As the U.S. Congress and executives continue the pursuit of political one-upmanship, it seems as if nothing else matters in the global finance. European banks, German politics, the Trans-Pacific Trade Agreement, IMF upgrading the British economic outlook … nope nothing going on except in the BOWELS of Washington. The U.S. has the media’s focus but today the Washington drama affected the bond markets in a very serious way. At 10:30 a.m. CST, Treasury auctioned 4-week TREASURY BILLS at 0.35%, the highest since October 2008, as markets are beginning to WORRY about some type of U.S. government default. There was a lack of bidders for the short-term BILLS as bond traders and market makers worry that default fears will make certain debt instruments unacceptable as collateral.
This is a potential problem for the FED for it is the first time in many years that a short-term government debt instrument is yielding higher than the INTEREST ON EXCESS RESERVES (IOER), which is presently 0.25%. At some point banks will stop parking funds and search for alternative higher yields, something the FED has been trying to prevent. It seems that the FED may have to move its bond purchases into the shorter end to prevent BILL yields from spiking again due to continued uncertainty in Washington. The politicians are center-stage but as James Carville so aptly put it 20 years ago: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
Today, the BILL auction intimidated everybody as the S&Ps and other equities started a renewed downward move post Treasury auction. As you trade, pay close attention to the short-term government yields, not the EURODOLLARS for the banks are deemed a better credit than the U.S. government. Whether Congress likes it or not, the U.S. Government is enslaved to the debt markets. The rest is commentary.
***Today, Jon Hilsenrath went back to being a journalist and presented a very good piece in the WSJ, “Tense Negotiations Inside the Fed Produced Muddled Signals to Markets.” Instead of waiting for someone to bring Mr. Hilsenrath a story he went out and researched his own and wrote a strong assessment detailing the consternation at the last FOMC meeting over the END OF TAPERING. This is important because tomorrow the FOMC minutes will be released at 1:00 p.m. CST and with all the focus on Washington there was little discussion about the intensity of the Fed debate. It seems that some Fed Governors were in favor of tapering QE (Stein and Powell) and so the FOMC release will be deemed “hawkish” and could cause some short-term negative impact.
Hilsenrath quotes Bernanke from his news conference saying, “We can’t let market expectations dictate our policy actions. Our policy actions have to be determined by our best assessment of what’s needed for the economy.” Chairman Bernanke has always loved models more than markets. He should familiarize himself with that renowned economist James Carville. Just be aware of the impact the FOMC release will have on markets, regardless of what other theatrics are in the center ring.
***The Financial Times had a piece on the need for more ECB actions to provide bank loans. The EURO has been well bid as the ECB’s QE program, long-term refinancing operations (LTRO) has been paid down–unlike in the U.S. where the FED’s QE program and portfolio has been expanding. The pay down of cheap ECB money is causing a slight rise in the overnight money market rates. Healthy banks want to pay down money so as to avoid the stigma of LTRO borrowings on their books. The European banking authority may penalize banks with LTRO funds when its runs its stress tests, which is another stupid European policy because LTRO is meant as a prop for debt-stressed banks.
The FT article provides a good chart of LTRO by country and the results are not surprising. German banks have repaid the greatest percentage while the peripheral-based sovereigns are in need of ECB financing. ECB President Draghi remains complacent as the stage lights are pointed elsewhere, but Europe is certainly not beyond the reach of the credit markets vigilance. The European yield curves have remained contained as even the Portuguese 2/10 has steepened by 40 basis points from last week, a temporary sign that investors are buying the short-end of Portugal’s sovereign debt. It’s all good over in Brussels and Frankfurt. Now, back to Washington.