Notes From Underground: U.S. Treasuries, A Fixed Market That Is Badly Broken

One of the most important elements to the purpose of the financial markets is to be an indicator of flawed policy. If money is too loose, the BOND VIGILANTES will assure policy makers that it is time to tighten by pressuring BOND YIELDS higher. As Bill Clinton’s attack dogJames Carville so elegantly stated: “I want to be reincarnated as the bond market because it intimidates everyone.” The huge FED QE PROGRAM has temporarily castrated the BOND market as FED INTERVENTION means that the BOND VIGILANTES lack the fortitude to signal the markets. Even the EUROPEANS have momentarily silenced the market by the huge liquidity pump via the LTRO program with another LTRO coming at the end of February.

For all the “pundits” proclaiming the onset of Bretton Woods II, it has arrived but it is in the fixing of BOND YIELD rather than currency levels. The lack of BOND sellers is going to force the FED into a massive buy of MBS under the guise of attempting to push mortgage rates down, but the only seller they will find will be the CHINESE AUTHORITIES as they seek to unload U.S. DEBT at artificially set prices. When will the markets become UNBROKEN? I don’t know but as sure as night follows day it will happen and the end result will be that the FED will not be pushing imaginary profits back into the U.S. Treasuries coffers.

Many analysts believe that the U.S. equals Japan and the U.S. Treasury market will resemble the JGB markets for many years to come … pure nonsense. Japan is different because 97% of JGBs are owned by Japanese citizens, thus the act of currency debasement through inflation would punish the voters on which the politicians depend. In the U.S., foreigners own 47% of U.S. PUBLIC DEBT, thus debasement through inflation means that the pain will be shared globally. As the need to inflate our way out of the “DELEVERAGING OF BALANCE SHEETS,” the onus will be on many nonvoters, unlike Japan.

Also, remember that Japan had a huge amount of savings to lean on and therefore a severe bout of inflation to minimize the pain of deflation would have caused huge problems for the pensioners in Tokyo. Deflation in Japan has not been nearly as brutal as the zero interest rate policy has been on savers in the U.S. as inflation outstrips the gross interest rate levels.

Yes, in 2011 the net capital return outpaced all other assets as the FED’S QE program and market fears pushed up the prices on the long end of the curve, but BANK DEPOSITS and MONEY MARKET FUNDS suffered under the FED‘s guiding hand of FINANCIAL REPRESSION. Are BONDS CORRECTLY PRICED? A broken market certainly cannot speak its mind. BUT HELL WILL HAVE NO FURY LIKE A VIGILANTE SCORNED.

***The January 5 WSJ had a most interesting letter to the editor from the President of the New York Fed, William C. Dudley. It seems that the most powerful Fed president had to answer the critics of the DOLLAR SWAP program in a very public medium. Mr. Dudley was answering an op-ed piece by Gerald O’Driscoll Jr., “The Federal Reserve’s Covert bailout of Europe.” President Dudley does not answer the covert nature of Driscoll’s criticism but merely goes on in the letter to justify why the action was necessary.

“The intention is to ensure that financial institutions headquartered outside the U.S. that are deemed creditworthy by their central banks have the dollars they need to fund their U.S. dollar assets and activities.”

Dudley further states, “if their access to dollar funding was severely impaired it could necessitate the abrupt forced sale of dollar assets, which could seriously disrupt U.S. markets and raise the costs for borrowing and lending in the U.S.” This last part is particularly problematic because under this rationale the FED is empowered to deem whenever they desire to intervene to halt a POTENTIAL credit crisis anywhere in the world.

Yes, the FED will argue that no money has ever been lost by those deemed creditworthy, but failed borrowers that are recapitalized through the printing press result in the quiet devaluation of money. The logic of President Dudley’s thinking should give us all pause as the FED has taken on the role of global banker under the guise of world systemic risk. Carville is going to have to amend his view to include the FED CHAIRMAN.

***A quick hit on the resignation of Philipp Hildebrand from his position as head of the Swiss National Bank (SNB). Mr. Hildebrand abused his position by allowing his wife to trade currency positions in a joint account that the two controlled. Readers of NOTES FROM UNDERGROUND know that I was pushing the same trade back in mid-August as the SWISSIE became absurdly overvalued. Fortunately, it was not pillow talk on my part.

The market has been roiled by this recent event but the fact is that Hildebrand’s replacement is Thomas Jordan, who in actuality has been the intellectual power behind the SNB’s intervention policy. It appears that Swiss currency policy will not be impacted as the market first thought, but actually may become more dynamic as Mr. Jordan has reportedly pushed for the institution of a PEG against the EURO so as to lessen the deflationary impact of a severely overvalued currency.


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10 Responses to “Notes From Underground: U.S. Treasuries, A Fixed Market That Is Badly Broken”

  1. PeterM Says:

    Your daily commentary is a must read for anyone with even a passing interest in markets. It is to the point and always puts me on the right track trading wise.

  2. Notes From Underground: U.S. Treasuries, A Fixed Market That Is … | Bonds Market Says:

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  3. yra Says:

    PETERM: thanks for the supportive comments for I believe this is the essence of NOTES.This is real time vies of the GLOBAL MACRO financial realm and thru this process of writing and feedback it helps me focus and sort out the noise that fills the airways.Will not always get it right as for timing –which as my friend and consultant CRAZY EYES always reminds me—if we are right at the wrong time we are wrong!

  4. chris Says:

    Hi Yra,

    Another insightful set of observations. The ‘fix’ in treasury market is frustrating. Given that the Fed/treasury can not afford to allow this market to discover true price levels, I do wonder how with ‘night turns to day’ certainty this event will come to pass. In other words, if we’re speculating, what kind of event would ever force the fed to withdraw from propping up treasury market.

  5. yra Says:

    Chris—it may not be the FED withdrawing but a buyers strike because the MATH just starts to become so negative.—the bond vigilantes have learne to keep their powder dry and the time will come when they will hold sway—world events are just not aligned yet as EUROPE and its deleveraging process is forcing investors in some form of safety.Remember that the Greek problems were elevated once China walked away from buying the 25 billion bond offering in Dec.of 2009

  6. Danny Says:

    Something that I struggle with is the notion that we can “inflate” our way out of our balance sheet problems. This is just one of those arguments I read over and over again but something doesn’t seem to click. My primary struggle is the notion that inflationary forces manifested primarily in consumption based goods are somehow viewed as a positive driver to the macroeconomy in the context of balance sheet re-building. How can a rising cost of goods purchased for consumption by Americans be viewed in a positive light?

    If there were some way to ensure the inflationary forces (via increasing demand outpacing new supply) would be manifested in productive goods vs. consumption goods, I think the argument would be much more sound. But the current reality seems to be “inflation” translates into a higher cost of current living standards, yet somehow we will retain our current ability to pay off our debts. Thus, I am having a challenging time concluding we won’t get stagflation (or worse rising prices and a general decline in GDP, whatever this is called) as we “inflate” our way out of our debt problems in that the average American has to spend more on one time consumable products (i.e. food, shelter, transportation, etc.) leaving less to spend on productive products that on some level lead to compounding growth or at minimum increased effeciency with current tasks. What am I missing?

    Thanks for your time,


  7. yra Says:

    Yes Danny–Happy New Year.The outcome of the mess may well be stagflation but it is the inflation part that is what the desired outcome will be as the over indebted will be able to pay back its debts via “money illusion”—if prices go up 6% and you get a 6% raise the next year do you really have an increase in pay?no ,and the same result is the payback of debt—nothing like a debased currency which inflation does ,to ease the burden of a balance sheet recession

  8. rob syp Says:


    Paul McCulley former Pimco guy (looking much different these days) discussed we are in a liquidity trap on CNBC this morning. Could you explain liquidity trap and is this what you’ve also been writing about? Being a eurodollar trader for many years now it seems there’s no reason to be trading interest rates in this enviornment.

    As Lenny Feldman once told me if you are not sure about what your doing then why bother?


  9. yra Says:

    Rob—invoking the name of the great one,Lenny,is all we need to know.But the liquidity trap that McCulley discusses is similar to the Keynesian notion of the PARADOX OF THRIFT that McCulley once wrote a marvelous piece on and also Schumpeter’s “pushing on a string[sorry to sound pedantic]—but a liquidity trap is when any monetary authority continues to flood the market with “liquidity” in the hopes of generating economic activity but all the grease goes into paying down debt ,KOO’s balance sheet recession,as the consumer and corporates retrench –no matter how much liquidity is injected the effect is minimal at best –even if savings goes sky high corporates are loath to borrow because they worry about demand and thus do not wish to invest in new capital.This is why U.S. corporates are sitting on so much cash.Wages are stagnant as unemployment rises as consumers hold back–thus Keyens pushed for the government to fill the void by ramping up its borrowing and stimulating demand —the problem in Europe is that the countires that need stimulus are being pushed into austerity.The public is fearful and not spending but hoarding cash and the government’s are going into severe austerity,THUS WE GET THE ADVERSE FEEDBACK LOOP.

  10. Kevin Says:

    I would tend to agree with Danny – after repeated QE we do have inflation, but in the prices of stuff we need to buy. We don’t have inflation in the stuff we have – houses, wages etc, that we use to collateralise and pay down debt.

    Also, unless they dramatically lengthen the maturity profile (i.e. the inverse of twist), to get any benefit from inflation the Fed will have to peg rates for many years to come, and potentially explicitly peg down the curve.

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