U.S. Bond Markets on the Edge of Collapse
Interest-Rates / US Bonds Dec 12, 2008 - 08:20 AM GMT
Mike Larson writes: I thought I had witnessed a lot of craziness in the bond market over the past year:
• The utter obliteration of subprime mortgage bonds …
• The crash of auction rate securities, and …
• The annihilation of bonds backed by buyout loans and commercial real estate mortgages.
But boy was I mistaken. We are truly entering the Twilight Zone. So much so that I decided to call this Money and Markets column: “Postcards from the Bond Market Edge.”
A few examples …
Treasury Auction Proves You CAN Get Money for Nothing
Back in the 1980s, the rock band Dire Straits put out a smash hit called “Money for Nothing.” It reflected the laments of a couple of blue collar workers who were complaining that rock singers got too much easy money for too little work. But I never thought I'd see the day when the U.S. government would get the same deal!
What do I mean?
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| The Treasury Department recently got a sweet gift from investors: $30 billion in FREE money! |
Well, the Treasury Department recently sold $30 billion worth of four-week bills. And like any debt instrument, T-bills usually pay interest. So you're guaranteed some kind of return if you hold them to maturity.
But these bills? They were sold at a 0% yield.
That means buyers literally agreed to give the U.S. government $30 billion in FREE money, accepting ZERO return. And those buyers were falling all over themselves to get a piece of this “great” deal.
The bid-to-cover ratio, which measures the dollar volume of buyers' bids against the volume of bills being sold, was 4.20. That was the highest ratio of bids to bills sold going all the way back to January 2002!
Government Borrowing Exploding … Is the Fed Next?
The deficit numbers being thrown around — and the funding options for them — are spiraling out of control. The government racked up $455 billion in red ink in the fiscal year that ended September 30, 2008. And on Wednesday, we learned that the 2009 deficit is ALREADY at $401.6 billion — just two months into the new fiscal year!
The full-year 2009 deficit could be $750 billion … it could be $1 trillion … or it could be even higher. These numbers are truly staggering. We are literally talking about the biggest deficit in any country … ever .
So how are those deficits going to be funded? By a wave of Treasury issuance the likes of which neither you nor I have ever seen. Don't take my word for it — listen to what Karthik Ramanathan, the acting assistant secretary for financial markets at the Treasury, said this week:
“Recent market estimates have suggested $1.5 trillion in net marketable borrowing in fiscal year 2009, with some raising the possibility of net marketable borrowing in excess of $2 trillion. While this uncertainty remains, it is our responsibility as debt managers to as transparently as possible meet these borrowing needs in the least disruptive manner.”
Yes, he did say that net issuance of U.S. Treasuries could hit $2 TRILLION this year! That's another potential $6,539 of debt for each and every person in this country — in just one year. The Treasury could be forced to roll out 7-year notes, sell more 30-year bonds, or otherwise pursue “novel” approaches to finance the deficit.
Heck, I wouldn't be surprised to hear about the sale of 50-year or even 100-year bonds!
Nuts, Right? And Things Get Even Wackier Than That!
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| The Fed is spreading around so much money to finance bailout programs, that it is now exploring the possibility of selling its own debt. |
Just consider: The U.S. borrows money via the nation's Treasury Department. And government bonds are auctioned by the Treasury to investors. Meanwhile, the central bank — our Federal Reserve — has the authority to issue currency. It can print as much money as it wants. But it cannot sell its own bonds.
Yet according to a Wall Street Journal report this week, the Fed is now exploring the possibility of selling its own debt. The reason: Its supply of Treasuries is dwindling fast because of all its bailout programs.
I've never heard of a central bank doing something like this. And the ramifications are potentially immense. You could have yet another huge source of quasi-government debt flooding the market at a time when the Treasury itself is selling bonds like they're going out of style.
At times like these, it pays to continue playing things safe. That means staying away from higher-risk debt and stocks. It also means avoiding getting sucked in by bear market rallies, no matter how tempting they look. The actions by the Fed and Treasury, and these odd bond market developments, tell me the credit markets are far from fixed.
Until next time,
Mike
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