The signal feature of world financial markets this week, a feature which many noticed but surprisingly few have commented upon, was the global ROUT of government bonds. This rout was most noticeable on the market for U.S. Treasury debt paper. Consider these rises in yields over the past week:
2-Year Treasury paper - up 60 basis points to 3.04%
5-Year Treasury paper - up 60 basis points to 4.22%
10-Year Treasury paper - up 58 basis points to 4.89%
30-Year Treasury paper - up 44 basis points to 5.31%
The shorter the term, the worse the rout on a comparative basis. The 60 basis point (0.60%) rise on the yield of two-year Treasury paper was reported to be the worst weekly bloodbath in almost a quarter of a century. Other "safe haven" assets, government bonds issued by Canada, Europe, Japan, Australia, and most other "developed" nations suffered comparable bloodbaths. And the debt paper of "developing" nations didn't sell at all, demand for such paper has halved in the past year. No doubt the ongoing saga of Argentina (will it or won't it default) has something to do with that.
Now, consider a number of other facts:
Now consider this fact, analysed in detail in the latest issue of The Privateer (the Mid November Issue - #437 - published on November 11):
Just over two weeks ago, on October 31, the U.S. Treasury announced that they were ENDING the sale of 30-year bonds. The result was a 34 basis point fall (5.20% to 4.88%) on the long bond yield, the biggest one day fall since October 1987. Right across the yield curve, this Treasury announcements pushed yields downwards fast. A week after the Treasury announcement, the Fed made its TENTH cut of the year - down 0.50% to 2.00%. Two days after that, the ECB (European Central Bank) followed suit with its third cut of the year - down 0.50% to 3.25%.
As of November 16, the Treasury long bond yield has got ALL of those 34 basis points back - and then some. The long bond yield is now HIGHER by 9 basis points (5.22% to 5.31%) than it was when the Treasury made their October 31 announcement.
As we stated in the latest issue of The Privateer, the Treasury HAD to get long-term rates in the U.S. down so that the huge mortgage refinancing boom could continue. Mortgage refinancing was and is the LAST method by which U.S. consumers can get the capital required to continue to consume. And if U.S. consumers don't consume, the U.S. economy is "toast".
But to continue to refinance mortgages, consumers need two things. They need lower long-term interest rates. And they need higher house prices. The Treasury gave them the lower long-term rates, for just over a week. As for the higher house prices, there are not many pockets of real estate left in the U.S. which can boast that phenomenon.
The HUGE problem for the Treasury is that all that their announcement of an end to long bond sales bought them was about two weeks. Now, Treasury yields have SOARED back to above the level they were at the end of October. What are they going to do now?
The HUGE problem for the Fed is that they have seen their scope for further rate cuts snuffed out in a week. Further weakness in Treasuries next week will inexorably drag the yield of Treasury "cash" (3-month bills) above the present Fed Funds rate of 2.00%. If that happens, how can the Fed credibly lower rates even more without sparking an almost certain sell-off on the U.S. Dollar itself?
The answer is that, barring some fantastic hocus pocus in derivatives and hedging markets, they can't. Wall Street is beginning to sense just this, with some worried comments starting to leak out about the difficulties the Fed might face in cutting rates again when the FOMC meets for the last time this year on December 11.
A large "risk premium" has been built into U.S. government guaranteed debt paper in the course of the past week. With the yield on 6-month Treasuries now ABOVE the Fed Funds rate and the yield on 3-month paper only just below it, the bond markets are telling us in a loud voice that they expect U.S. rates to stop falling - and even to start RISING - soon.
This week has seen the biggest weekly bloodbath in the world's ultimate "safe haven" asset for many years. It has also seen the $US price of Gold continue to gently subside, falling closer and closer to the bottom of the uptrend which has sustained it since April. One of these will have to give, either U.S. Dollar denominated paper assets or Gold "priced" in U.S. Dollars.
The "swing point" in all this is the U.S. Dollar itself. Watch for the point when the present U.S. Treasury sell-off STOPS. That point will not be a signal that investors have re-considered the risk involved in holding Treasuries, it will be a signal that they have sufficiently lightened their exposure to the risk of holding Treasuries. If they then go on to lighten their exposure to the U.S. Dollar - which they have NOT YET done - it will begin its long delayed fall.
And if the U.S. Dollar starts to fall, then there is very little left that anyone can do to prevent the $US price of Gold from beginning to RISE. We wait - and watch.