Thursday, September 2, 2010

Bond trader: "Unprecedented" Treasury Volatility

I wanted to write an update early today because I am busy tonight.

I will start with a chart and then share a conversation with a credit trader that I had yesterday.

Let me first start real quick with a chart on bonds because this is what we talked about.

Folks, the volatility we are seeing in the treasury market over the past week is truly historic. Let's take a look at the 10 year the last few trading sessions:

My Take:

As you can see the 10 year is moving a full point per day in either direction at times.   This type of volatility has never been seen before according to my c friend that I have in the credit markets.

In 30 years on the street he told me that he has NEVER seen moves this big on a daily basis in treasuries.  It's unheard of to see moves like this and he added that it's not a good sign.

My friend explained that the bond market is getting extremely speculative and  traders are loving the volatility. 

He also added that this is not a "healthy" situation.  In fact, he is horrified by the price action.  As he put it "this is not going to end well". 

I'll be honest:  I have never heard him so bearish over the longer term.  He has no answer as to how we ever get out of this.

I brought up the idea of a "reset" and he pretty much hammered me on this.  He said "how do you reset?".  I sat for a second and thought about it and I then threw him a few scenarios.

I offered explanations like inflating out of the debt with a currency devaluation, a new world currency, or a 50% cut in government spending where the debt gets defaulted on etc.  He didn't buy any of it.

In his view, all of the answers ended up with the same result: Failure.  The way he sees it from what I gathered, he basically believes this plays out just like the plot in the 1980's movie "War Games" where a computer and a boy play a simulation game of nuclear war between the USA and Russia.

The two played the game several times and it always ended in the same way:  One side launches the nukes and the other side then retaliates.  The end result is always the same: Total nuclear destruction of the planet.

The trigger that started the war was irrelevant because it always ended with the same result.. 

In my friends view the same thing will happen with our economic system:

No matter what the economic trigger is, the end game never changes:  Systemic failure and chaos.  He just didn't see how any of my scenarios could rationally "work".  He put holes in all of my "reset" solutions. 

In the end I agreed with him which is sad because I really want to find a way out this mess and I am still hoping for a miracle.  The reality is a solution is a long shot at best.

We also concluded that nobody really has the answer as to how this plays out.  This is why you are seeing large hedge fund managers retiring(more on that later)..

You can read a million blogs on the financial markets that will claim that they have this all figured out.  The reality is they really don't. 

We have never dug a hole like this so deep before so how can anyone actually predict how we come out the other side?

As my friend said:  "We are in uncharted waters".  I think this is why you are seeing bond prices at near all time highs at the same time gold is also near all time highs.

The way I see it, most investors really don't know if the US dollar will explode into a hyperinflationary event or soar as the Japan scenario continues to develop.

The market is telling you it doesn't have an answer by taking bonds and gold to new highs at the same time.

The Bottom Line

He ended our conversation with a question that I thought was a good one:  " Jeff, What I want to know is what is the big money doing?".   He added "When guys like Druckenmiller are walking away it's time to be nervous".

His point was if he is if guys like Druckenmiller are willing to walk away from their billions in fees, then it's fair to assume that they don't understand how the game works anymore, and if this is the case, you can then assume they are also asking themselves if the game can actually still work moving forward.

I think this is an excellent point and it's why my friend asked the question about the big money.  He believes some of them are asking themselves questions like this:

What do I do with my billions if the system or the USD is going to fail? 

We finally finished up our conversation by offering up solutions to the question like moving to Asia, buying farmland etc etc. 

As we ended the night discussing this, we came to the same conclusion on this question that we did with all of the others:  "Nobody has the answer".

I am guessing this will all end in a way that no one can predict because we have never been through anything like this before.  We have never seen a country that held the world's reserve currency potentially default.

Like they say....."There is a first time for everything". 

I'll be back with a writeup on the big jobs report tomorrow.

Disclosure:  No new positions taken at the time of publication.


getyourselfconnected said...

"You can read a million blogs on the financial markets many will claim that they have this all figured out. The reality is they really don't."

Best line ever. I certainly do not have this all figured out! Great conversations like with your friend add to the thinking process very much and I thank you for that.

CT-Hilltopper said...
This comment has been removed by the author.
Jeff said...

Thanks get

I always like to share stuff from the front lines when I can.

Whats funny is anyone that's involved on Wall St will tell you on the down low we are all screwed.

I don't know one person that's in the game that is fundementally bullish. Not one person.

Their tune changes of course when they need to suck in the sheeple.

flipdippy said...

Jeff, this has actually been very predictable. There is news, the economy, and the markets. The news is bad and gets worse. The economy is bad and gets worse. The markets move in the direction which generates the most profits for algo traders and insiders on wall st.

Yes, at some point, there will be a failure that makes fall of 2008 look like a happy time, but we're not there yet.

It takes time to move money from bonds back into stocks. On top of that, this is a holiday week. That's your movement this week.

We'll crap out here soon - maybe this afternoon or early next week, and the next stop will be down 20% before the market pauses to see if it'll head down below 2009 lows or if it rallies into the end of the year.

Your bearish bias has been keeping you from interpreting events correctly. As sean connery once said, "Indiana...Let it go".

The traders and insiders are lost because they are trying to interpret what computers are doing using tools that weren't meant for that sort of technical analysis.

Jeff said...


Come on dude.

This is a macro economic blog.

You know that by now. I don't trade the markets. I have zero desire to "trade with the machines".

My interpretations are for the longer term and should not be used for trading analysis.

The market is a total fraud and I refuse to partake. Period.

I think that most of my readers understand this.

95% of my money sits in bonds and money market funds. I trade maybe 5% and it's all hedged.

My goal is to preserve capital. I don't think you can consistently grow capital investing at this point because the market is a mess.

Maybe I will do a post stressing this.

Best of luck with your trades.


Jeff said...

Let me add that I own some metals too:)