents an hour so they will have jobs. China gives us money so we can spend more on propping up the financial industry...its a house of cards...china props us up, we prop up the financials, the financials party like its 1999. House of cards.

[I AM NOT THAT GUY 5,715]

For all the hand-wringing, USD is still the world's reserve currency and our treasury auctions show no sign of failing to attract buyers.

When you look at the size of the reserves, and compare the USD to other currencies, then you have to be convinced, but I still can't shake the feeling that I am whistling past a graveyard. It would only take one country to start a "run on the bank", and that would throw the whole world economy into a freefall. There are a few countries that hold enough notes to make that happen. I don't know if we could stop what Japan tried a decade ago, when they tried to sink the Yen, and flood the US market with imports, to get their economy going. The US was able to stop the run using our reserves to buy enough Yen to keep its value.

[scandal 951]

Here's a link you may find useful http://www.treas.gov/tic/mfh.txt

As of March, China holds 767.9B of US debt, Japan 686B, then down from there.

Note that total US debt outstanding is now in excess of $11 trillion. Why does the debt held by foreigners amount to a much smaller number?

Because much of our debt is held internally in inter-governmental debt (e.g. Social Security is still running a surplus and has been 'lending' its surplus to the US Treasury for decades). The public debt outstanding also does not count Savings Bonds and State and Local bond issuances. Consequently China holds roughly 800/11000 = approx 7% of the total US outstanding debt.

I'm not minimizing what would happen if China or Japan suddenly decided to get queasy and initiate a massive sell-off of their treasury holdings. We know very well what would happen - the bond market would go into a freefall and we'd experience an economic collapse to make 2008 look like a game of patty-cake. For that reason, it's just not in the cards. China is in bed with us. They have every vested interest to see our economy recover, our consumption increase, our currency remain stable, and our debt issuances hold their value. They're just not gonna dump T Bills or long bonds onto the market.

The bond market collectively is much larger than China. China (and other sovereign holders) tend to be fairly passive participants unless they're directly interfering to influence their exchange rates. Most of the daily turnover comes from hedge funds and other active traders who are either taking directional positions or else looking to hedge Treasuries against corporate bonds or debt issuances of other nations. So long as the bond market as a whole has confidence, the game can continue to be played. For the time being that remains the case. This past week with the steepened yield curve, we got our first sign of what a dramatic bond market shift of confidence could look like as there is a "flight to safety" at the long end of the curve. The market is clearly fearing inflation (due to massive amounts of debt issuance at low rates, and the FOMC keeping rates low for the forseeable future). However the market is not (yet) fearing US debt insolvency.

As to reserve currencies, I believe this has much more to do with political stability than economics (though of course the latter plays a role as well).

Fundamentally the US is a constitutional democracy with over 200 years history of stable government, liquid capital markets, a productive workforce, a responsible central bank, and AAA ratings of its sovereign debt.

Nobody else - not Europe, not Japan, not China - can claim these factors. And at the end of the day, it's the bond market that will cast the deciding vote. For now, the greenback is king. Should CNY or JPY or EUR one day become the global reserve currency, I won't lose any sleep over it.