by Lee Adler, Wall Street Examiner
Originally posted Friday morning at Capitalstool.
The bond market crash is taking a breather this morning. The 10 year yield is “holding” at 1.696, off its high of 1.754 yesterday. The projection for the current move is now 2.16. After that, only Jaysus knows, and Jaysus isn’t saying yet.
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I’m agnostic on whether they get that high on this move. As moves go parabolic like this, the end move projections can exaggerate the target.
In this case, it depends on Lord Jaysus. What Jaysus says is one thing. It’s what he does and when he does it that will have the real impact. Bond market penitents anxiously await his Third Coming.
I repeat the theme. The Fed has no choice but to resort to yield control, which means QE infinity. Infinity in this case means mostly in terms of quantity, but also for a very long time. I get into the nitty gritty of what’s happening and what’s likely to come next in the Liquidity Trader Money Trends reports. Again, the issue is not inflation. The issue is not economic recovery. The issue is not rising yields. The issue is not interest rates. These are all second order effects, or wholly tangential.
The issue is falling bond prices due to SUPPLY. Treasury supply, with a heaping of corporate issuance piled on for good measure.
The issue is also that inherent demand is insufficient to keep market prices stable in the face of this torrent of supply. So bond prices fall relentlessly. This is true even with the Fed directly buying or indirectly funding 85-88% of new issuance since last August. Bond prices have consistently and relentlessly fallen since then.
What changed was that prior to August, since March, the Fed had been funding MORE than 100% of new issuance.
It’s mind boggling. The market only needs to absorb 15% of new issuance because the Fed is taking care of the rest. But it can’t do it.
Ultimately, it comes down to the fact that the Primary Dealers, the criminal syndicate that the Fed appoints to run the Treasury market, accumulated massive inventories around the highs in price. They did so by borrowing 90% of the purchase prices with repo. All of that is now under water.
Yes, their inventories are hedged in the futures market, but it’s not a perfect hedge. If it was, they’d be net short and making money. They are not. They remain net long to the tune of many billions. They’re getting crushed.
That’s why the US Treasury has stepped in recently to try and stop the hemorrhaging. Yesterday the Treasury announced more paydowns of T-bills to stuff money back into the pockets of the dealers, banks, and money market funds that hold the expiring bills. The Treasury will add $5 billion back to the market on Tuesday, and $26 billion on Thursday with these paydowns.
It’s no coincidence that the $26 billion in T-bill paydowns on Thursday exactly equal the Treasury’s $26 billion in new long term paper issuance on Friday. They desperately want to avoid resorting to yield control and infinite QE. The Fed and Treasury are praying that the holders of the expiring paper take that money they get back, and buy further out on the curve to push bond prices back up.
The Treasury started doing this massive pseudo QE on Februrary 23. Each week the Treasury has pumped $50-90 billion into the market with these paydowns of expiring T-bills. But the gambit is not working. At least it’s not working well enough to make a material difference.
So we are faced with the fact that the dealers’ bond inventories acquired ever since March of last year are getting ever deeper under water. As trading inventory, the dealers are required to mark to market in real time. The losses are real. Their lenders want more collateral because of that. This causes forced selling. That’s all this is. You need not read any more into it than that.
Even if they’re selling out of it as they go, they are still taking losses on anything acquired through yesterday. No doubt they are getting out. Their bank lender wise guy buddies are giving them no choice.
Meanwhile, the Fed sits on the sideline in shock, hoping against hope they need not take emergency action yet again. Jaysus says, “Remain calm, all is well,” while knowing that all is NOT well. In fact, it’s terrible.
That’s where this Treasury ploy of paying down mass quantities of T-bills comes in. It has been a last ditch attempt to avoid the inevitable infinite, unlimited Fed QE that will be necessary to stabilize the bond market.
I illustrate the problem with my newly updated chart of the TLT, the 20 year Treasury bond ETF. This will make it easy to understand just where this is headed.
Click to engorge.
The bonds have lost 22% of their value since last July when the Fed cut back QE to “just” 85% of new issuance. They have lost 15% since bond prices broke down from the top on January 6. Meanwhile, the Primary Dealers acquired their inventories with no more than 10% equity. To quote the guys at South Park. “AND IT’S GONE!”
At the peak of the crisis, from March through July, the Fed had been absorbing more than 100% of new Treasury issuance, plus a little more. The Fed was giving their dealer strawmen plenty of slosh to play with in stocks. That stopped in July. The Fed thought that the market had recovered enough to handle the Treasury issuance on its own.
The Fed was wrong. What else is new? The market showed them immediately that they were wrong by simultaneously topping out and immediately heading lower in price, of course reflected in higher yields.
And they’re just waking up to this in recent weeks. Meanwhile, we’ve been all over it since the turn started. Why didn’t the policy makers address the problem then? Too many clueless eCon Phd’s and not enough common sense, I suppose.
The Fed’s history of long term serial blunders goes on. Each policy blunder requires an ever bigger rescue, which in turn merely compounds the problem. How do we exit this spiral without reaching a catastrophic criticality?
We probably don’t, but there’s a slight possibility that they could get lucky. I chronicle the attempt to thread that needle in the Liquidity Trader Money Trends reports.
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