Friday, April 17, 2009

The Bond Market Turns Up The Heat!

Hello All!

I'll be fairly quick today. What a surprisingly boring Friday considering it was an options expiration day. Stocks closed pretty much flat as a board as the market continues to calm down and gain a false sense of security. The VIX was down again today at under 34.

PUTS are starting to get cheap again as a result. I picked up a few June QQQQ's the other day for .67 a piece. I took a very small position here as I continue to very slowly scale in short here.

I think the risk is to the downside moving forward(what a shocker right?). We are pretty severely oversold here. IMO the next several weeks will be all about the bond market.

Take a look at the 10 Year today and this week:

Final Take:

The bond market appears as if it wants to force the Fed's hand here. If you recall, Ben's quantitative easing policy started with the 10 year yielding 3%. Yields immediately dropped to 2.5% on the Fed's announcement..

As you can see above, yields rose sharply today to close at 2.93%. We have taken a few runs at the 3% level in the last few weeks. I think that the traders in Chicago are about to take a more serious run at 3% in order to see how the Fed reacts. Traders have been trying to figure out exactly how aggressive the Fed will get with their QE when yields rise.

The only way to find out is to take them higher and force Ben to make a move. You see the bond guys know the Fed cannot afford higher lending rates because it will blow up whats left of the housing market.

What they don't know is how far the Fed will go in terms of buying treasuries. Making things even more interesting here is the staggering amount of treasuries that need to be sold in 2009. We are expected to issue around$2.5 trillion dollars in treasuries this year to finance our Ponzi government spending versus the $750 billion or so we issued last year. This is turning into quite a game of cat and mouse we have going here between the bond market and the Fed.

The bond boys are really smart guys and I expect them to eventually take a serious run at the Fed. Markets hate uncertainty and the Fed has created plenty of this since it announced its QE policy.

How far will the Fed go in order to keep lending rates low? Who knows? The Fed has to be extremely nervous given the enormous amount of treasuries that need to be sold this year. There is a limit to the Fed's resources despite their claims, and the bond traders realize this especially given the massive supply.

If demand around the world for our worthless debt crashes will the Fed give up if they are the only buyer left bidding on bonds? If theFed decides to walk away from treasuries at a certain point lending rates are going to skyrocket. This will destroy whast left of both the housing and equity market.

Keep an eye on this story.

If bond yields on the 10 year begin to creep up over 3% find a place to hide!


John Maynes said...

Very interesting point. Thanks for the posting, Jeff.

will the Fed give up if they are the only buyer left bidding on bonds?You gave the answer. They won't. Printing money makes Ben a happy camper.

Jeff said...

That would be my guess too given ben's track record. That's a scary conclusion

nodice said...

Jeff, I think you are making too big of deal about the rise in bond yields. In my opinion its just a reflection of risk adversion declining as the economy is showing some signs of life. Yields could probably go to 3.5% and still not have much of a drag on the economy. 3% was considered ridiculously low not too long ago.
Now we got desensitized by these low yields.

If bonds start tanking big while the market tanks big then that's probably a better sign to indicate hyperinflation/default concerns.

Macroanalyst said...

I agree with nodice. Rising yield could be a reflection of people getting out of treasuries and going back into equities as risk aversion dissipates. However, I must say that things are still grim as far as unemployment and housing goes.

Jeff said...


In a normal market I agree.

This is not a normal market IMO. If everything was okie dokie with the 10 year at 3% then why did the Fed begin the QE policy?

The reason they started this policy at 3% yields was because housing prices were too high for anyone to qualify for a mortgage.

The Fed was backed into a corner. If the 10 year moves back up to even 5% I think housing is doomed because prices got so out of whack with incomes.

I could be wrong here but I don't think the Fed would have used such drastic policy if they were not backed into a corner.

Lets see what happens

Jeff said...



Thats the problem. Unemployment is soaring. California just hit 11% according to the numbers on Friday.

That means the real unemployment number is probably hovering near 20% out there when you include all of the people who are part time or have given up looking for a job.

The stats are pretty grim out there. This will only mean more pain for the banks.

nodice said...

I hear you Jeff,

I believe the bond market is too powerful for Bernanke and the fed. Bernanke did QE simply because he ran out of options and had to do something.

I doubt QE has any meaningful effects on yields except for knee jerk reactions like what happened when Ben announced the start of QE about 1 month ago...yields are now just about where they stood before that announcement.

Bond yields crashed late last year well before the fed did any QE correctly sniffing out serious economic weakness and deflation.
The move was also exacerbated I'm sure by hedge funds who shorted bonds believing they were in a bubble (Jim Rogers and Doug Kass were pouding the table when yields were at 3.5%).

If the bond market sniffs out inflation then I doubt big Ben won't be able to do anything about it whether he likes it or not.

I agree that 5% rates would not be good for housing but going back to the 3.5% range I don't think would cause much harm. But like I said, so long as the stock markets aren't tanking while yields rise then I would consider the rise in yields is a sign that perhaps the ecnonomy may be least temporarily.

Jeff said...


Great points

I agree...The market is pricing in stability in the short term here.

In fact, we could see yields drop significantly further if you look at what happened in Japan's deflationary spiral before seeing a rise in yields.

I think their long end bonds got down to 2% at one point.

I gotta think all of this creation of money will result in inflation down the road at some point which will take yields through the roof.

The Fed is increasingly becoming weaker and running out of bullets.

I see a double dip type economic crisis here. The first one is the collapse and serious deflation. The next one will be a massive inflationary recession/depression.

The scary thing here is we will eventually face inflation at a time when people aren't working and have no savings.

This scenario is certanly a frightening one to me.

opportunistic said...

"The stats are pretty grim out there. This will only mean more pain for the banks."

I believe you mean more $money$ for the banks

teddy bear said...

no pain, no gain :D

Jeff said...


LOL...Well Put!

It seems the worse the economy gets the bigger the bailout is to the PIGS!