Bond Bubble Springs a Leak?

Hmmm… is this it for the bond bubble?


Above is a new page in the credit crisis playbook. You’ve no doubt heard the old routine: When stocks plummet, flee to U.S. Treasuries — bond prices go up, bond yields go down.

But yesterday, stocks fell… and Treasury bond yields soared. Instead of selling U.S. stocks and buying American debt, traders decided to sell both. At 3.38%, the yield on a 10-year note is at its highest level since November.

Why? Standard & Poor’s served the bond market a stiff glass of reality when it threatened to strip Britain of its coveted AAA rating. Oddly still relevant, the rating agency gave the U.S an implicit shot across the bow… if the U.K. can lose its AAA, the U.S. can too.

At the same time, the Federal Reserve purchased fewer Treasury securities than the market expected. During an auction yesterday, the Fed purchased “only” $7.3 billion in U.S. debt, or about 16% of the total debt offered. At a similar auction earlier this week, they bought upwards of 30%… not exactly the buyer of last resort.

And nearly simultaneously, the U.S. Treasury quietly announced it will pump another $162 billion worth of U.S. debt into the market next week. Total marketable U.S. debt will soon exceed $6.36 trillion. It’s no wonder traders are finally pushing up yields… who the hell is going to buy all this stuff?

“New Treasury bond issuance may become more challenging,” warns our resident macroeconomic sage Rob Parenteau, “not just because of the huge supply forthcoming, but because the quantitative easing measures adopted by the Fed and other central banks are designed in part to force investors out of the risk spectrum and away from cash and default-free Treasury holdings.

“We are especially concerned the large buildup of long Treasury positions at primary dealers is unlikely to be sustained and there may be a rout in the Treasury market reminiscent of 1994, when Goldman Sachs had to borrow from the Japanese in order to stay afloat after getting caught the wrong way round in yield curve carry trades.

“With 10-year Treasuries hitting 3.36% and passing through their 200-day moving average earlier this month, our concern is looking less and less theoretical.

“Unless U.S. macro data start to get more alarming soon — and auto production cuts could dampen the Institute for Supply Management’s numbers, while the minor consumer bounce in Q1 was really mostly over in January and could cool further in Q2 — Treasury yields are likely to surge higher. So far, the backup in Treasury yields has not taken 30-year fixed mortgage rates higher, but this is the type of challenging setup in the Treasury market that could squash attempts to stabilize the U.S. housing market.

“If you were planning on refinancing your mortgage this year, you may wish to consider acting sooner, rather than later.”