Opinion

Felix Salmon

T-bond one-liner of the day

By Felix Salmon
May 28, 2009

The rise in US long-dated Treasury yields summed up in a nutshell, from Fitch’s David Riley: Treasuries were “moving from a risk-free asset to a return-free risk asset”.

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“(1) Is this simply an unwinding of the unsustainable “bubble” that had emerged in US Treasuries during the flight from risk, that is now gradually deflating as risk aversion ebbs. If so, the movement should be fairly limited and could be interpreted as part of the “normalisation” of financial conditions.”

My view has been that, for QE to work,especially against Debt-Deflation, you need short term interest rates to stay low, while you need long term interest rates to rise. In terms of incentives, you want to attack the fear and aversion to risk, by having a disincentive to buy short term bonds at no yield, the flight to safety, giving a push towards stocks and corporate bonds, and you want rising long term interest rates, signaling confidence in a recovery, as the spread is widening, and giving an incentive for longer term investing. It seems to be working.

I think that this is the first post that I’ve found that at least posits this position, but I thought that this is what Bernanke was aiming for when he said that he wanted to attack the problem of the fear and aversion to risk. Quite frankly, the longer and shorter term rates moving in tandem doesn’t make sense to me, unless you’re trying to work simply on mortgage rates, which to me is a bad idea.

 

FWIW, that quip is James Grant ©2008.

Posted by maynardGkeynes | Report as abusive
 

I’m glad that James Grant was brought up:

http://www.greenlightadvisor.com/documen ts/Grant120408FTcom.pdf

“In their magnum opus Security Analysis Benjamin Graham and David L. Dodd advise that “bonds
should be bought on their ability to withstand depression”. They wrote that in 1934. So far is that
rule from being honoured by today’s financiers that not a few bonds—and boxcars full of
mortgages – could hardly withstand prosperity. Two urgent questions present themselves. One: does
something far worse than recession loom? Two: does that certain something definitely spell much
lower interest rates?
We can’t know, but we can at least observe. What I observe is a monumental push to reflate. The
Federal Reserve is creating more credit in less time than it has ever done before – in the past three
months the sum of its earning assets, known in the trade as Reserve Bank credit, has grown at the
astounding annual rate of 2,922 per cent. Are the bond bulls quite sure that these exertions will raise
no inflationary sweat?
Evidently, they are—at least, forward swap rates betray no such concern. The market’s best guess as
to what the 10‐year Treasury will yield in 10 years’ time is 2.78 per cent, never mind the famous (and
now, as it seems, prophetic) remark of Fed Chairman Ben Bernanke that the Fed could drop dollars
out of a helicopter in a deflationary pinch.
The non‐Treasury departments of the credit markets have crashed. No surprise then that prices and
values are deranged. Market makers have closed up shop for the year, while hedge funds cower in
fear of redemptions. You’d suppose that professional investors – doughty seekers of value – would
be combing through the debris for bargains. Alas, no. Most seem content to lend money to Henry
Paulson (subsequently to Timothy Geithner) at 2 per cent or 3 per cent.”

And:

“Risk‐free return” is the standard tag attached to the government’s solemn obligations. An investor I
know, repulsed by prevailing government yields, has a timelier description – “return‐free risk”.

I think that it’s these investors that we’re trying to tempt.

 

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