I have been working on a report where I examine the Treasury market (and auctions) very closely. I need to fire off a quick update based on today’s market actions, which have my full attention.
For the past year or so, all the world’s markets have been trading like one gigantic casino. I ascribe this to the fact that market participants the world over have been reacting to the liquidity flood that’s been released by the world’s central banks.
Nobody really cares if things are overvalued or undervalued. What they care about is chasing the momentum and not being left out. Liquidity provides a very compelling explanation for what we’ve been seeing in various markets over the past year.
Right now I am *this close* to issuing an alert based on a breakdown in the US Treasury market that has resulted in the largest one-day losses in bond prices in quite some time. They are not yet large enough to cause an alert to be issued all on their own, but rather I am on edge, because for months, the Treasury market has been extremely quiet. Today it’s not.
Recall that the Fed has been massively interfering in the Treasury market, both directly (via Treasury purchases in a program that ended last fall) and indirectly (via MBS purchases that create liquidity that gets recycled back into the Treasury markets). The Fed has engineered zero-percent interest rates on the short end and higher rates on the long end, so that big banks can borrow short and lend long, which is the same thing as having a license to print money. The higher the difference between the short and the long rates, the more money can be “made” by big banks.
However, the Fed has a competing interest, which is to keep the yields at the long end not too high, because mortgages are pegged off the long end and the Fed wants to keep the housing market somewhat alive. So there is a balancing act going on: Keep the yield curve steep enough to help out the big banks, but not so steep that a nascent recovery in the housing market is killed off.
by erik-t-2