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Tuesday, 24 February 2009
Excerpt from The Gloom, Boom and Doom Report
So, while I have great sympathy for my “deflationist” friends who believe that the ten-year Treasury note yield will decline to 1.5%, I regard being long Treasuries as a very risky proposition from a longer-term perspective.
When the Fed comes in and buys Treasuries it will be a very big day, but likely not the way experts expect it to be. First of all, because of the intertwined relationship between the government, the Fed, the Treasury, and the large financial institutions, “insiders” will have driven the Treasury market higher long before the official announcement of the Fed buying Treasuries.
So, I would expect the Treasury market to sell off when the Fed “comes in to buy Treasuries”, as everybody under the sun will have already front run the Fed. Moreover, it is unlikely that, after an almost 28-year bull market in Treasuries (since September 21, 1981), there is much upside potential left for this market.
In fact, I suspect that the majority of Treasury bond buyers will be as frightened as Professor John Cochran about the consequences of the future “inflation that will result from a trillion dollars of money permanently dropped on the economy” and actually dump Treasury bonds on to the Fed. (I also suspect it will eventually be far more than a trillion dollars.)
Therefore, I would be extremely surprised to see a new low for long-term Treasury bond yields. The yield on 30-year US Treasury bonds has already increased from a low of 2.52% on December 18, 2008 to over 3.5% despite continuous horrible economic news. Lastly, Mr. Bernanke and Mr. Geithner may not fully realise the reaction of foreigners to the Fed capping “Treasury rates” at an artificially low level, since they own over 50% of the Treasury debt.
Let us assume that our that our money printer in the US Fed decided that the current yield on ten-year US Treasury notes at 3% is too high and he wished to take it down to 2% by buying up Treasury notes. What do you think investors - and, especially, foreign central banks - might do?
My belief is that they would wholesale dump Treasury notes on to the Fed, especially since the foreign exchange reserves of emerging markets are now contracting due to collapsing exports. And since the bulk of foreign exchange reserves are in the hands of the emerging economies, which have even larger economic problems than the US, it is likely that they, along with private foreign investors, would be selling their holdings. In fact, if we were to look at recent foreign trade statistics, which show an unprecedented collapse in global trade post-Second World War, I wouldn’t be surprised to see the non-gold international reserves of emerging economies contract by 50%, from a peak of over US$4.6 trillion to around US$2.3 trillion.
The point is that there is an extremely close correlation between foreign trade and international reserves. Therefore, further weakness of foreign trade in December 2008 and January 2009 suggests that international reserves are in a solid downtrend. So, if non-gold international reserves contract, global liquidity will tighten further and the demand from foreigners for US government bonds should contract. The Fed will, as has been suggested by policymakers and financial pundits, step in and buy Treasuries in order to keep or lower their yields. Initially, this is unlikely to be inflationary because diminishing appetite for government bonds by the private sector will be offset by increased demand by the Fed, which will simply expand its balance sheet further.
However, at some time in the future there will be an even “bigger day” than the “big day when the Fed comes in to buy Treasuries”. That day will come when the global economy recovers and inflationary pressures reassert themselves. At that time the Fed will be confronted with two choices: either continue to monetise and risk accelerating inflation - and possibly hyperinflation; or terminate its Treasury bond price support interventions.
In my opinion, in either case the entire fixed interest markets will tank. This is certainly not an event we should expect in the near term; however, we should expect the various bailout packages to add enormously to government debt so that when, in the future, the Fed is forced by an expanding economy and accelerating inflation to increase rates, it will be very reluctant to take the right action.
So, while I have great sympathy for my “deflationist” friends who believe that the ten-year Treasury note yield will decline to 1.5%, I regard being long Treasuries as a very risky proposition from a longer-term perspective.
1 comment:
Excerpt from The Gloom, Boom and Doom Report
Marc Faber
March 2009
When the Fed comes in and buys Treasuries it will be a very big day, but likely not the way experts expect it to be. First of all, because of the intertwined relationship between the government, the Fed, the Treasury, and the large financial institutions, “insiders” will have driven the Treasury market higher long before the official announcement of the Fed buying Treasuries.
So, I would expect the Treasury market to sell off when the Fed “comes in to buy Treasuries”, as everybody under the sun will have already front run the Fed. Moreover, it is unlikely that, after an almost 28-year bull market in Treasuries (since September 21, 1981), there is much upside potential left for this market.
In fact, I suspect that the majority of Treasury bond buyers will be as frightened as Professor John Cochran about the consequences of the future “inflation that will result from a trillion dollars of money permanently dropped on the economy” and actually dump Treasury bonds on to the Fed. (I also suspect it will eventually be far more than a trillion dollars.)
Therefore, I would be extremely surprised to see a new low for long-term Treasury bond yields. The yield on 30-year US Treasury bonds has already increased from a low of 2.52% on December 18, 2008 to over 3.5% despite continuous horrible economic news. Lastly, Mr. Bernanke and Mr. Geithner may not fully realise the reaction of foreigners to the Fed capping “Treasury rates” at an artificially low level, since they own over 50% of the Treasury debt.
Let us assume that our that our money printer in the US Fed decided that the current yield on ten-year US Treasury notes at 3% is too high and he wished to take it down to 2% by buying up Treasury notes. What do you think investors - and, especially, foreign central banks - might do?
My belief is that they would wholesale dump Treasury notes on to the Fed, especially since the foreign exchange reserves of emerging markets are now contracting due to collapsing exports. And since the bulk of foreign exchange reserves are in the hands of the emerging economies, which have even larger economic problems than the US, it is likely that they, along with private foreign investors, would be selling their holdings. In fact, if we were to look at recent foreign trade statistics, which show an unprecedented collapse in global trade post-Second World War, I wouldn’t be surprised to see the non-gold international reserves of emerging economies contract by 50%, from a peak of over US$4.6 trillion to around US$2.3 trillion.
The point is that there is an extremely close correlation between foreign trade and international reserves. Therefore, further weakness of foreign trade in December 2008 and January 2009 suggests that international reserves are in a solid downtrend. So, if non-gold international reserves contract, global liquidity will tighten further and the demand from foreigners for US government bonds should contract. The Fed will, as has been suggested by policymakers and financial pundits, step in and buy Treasuries in order to keep or lower their yields. Initially, this is unlikely to be inflationary because diminishing appetite for government bonds by the private sector will be offset by increased demand by the Fed, which will simply expand its balance sheet further.
However, at some time in the future there will be an even “bigger day” than the “big day when the Fed comes in to buy Treasuries”. That day will come when the global economy recovers and inflationary pressures reassert themselves. At that time the Fed will be confronted with two choices: either continue to monetise and risk accelerating inflation - and possibly hyperinflation; or terminate its Treasury bond price support interventions.
In my opinion, in either case the entire fixed interest markets will tank. This is certainly not an event we should expect in the near term; however, we should expect the various bailout packages to add enormously to government debt so that when, in the future, the Fed is forced by an expanding economy and accelerating inflation to increase rates, it will be very reluctant to take the right action.
So, while I have great sympathy for my “deflationist” friends who believe that the ten-year Treasury note yield will decline to 1.5%, I regard being long Treasuries as a very risky proposition from a longer-term perspective.
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