A 'Bloodbath' in US bonds?
I have a two part answer: Within a year? Yes I think that is likely. Within the next couple of months? Less likely. I have more explanation at the bottom of the post.
I have been discussing US sovereign debt in several posts
-- Debt Saturation - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=357428
-- What the Bond Market is Trying to Tell the Stock Market: A Look at the Yield Curve and Expectations - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=355853
-- Treasury pays most since August to sell 3-yr. debt - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=368822
-- Is Never Good For You? - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=358827
-- Something Very Strange Is Happening With Treasuries - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=346594
A 'bloodbath' in US bonds?
Apr 02, 2010
Are the markets losing patience with US government debt? Last week three US government bond auctions met with unexpectedly lacklustre demand. The yield on the ten-year Treasury jumped to a nine-month high of 3.9%.
In a further sign of market stress, the ten-year yield rose above the ten-year swap rate for the first time in living memory. The swap rate measures the cost of interbank borrowing. So this move implies the US government is a bigger credit risk than banks. The worry is that investors are now balking at the record debt sales needed to cover this year's deficit of $1.4trn and imposing a sustained rise in yields (via falling bond prices). In short, they want higher interest rates to compensate for the huge supply increases. The trouble is Treasury yields are the benchmark for interest rates across the economy. Higher yields will mean higher mortgage, credit card and corporate borrowing costs. That's a nasty cocktail that could choke off the anaemic recovery and hit equities.
But this could well be just a "short-term bout of jitters" that occasionally hits markets rather than the beginning of a "bloodbath" in US bonds, says Capital Economics. A disappointing German auction earlier this year raised similar concerns, but German yields have fallen back. A key trigger for last week's panic was the passage of the $940bn healthcare bill. This must have reignited concern over the scale of spending, says Richard Barley in The Wall Street Journal. But the healthcare fuss is hardly news. Technical factors also explain the bond sell-off. Speculators betting on the yield gap between Treasuries and swaps were probably caught out by the sudden market move and were forced to sell Treasuries to close out positions.
Considering this last paragraph, I agree. I think soverign debt issue in the Eurozone is far more acute than it is in the US at the moment. But this is a falling domino that eventually spreads to the US and hits the US harder. Consider this scenario:
1. Abosolute Greek (or other EU) bond failure, rates skyrocket and bond investors go to the "safe havens" = Germany debt and more likely US Treasuries
2. Ben and Timmy have been waiting for a moment like this. The US Governement is insolvent. Running massive and growing defecits in the face of shrinking tax revenues. The US Sovereign yield curve is already steep so the bond market is already giving them warning that more shennaigans will not be tolerated. But in a panic event outiside the US that drives buyers to the US debt market is exactly what Drs. Bernanke and Geither ordered.
3. With fresh, panic-stricken buyers then can offer debt with impunity. In fact based on how badly the Governemnt is invsolvent, expect a statement like "In order to guarantee that 'this doesn't happen in the US', the Fed and the Treasury are authorizing another round of Quantitative Easing"
4. The Fed *needs* to do this. The governement is broke. But this paradoxically will bring on the next crisis: Debt Saturation - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=357428
5. US Monetary policy over the past several decades has forced the world to become speculators, and when speculators perceive higher risk than reward, then bad things happen.