Posted on 03/22/2011 6:51:34 AM PDT by SeekAndFind
The wisest and most successful bond investor of all time, Bill Gross, has dumped his bond fund’s $150 billion investment in U.S. bonds. One should not ignore the importance of this event. The largest bond fund in America no longer believes that Treasury bonds are a good investment. Moreover, Gross is not alone. Blackrock, the world’s largest money manager, is now underweighting Treasuries overall and reducing the duration of the bonds it still holds. That means they are dumping their long-term bonds, which are the most sensitive to interest-rate changes, in favor of Treasury instruments that mature in a year or less. Other bond funds, such as the $20 billion Loomis Sayles funds, are also forgoing Treasuries in favor of high-yield corporate bonds. Virtually everywhere you look, from great investors such as Warren Buffett to insurance companies such as Allstate, everyone is dumping their long-term U.S. debt and either buying debt that matures in less than a year or moving their money elsewhere.
So who is still buying U.S. debt? According to Bill Gross, the “old reliables” — China, Japan, and OPEC — are still in the market for 30 percent of all new debt. The rest, however, is being purchased by the Federal Reserve. There is no one in else in the market. For the first time ever, Americans are refusing to purchase their own country’s debt.
Gross estimates that the “old reliables” are still good for $500 billion a year in purchases, and will be for some time in the future. This is pretty much the amount they’ve had to buy in the past to rebalance capital flows distorted by the U.S. trade deficit. Gross, however, may be wrong this time. Japan, needing to finance its reconstruction, is much likelier to be a net seller of U.S. debt, while China’s economy is slowing and actually ran a trade deficit in the last quarter. That leaves only one buyer of consequence — the Federal Reserve.
Researchers at Gross’s firm, PIMCO, estimate that in the last quarter, the Fed purchased 70 percent of all new Treasury debt. This is a disaster in the making. By printing new money to buy debt, the Fed is both holding interest rates artificially low and flooding the world with dollars. Fed purchases have lowered rates to the point where there was no room for further decreases. With no more upside potential to holding debt, investors are fleeing on the assumption that the Fed will soon exit the market, causing rates to rise dramatically. Such a rate rise lowers the value of all current U.S. debt: Who will pay $1,000 for a bond paying 3 percent when she can get one paying 5 percent? Anyone who wants to sell a $1,000 bond they already own is therefore forced to lower the price if they wish to attract buyers. No one holding any of the almost $10 trillion in U.S. public debt is getting much sleep these days.
When the Fed’s $600 billion QE2 buying spree ends, there will not be enough buyers left to purchase the $1.4 trillion in debt the administration has built into this year’s budget, at least not at current interest rates. Gross believes interest rates have to rise approximately 1.5 percent (150 basis points) to attract sufficient buyers. This may be optimistic.
The Fed is not only looking to stop buying new debt, it also wants to get rid of the nearly $1.3 trillion currently on its balance sheet. Absorbing $1.4 trillion in new debt, rolling over maturing debt, and simultaneously purchasing debt the Fed bought during its quantitative-easing forays is a lot to ask of the market.
Moreover, there is a real risk that bondholders who see the value of their assets fall will stampede for the doors. There are already signs that the smart money is looking for just such an event. Short sellers — those betting on a bond sell-off — pumped over three-quarters of a billion dollars into short positions in just the last quarter. This compares with a negative flow of short funds in the same period last year. If the short sellers are right, and there is a stampede, all bets are off. The bond-market bubble that the Fed’s purchases created will explode, likely setting off a renewed financial crisis.
Come June, the Fed will be in a bind of its own making. If it stops pumping money into the system, interest rates will increase, and not just on Treasury bonds. Mortgage rates will rise and business credit will become more costly. The recovery could be strangled in its infancy. If it keeps on buying bonds, however, it risks never being able to wean the markets off the equivalent of monetary crack. Worse, the flood of dollars will continue to drive down the value of the dollar, raise commodity prices, and propel global inflation.
There are already signs that inflation, while still subdued in the United States, is looking to break out. It has begun wrecking havoc through many areas of the globe, for example providing the catalyst for much of the upheaval in the Middle East. And when it strikes here, the Fed will be out of options. It will have to turn off the money pumps, raise interest rates, and batten down the financial hatches. The resulting recession will be long and nasty.
It is time to face facts. Spending is so out of control that Treasuries are no longer a safe haven for investors. The markets are saturated with U.S. debt and increasingly unwilling to absorb more. There is only one way out of this mess — cut spending, fast and deep.
Given that the Congressional Budget Office last week stated that the administration’s budget would raise the debt by $2.3 trillion more than the White House Budget Office claims, these cuts are going to hurt. They will probably hurt a lot. That is the cost of fending off a true catastrophe.
— Jim Lacey is the professor of strategic studies at the Marine Corps War College and the author of the forthcoming book The First Clash. The views in this article are the author’s own and do not in any way represent the views or positions of the Department of Defense or any of its members.
This is really, really, really bad.
They must see something...
They must have seen the following web site,
Factor in another war, spending like there is no tomorrow and the new Obama Care... I don’t think the US Dollar is going to last much longer.
If you were a Hedge Fund manager and you heard the announcement of QEIII what would you do? These guys know suicide when they see it. We are going to see a bond market collapse at some point. This train has been going down the tracks for awhile now.
Understatement of the century.
Mike
National Security Issue.
We are one failed treasury auction away from complete financial disaster..................
Actually, there are many ways out.
"Cut spending, fast and deep" is the least probable - in fact, it"s SO improbable that I'm surprised you even mentioned it.
” “...China, Japan, and OPEC — are still in the market for 30 percent of all new debt. [......] This is really, really, really bad. “
Not nearly as bad as it’s gonna get if/when Japan is forced to liquidate its Treasuries holdings to finance its rebuilding....
We ain’t seen nothin’, yet....
PIMCO did the same thing in June 2009. They chase yields and right now yields are low on US treasury bonds. It doesn’t mean anything.
I don’t have much respect for bond funds anyway. They pretend to be a replacement for buying and holding bonds directly. But because they constantly have to buy and sell bonds as funds flow in and out of their mutual fund, they behave like equities, not bonds.
I really think bond funds should be eliminated from most people’s portfolios.
1. Qualitative easing (i.e. the Fed creating money from thin air) ends and the interest rates have to rise significantly to convince buyers to come buy our bonds: interest rates rise and old bond values drop.
2. Qualitative easing is renewed and the Fed prints up even more funny money. Inflation rises and long term interest rates also rise so old bond values drop.
3. A miracle occurs, the sun breaks through the clouds and the economy really recovers in 1980s style. Business grows, people start buying houses again and more demand for loans occur: interest rates rise and old bond values drop.
I have a hard time seeing any situation where interest rates for loans stay at their current, artificially low rates for much longer. If you want to buy a house or refinance your current one with a low rate long term loan, do it quickly.
It is time to face facts. Spending is so out of control that Treasuries are no longer a safe haven for investors. The markets are saturated with U.S. debt and increasingly unwilling to absorb more. There is only one way out of this mess — cut spending, fast and deep.
Since the coalition of Dems and weak-kneed Republicans are clearly unwilling to make the $1.5 trillion cut that it will take to avoid this catastrophe I conclude that they are seeking just such a disaster. Collapse is the goal.
The last people to see anything are hedgies. They are the ultimate sheep. Its only leverage and press releases that give them any influence.
I fear the same thing.
Actually, there are many ways out.
“Cut spending, fast and deep” is the least probable - in fact, it”s SO improbable that I’m surprised you even mentioned it.
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OK, I’ll bite. A huge tax increase is an option. What are the others?
ping
.....We are one failed treasury auction away from complete financial disaster....
If the Fed is now purchasing most of the debt, have not we already reached that point?
It depends on the definition of failed. It seems to me that point is already passed.
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