Before reading the articles below, have a look at this chart which shows treasury yields for all maturities. Notice how long term rates have started moving up sharply. The growing gap between short and long term yields means the US yield curve steepening.
The Fed is confused
The Guardian reports that Federal Reserve puzzled by US yield curve steepening.
(emphasis mine) [my comment]
Federal Reserve puzzled by US yield curve steepening
Reuters, Sunday May 31 2009
By Alister Bull
WASHINGTON, May 31 (Reuters) - The Federal Reserve is studying significant moves in the U.S. government bond market last week that could have big implications for the central bank's strategy to combat the country's recession.
But the Fed is not really sure what is driving the sharp rise in long-dated bond yields, and especially a widening gap between short and long term yields. [You have got to be kidding right? Are they being dishonest or are they just incredibly incompetent?]
Do rising U.S. Treasury yields and a steepening yield curve suggest an economic recovery is more certain, meaning less need for safe haven government bonds and a healthy demand for credit? [Answer: No] If so, there might be less need for the Fed to expand the money supply by buying more U.S. Treasuries.
Or does the steepening yield curve mean investors are worried about the deterioration in the U.S. fiscal outlook, or the potential for a collapse in the U.S. dollar as the Fed floods the world with newly minted currency as part of its quantitative easing program. This might be an argument to augment to step up asset purchases.
Another possibility is that China, the largest foreign holder of U.S. Treasury debt, has decided to refocus its portfolio by leaning more heavily on shorter-term maturities.
With officials still grappling to divine the factors steepening the yield curve [is it really that hard to understand?], a speedy decision on whether to ramp up the Treasury debt purchase program or the related plan to snap up mortgage-related debt seems unlikely.
"I'm in wait-and-see mode," said one Fed official who spoke on the condition of anonymity. "We laid out the asset purchase plan and we're following it. That is going to have some affect on various interest rates, but together with a hundred other things. So I don't think we should be chasing a long-term interest rate," the official said.
An important clue could come on when Fed Chairman Ben Bernanke testifies about the economy to U.S. lawmakers on Wednesday morning.
After lowering short term interest rates to near zero in 2008, the Federal Reserve said at its March meeting that it would buy up to $300 billion in longer-term Treasury securities over six months as part of its efforts to increase the money supply and ease the credit crunch of the past two years. So far, the Fed has bought $130.5 billion or about 44 percent of that $300 billion.
The Fed also has a goal of buying up to $1.25 trillion of mortgage backed securities (MBS) and $200 billion of debt issued by agencies like Fannie Mae and Freddie Mac. The Fed purchases of agency MBS total $507.075 billion so far in 2009.
But last week the benchmark 10-year U.S. Treasury bond yield jumped to a six month high around 3.75 pct, while the spread between 2-year and 10-year bond yields widened to a record 2.75 percentage points.
Economists at Barclays Capital in New York have argued that the Fed should announce plans to increase its planned purchases of longer-dated Treasuries to $1 trillion from $300 billion to drive yields back down [they will end up doing this], lower home mortgage rates again, and support the embryonic economic recovery.
They warn the Fed cannot afford to hold fire until its next scheduled policy meeting on June 23-24.
Bond Vigilantes scared of accelerating inflation
Bloomberg reports that bond vigilantes confront the US.
Bond Vigilantes Confront Obama as Housing Falters
By Liz Capo McCormick and Daniel Kruger
May 29 (Bloomberg) -- They're back.
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."
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. Dur ing 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 [Hah, that is a good one. Inflation will reach AT LEAST 100% this year]. 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 [The US is headed towards hyperinflation so this "embedded inflationary premium" is only going to grow]," Gross said yesterday in an interview at a conference in Chicago.
"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." [Impossible to do]
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.
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.
"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.
The world's largest economy will begin to expand next quarter, according to 74 percent of economists [74 percent of economist do not have a clue] 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.
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. [Fed "Officials" are either incompetent or dishonest]
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." ['AAA' = toxic, so the US is in no danger of a downgrade (at least from US credit rating agencies)]
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 [Agreed], 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."
China is not happy
China's Yu, a former central bank adviser, says global crisis 'inevitable' unless US starts saving
Global Crisis 'Inevitable' Unless U. S. Starts Saving, Yu Says
By Bloomberg News
June 1 (Bloomberg) -- Another global financial crisis triggered by a loss of confidence in the dollar may be inevitable unless the U.S. saves more, said Yu Yongding, a former Chinese central bank adviser.
It may be helpful if "Geithner can show us some arithmetic," said Yu. "We need to know how the U.S. government can achieve this objective." [it can't. See my arithmetic below]
Yu said U.S. tax revenue is not likely to increase in the short term because of low economic growth, inflexible expenditures and the cost of "fighting two wars."
China wants to know how the U.S. will withdraw excess liquidity from its financial system "in a timely fashion so as to avoid inflation" when its economy recovers, said Yu, now a senior researcher at the government-backed Chinese Academy of Social Sciences.
He questioned whether there would be enough demand to meet U.S. debt issuance this year. [There won't be]
Referring to the Federal Reserve "as the world's biggest junk investor [ouch]," and to Chairman Ben S. Bernanke as "helicopter Ben," Yu said the Fed has dropped "tons of money from the sky since the subprime crisis."
"The balance sheet of the Federal Reserve not only has expanded like mad but is also ridden with 'rubbish' assets [anyone else impressed with the honesty and directness?]," he said.
Bloomberg reports that China's Yu Tells U.S. Not to Be Complacent About Debt.
"I wish to tell the U.S. government: 'Don't be complacent and think there isn't any alternative for China to buy your bills and bonds'," Yu said in an interview yesterday. "The euro is an alternative. And there are lots of raw materials we can still buy." [raw materials = gold/silver?]
The U.S. should take China's interests into consideration "so that your own interest can be protected," Yu said. "You should not try to inflate away your debt burden." China could still diversify some of its Treasury holdings into euros or commodities, Yu added.
Nogger's blog makes fun of China's situation.
[I enjoyed this bit of humor]
I have this mental image of China now running round Duluth airport fifteen minutes before it's plane is about to leave, buying anything that's on the shelves, just to get rid of this bloody foreign currency it doesn't want. "I'll give you $760 billion dollars for the Barack Obama Mug and that inflatable pillow."
It can't be of any great surprise that China would rather like to swap what has suddenly become the largest collection of Monopoly money in the world for grains, metals, or just about anything else.
You want your $760 billion back China? Here you go mate, but mind the print it's still a bit wet.
The world could just about be ready to enter a new phase of mega-inflation. [Agreed]
My reaction: The rising yields of long dated treasuries were predictable. I outlined nine reasons US interest were headed up in my article *****Fed Planning 15-Fold Increase In US Monetary Base*****
1) The Federal Reserve is 'puzzled' by US yield curve steepening
2) Investors from Beijing to Zurich are challenging a president's attempts to revive the economy with record deficit spending. These Bond Vigilantes (investors worried about inflation) are dumping long dated treasuries.
3) China is concern with the fed's ability to withdraw excess liquidity from its financial system to control inflation
4) China warns that there are alternatives to the dollar.
The arithmetic of shrinking the Fed's balance sheet
China raises a valid point about the Fed's ability to shrink its balance sheet. To withdraw excess liquidity from its financial system, the fed will need to sell assets, and there are three problems with this:
1) The balance sheet is ridden with 'rubbish' assets
China is also right to refer to the Federal Reserve "as the world's biggest junk investor." Less than half the assets on the fed's balance sheet can be sold to shrink the money supply.
The screenshot of the Fed's balance sheet shown below illustrates the problem of toxic assets. The blue circle represents assets which could be sold to shrink the money supply and loans to foreign central banks which are being repaid. The red X represent loans to insolvent financial institutions (which means loans can't be called in) collateralized by toxic 'AAA' securities (which are virtually worthless).
US Monetary Base VS Sellable Securities Held By FED
2) Market value of fed's assets falling fast
All the Fed's sellable assets are interest bearing securities, whose market value is vulnerable to interest rate fluctuation. Worse, of these interest bearing securities, over half of them have a maturity of over ten years, as seen in the graphic below.
With long term interest rates going parabolic, the value of these long dated assets is getting killed. Especially worrisome is the value of the 427 billion mortgage-backed securities. If the fed tries to sell these assets, it will only get a fraction of what it paid for.
3) If the Fed does try to sell these assets to control inflation, the US will go bankrupt
Interest rates are already going up because the US government is selling so much debt. If the fed starts unloading treasuries too in an attempt to shrink the money supply, the treasury yield along the entire curve would skyrocket, more so then in the eighties. With 20% interest rates, the cost of servicing the US national debt exceeds tax income.
Conclusion: After a closer look at the fed's balance sheet, the dollar's hopeless situation is easily be understood.