Wednesday, March 24, 2010

Have the Bond Vigilantes Finally Woken Up?

Bonds sold off hard today after the results of the 5 year auction were announced. As you can see below, it wasn't pretty:


The bid to cover ratio of 2.55 can only be described as ugly. The primary dealers got stuck eating just about half of the auction which is another sign of weak demand.

My Take:

So now we need to ask ourselves: Has Bondzilla awoken as a result of the passage of healthcare reform? The last time we saw the bond vigilantes was back in the early '90's after Bill Clinton was voted in as President.

Ironically, the trigger for the sell off in bonds back then focused around the exact same issue except it was called "Hillary Care" last go around.

Here is the cliff note version of what occurred:

Clinton announced colossal spending programs when he got into office. The largest piece of the spending revolved around nationalized health care. The bond vigilantes responded immediately and sent yields threw the roof until Clinton backed off on his spending.

Clinton eventually backed down, and a few years later the economy soared when the tech boom hit. Our deficit rapidly turned into a surplus over this span because the bond market forced the government to keep their spending in check.

What scares me about today's problems is the economy is much more fragile and vulnerable this go around versus the early 1990's. If the bond vigilantes decide to run up yields in response to our deficits and spending on massive programs like health care reform, the economy is going take a dramatic turn for the worse.

The problem this go around is our deficits are trillions not billions. There is no way that this can be turned around anytime soon. If rates shoot up, the banks are going to be in a world of hurt because their balance sheets will deteriorate significantly. Home values will drop as a result of higher borrowing costs. This will put further strain on the consumer.

Sophie's Choice

It must be hard to be a "bond vigilante" right now. Basically they can't win. All of them know that our spending is ridiculous and completely out of control. The problem they have is if they take rates higher, they risk blowing themselves up in the process because it could very well take down the whole economy.

If they continue to ignore the problem and let our deficits continue to overwhelm our GDP than we risk becoming the next Greece or Iceland.

I am glad I am not in their shoes! Let's hope that they have the strength to do their job and force the government to stop all of this insanity.

Let's face it, the only fiscal "cops" left in this economy are the bond vigilantes. If they don't wake up and force the government to reign in it's spending, this country is in serious trouble.

Its has become clearly obvious that Wall St, Washington, and the Fed have a spending "addiction". The disease has totally taken them over, and they can now no longer control themselves.

It's up to the bond vigalantes to clean up this mess because none of our politicians have shown the desire to stand up and prevent this economic trainwreck and its catastrophic consequences.

The Bottom Line

The market is really starting to get interesting. You have the dollar soaring as Europe falls apart. Adding to the fireworks is the fact that the Fed plans on exiting the MBS and treasury markets at the end of the month.

This event should be really interesting to watch if rates continue to rise. Talk about a recipe for disaster!

Equities meanwhile have continued to rise in the process which has surprised a lot of the pros. Many traders expected equities to move to the downside when the dollar started to soar. To date this hasn't been the case.

IMO, the one thing that has defined the stock market during this meltdown is the contrarion way in which it moves. It consistently yings when it should yang. Assets that should collapse rise and sometimes even soar.

The examples of this are endless:

Commercial real estate

Banks

Fannie, Freddie, AIG

Junk Bonds

Treasuries(until today)

I could go on and on but I will leave it there. You can thank the speculators for these unrealistic ridiculously inflated values!

Recently(while I have been watching the stock and bond markets) I have been asking myself: Where is all of the money coming from to support both bonds and stocks like this? The only answer I could even think of was that Europe might be fleeing to the safety of US investments as a result of their sovereign debt issues.

I concluded that there was no way it was sustainable and today we got some confirmation of this. We should also realize that one day does not make a trend. Especially in this whacky market!

Keep a close eye on the bond market as the Fed begins to pull out of MBS and treasuries.

If appears that the bond vigilantes might begin to do their job. Health care reform may have been the straw that broke the camels back. If you are in the long bond for yield, you might want to consider shorting treasuries via TBT as a hedge.

Fasten your seatbelts folks! Things are about to get very interesting.

Disclosure: Long TBT in longer term accounts.


9 comments:

Herb said...

Many traders expected equities to move to the downside when the dollar started to soar. To date this hasn't been the case.

Are you talking about the dollar soaring do to inflation or gaining in value against other currencies?

Jeff said...

Herb

The thesis for many is deflation.

In deflation the dollar rises because the money supply shrinks and equities tank.

The dollar becomes more valuable because there are less of them. Not saying this thesis is right. But many believe we are headed for a Japan style deflationary spiral.

The recent rise in the dollar is a flight to safety trade from Europe.

Its the "we're screwed but they are screwed worse" concept.

I think this is why equities and bonds are rallying right now. Lots of money running from the European debt crisis.

I think the dollar will roll back over once this is done with because I don't think its worth a crap either IMO.

Crazy times.

flipdippy said...

The dollar is a strange thing my friend. Like it or not, it does hold a special political position other currencies do not. Before it ultimately craps out, I think dollar long or dollar short most currency player will be wiped out by the illogical movements in the dollar. I would like to think the dollar finally rolls over right now, but who knows.

On the upside, other markets are finally making sense. Bonds are acting as they should, given the headwinds they see.

Retail seems to have been snookered back into buying equities...I mean who else is buying the sectors you mentioned?

QE round 1 is winding down, MBS buybacks are ending.

Seems like we're due for a sudden and sharp drop to scare people back into bonds to drive those yields back down before we continue on the stairway to heaven.

Guessing it may not be until sometime next week after they paint the tape for this Q.

I have been so sick with the way in which everything is upside down anymore I think I'm beginning to alienate my friends and family with the apocolyptic doom and gloom stuff. Soon I'll be 50 lbs overweight and blogging from my basement about how Dennis Kneale is a Ahole like Denninger.

Jeff said...

Flip

LOL

I hear you man. You are cracking me up.

I am lucky on my end because my family is filled with people from Wall St and real estate and more than half of them have lost their jobs and are still unable to find work.

AS a result, we all sit there and talk gloom and doom together. I have one family member who watched the credit market meltdown first hand from the inside.

When I am out with my friends I keep the Gloom and doom to a minumum. Its funny, as they start losing their jobs they are sometimes going gloom and doom on me..lol

I agree with your take on the dollar and the markets.

Once again the retail speculator is in a frenzy buying everything in site. I also think are dead on regarding the window dressing for the quarter.

I wouldn't be surprised if we saw a pullback in early APril.

getyourselfconnected said...

Jeff,
if you thought the 5 year was bad, cannot wait for your take on the 7 year!

Jeff said...

Get

Worked tonight but that was ugly!

If this continues things are going to unravel. Let's see if the trend continues. Wouldn't be surprised to see a drop in stocks to scare investors into treasuries if it continues

getyourselfconnected said...

I think that well is runnin dry; so much upside now it would take a 10% stock move lower to get any fear.

Heckuva job Bennie!!

Anonymous said...

the market is not moving like it has historically, or as it should because it is not a legitimate, free market.. its a game of "Simon Says", and the degenerate gamblers just follow along.

jeff said...

Anon

Great analogy.

If you are a fundemental investor you want no part of this sham.