Mysterious Actions in the Bond Market

Once again, I'd like to share a post from this week's "In Session" forum area.


Welcome to June, and welcome to this week's edition of "In Session."  As always, if you have anything left over from last week that you'd like to discuss this week, copy it on over or post a link back and we'll see about getting to it.

This week, I am still tuned into some confusing cross-currents in the world of bonds, specifically US Treasuries, that I do not yet understand.

First, there was this dire warning late last week about the re-emergence of the dreaded "bond vigilante," which had gone into hiding for more than a decade:

Bond Vigilantes Confront Obama as Housing Falters (Update3)

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.”

According to this report, there's some pressure being applied by the bond market to the grand plans of the government deficit spenders and the Fed monetizers.

But then I wake up and read this next report, which really makes me scratch my head:

Treasuries, Dollar ‘Only Game in Town’ as China Buys (Update3)

By Daniel Kruger and Susanne Walker

June 1 (Bloomberg) -- For all the hand-wringing over the dollar’s slide, the expanding U.S. deficit and the nation’s AAA credit rating, the bond market shows international demand for American financial assets is as high as ever.

The Federal Reserve’s holdings of Treasuries on behalf of central banks and institutions from China to Norway rose by $68.8 billion, or 3.3 percent, in May, the third most on record, data compiled by Bloomberg show. The Treasury said bidding from foreigners was above average at its $101 billion of note auctions last week.

Apparently foreign central banks snapped up more than two-thirds of the most monstrously large Treasury auction on record.  I am quite perplexed by this for two reasons:

  1. Where did they get the money from?  Global trade is down by record amounts, and the US is importing roughly 50% less than it did last year.  Further, most countries are spending wildly at home to stimulate their own economies.  So where did they happen to find more than $68 billion lying around for the purposes of investing in US Treasury bonds, which are currently yielding desperately low rates of interest?  This was the third highest weekly purchase on record, surpassing the heydays of 2006 & 2007.  All I can figure is that some heavy threats and promises must have been made, to secure this level of foreign participation in these auctions at this time.
  2. Why would foreigners want to "invest" in Treasuries at this time? The dollar is declining, Treasuries lost a record amount the week prior, and the US government is running fiscally reckless and ruinous budget deficits.  Taken together, these are three very compelling reasons to not buy US Treasuries at this time, but somehow foreign central banks snapped up the third highest amount on record.  

Given their own troubles at home and the multiple reasons that a sane person would not want to buy Treasuries right now, I am mystified by these foreign purchases of US debt.

However, the key to understanding this is to realize that central banks are called "non economic participants" for a reason.  They do not make decisions based on sound uses of money.  They make decisions based on other factors, such as "helping each other look good" and "maintaining confidence in a fraudulent system."

I thought that the disconnect between how you and I might see the economic world and how central banks see it was perfectly captured by the audience's reaction to statements made by Timothy Geithner on his recent trip to China:

BEIJING, June 1 (Reuters) - U.S. Treasury Secretary Timothy Geithner on Monday reassured the Chinese government that its huge holdings of dollar assets are safe and reaffirmed his faith in a strong U.S. currency.

A major goal of Geithner's maiden visit to China as Treasury chief is to allay concerns that Washington's bulging budget deficit and ultra-loose monetary policy will fan inflation, undermining both the dollar and U.S. bonds.

China is the biggest foreign owner of U.S. Treasury bonds. U.S. data shows that it held $768 billion in Treasuries as of March, but some analysts believe China's total U.S. dollar-denominated investments could be twice as high.

"Chinese assets are very safe," Geithner said in response to a question after a speech at Peking University, where he studied Chinese as a student in the 1980s.

His answer drew loud laughter from his student audience, reflecting scepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home.


Laughter is, of course, the perfectly rational response to Timothy's banalities about the safety of Chinese assets when parked in the currency of the country most responsible for the current crisis and leading the way in terms of fiscal and monetary recklessness.

I find it telling that regular people find his statements ludicrous and laughable, yet the policy folks seem to have no clue as to how far off the reservation their actions and words appear to the average person.

Maybe some Chinese students have tipped Timmy off in this regard?

Finally, I am squinting suspiciously at the bond market itself.  The moves there lately have been quite dramatic, with gaps and reversals all over the place.  Looking at the past five trading days is enough to make one recall the Tacoma Narrows bridge incident.

Stocks are for show and bonds are for dough.  This bears watching.

This is a companion discussion topic for the original entry at

Comment #1 - Wahoo!

Good read, thanks!
FSN was saying that China is moving to the short side of the bond and, I forgot the basis point spread between the short and the long but it was staggering. Jim’s reasoning? They expect interest rates to go up and don’t want to be locked in for 30 years…


This is a couple weeks old, but seems relevant. By Adrian Douglas
Have the China Watchers Never Heard of a Decoy


Is anyone here buying short bond ETFs?  I bought some TBT on thursday, to see a huge loss on friday, which was then made up today.  Long term, bonds are going to get destroyed.

 been playing with TBT since Jan. The last 2 weeks have been bery good.

Well the basic thesis is that the US goverment actions will eventually caused the dollar to discombobulate.
So, if you have large (or small) amounts of dollars (treasuries) and you are no longer deeply concerned the world economies are going to have a meltdown, what do you do?

Well, jeez, maybe I should take those dollars (sell treasuries) and buy some other currencies (open a foreign saving account?).

Anyways, you take your dollars and give them to a foreign goverment and say give me you crap currency please.

They say sure no problem. So now they have a bunch of US dollars, What the heck do they do with them.

Well they could stick them in the closet, but that is already packed full of US dollars. No, they will buy US treasuries.  Wow, thats accomplished alot.

With the information on the site yesterday that more than 96% of the bonds bought at the end of the week were either 3 to 6 month bonds and that only one day last week the 10 year bonds where being bought, it looks like foreign investors are trying to quietly get out of long term bonds.  If they only sell sell sell the long term bonds, than even the MSM may actually see it.  In addition, to keep the US bailout machine going they know they need to keep pumping money in, however they are also smart enough to know that this can not and will not last forever.
In short, foreign investors are work their exit strategy now.  They are patient, they are methodical, and they are smart.  I just wonder if they will allow us a softer ((notice soft was not used only softer)) or pull the rug from under our feet.

If you are at the end of your rope like most of us are tie a knot and hold on good and tight.  Once we regain our strength back lets start climbing this rope and move on. 

First, let me say I’ve been a bear for over a decade based on debt levels, demographics, trade deficits and asset valuations.   That said, I just don’t see hyper-inflation or even high inflation in the cards, at least in the next few years.  I also don’t see the Fed destoying the U.S. dollar in order to bailout speculators and bad debt.  That would not only ruin the dollar franchise, it woud violently upset the world economy and run drastically contrary to the Fed’s dual mandates of maximum employment and price stability.   Unquestionably, the Fed has made dreadful mistakes over the past twenty years, but it doesn’t follow that they will compound the mistakes with high or hyper-inflation. 

My guess, is the Fed will print money only to the extent necessary to keep credit deflation from destroying the banks and the financial system at large.  Beyond that, I see low growth and low inflation ahead.  In my view, by preventing the bust, the Fed is all but guaranteeing low growth in the next decade.  It’s more than just infuriating that so many greedy, incompetent bankers will benefit from the Fed/Treasury bailouts, but that decision has been made. 

I see a Japanese type stagnation in our future.  Really a worsening of the last decade, only with lower growth and less access to credit.  Ten year TIPs are indicating  ~ 1.65% real growth and 2% inflation.  That looks reasonable to me, especially if you consider the fear premium in treasuries right now as evidenced by the near zero yield on the short end against rising oil.  One thing to consider is that TIPs provide some inexpensive insurance against both inflation and deflation.  TIPs won’t make you rich, but neither will wall street. 

Making money from money has never been easy.  It only seemed easy because of wall street lies, media propaganda and reckless credit issuance.  Those drivers are gone (for now) and as a result treasury yields are low as I believe they should be based on our economic future.    

Thanks for all your insightful work, Chris.  You really seem like a good egg.   










I confess, bonds confuse me. Does anyone have a good ‘bonds for dummies’ link? Even the wiki entry confuses me. For example I’m trying to understand Chris’s bond (or is it ‘treasury’?) chart. I take it the ‘y’ axis is interest rate? What sets it? Simple supply and demand like a stock? And what do the ‘bought’ and ‘sold’ refer to? And then they say (for example) ‘yields went up so bonds fell’? Huh? I know it’s me because normally Chris explains things in a way I easily grok. But bonds… If bonds are acting mysterious and I find bonds already mysterious then I’m going to be extra confused.

Have a look here: Institutional - How Treasury Auctions Work

Chris’ chart is the 10 Year Treasury Note Yield (^TNX). The 10 Year Treasury Note Price (^UST) is the reverse.

Thanks for the link. Actually I ended up Googling ‘treasury bond for dummies’ and lo and behold some good hits came up. There is a Google book that explains things pretty well. I think I get it now. If you buy a bond it has a certain interest rate. If interest rates rise, new bonds have more value, so your existing bond must fall in value until it has equal value to the higher interest rate bond. Right? So when one invests in bonds thru say, an ETF, you hope interest rates fall since your existing bond is worth more. Likewise if you think interest rates will rise then one wants to short existing bonds as their value must fall to match the higher value of new bonds, right? I think my confusion came from the difference between new bonds and existing bonds. I still don’t think I understand all the implications of Chris’s graph yet, but I’m working on it.

Perhaps this article will shed some light as to how FCB are able to buy enormous amounts of US gov’t debt, despite the 50% reduction in trade deficits:

"Under the agreement, the Bank of England, the European Central Bank, the Swiss National Bank and the Bank of Japan would offer their domestic currencies to the U.S. Federal Reserve for lending to U.S. firms, should the need arise. The swap lines established total up to $295 billion."

I suspect that the Federal reserve is supplying FCB with US currency to buy US gov’t debt.

China isn’t about to dump the dollar. That would be plain stupid. Instead China is in the process of spending its US dollar reserves for commodities, and farm land. China also has no immediate desire to float the Chinese Yuan. That would result in deflation in China and make its exports less competitive on the global market. If China can replace its export economy into a domestic consumption economy then it may permit the Yuan to float.

China also faces some heavy turbulance when its excessive corporate and consumer debt comes home to roost. China has made lending very easy, which is bound to have ramifications as it did when the lending became easy in the USA. Economic pain in China will likely return when its stimulous budget plan runs out of steam (probably in 2010).






Junk bonds have come back from the dead
06/04/09 Baltimore, Maryland Junk bonds have come back from the dead — and then some. Of all the asset classes, you’d think the market for debt from financially fragile companies wouldn’t fare well during a “credit crisis.” In fact, we’d suspect it would be one of the last asset classes to recover. But no, anything is possible in 2009… Check the chart of HYG, an ETF that tracks the “distressed debt” market.


“I think that high-yield bonds have moved up way too far, way too fast,” says Strategic Short Report’s Dan Amoss. “Like low-quality stocks, many of these bonds are pricing in a return to the bubble economy, when that is clearly not going to happen. I agree with NYU professor Ed Altman — creator of the Z-Score and an expert in distressed debt investing — that the high-yield bond market will not bottom until defaults peak. Defaults will probably not peak before late 2009 at the earliest. The recent rally in junk stocks and bonds was primarily a function of the Fed’s hyperinflationary policies, which have served as rocket fuel powering any risky asset class with momentum, regardless of fundamentals.”
Author Image for Ian Mathias

Ian Mathias

Tacoma Narrows… I love it!
It certainly is confusing. 

Chris, thanks for publishing this site and being honest about what confuses you.  I love that you’re transparent about what confuses you, rather than attempting to draw baseless conclusions.

Keep it up!