Bond market vigilantes saddle up

By J Saft
April 10, 2009

jimsaftcolumn– James Saft is a Reuters columnist. The opinions expressed are his own –

Efforts to reflate the economies of the U.S. and Britain are running into one potentially major problem; the bond market.

Appetite for government debt in recent sales has been very poor, raising the cost to the two governments of borrowing and blunting their efforts to bring down market interest rates by buying back their debt.

This is a big risk for British and U.S. efforts to rescue their economies, and could be yet another self reinforcing downward force if holders of government debt get the frights.

Both countries are running hugely expansionary fiscal stimulus programs that will need to be paid for by gargantuan sales of government debt. At the same time both have such low official interest rates, 0 to 25 basis points for the U.S. and

50 basis points in Britain, that they are engaging in purchases of their own debt, or quantitative easing, in the hope that this lowers rates for consumers and businesses and encourages money to be spent or invested.

It is impossible to know exactly how effective the policy is, after all we don’t know what rates would be without it. We can though see two things clearly; there are lots of sellers when the U.S. and Britain seek to buy their own bonds, but when it comes to the far larger operation of issuing bonds to fund ongoing needs, investors are markedly less enthusiastic. The U.S. Treasury got a very poor response on Tuesday when it auctioned $6 billion of 9-year, 9-month inflation-indexed notes at a yield of 1.589 percent, better terms for investors than similar issues on the secondary market at the time. Of particular note was the fact that so-called indirect bidders, mostly foreign central banks, stepped up for just 26.1 percent of the sale, as against 47.2 percent at the last such auction in January, which was before the policy of Fed purchases of Treasuries was announced.

Mohammed El-Erian of leading bond investor PIMCO told CNBC that government bonds were “not worth owning right now” because of the “tremendous” amount of debt the U.S. will have to sell.

The Fed will buy up to $300 billion worth of longer-dated Treasuries over the coming months to help keep interest rates low throughout the economy but at the same time it is buying from a market that is well aware that the Treasury needs to sell some $2 trillion of debt this year.

Speaking in Tokyo, it was clear that Dallas Fed governor Richard Fisher is aware of foreign investor’s concerns and has been seeking to reassure:

“Demand for U.S. Treasuries … will be determined by their attractiveness relative to alternatives and they may be judged more, rather than less, attractive under most reasonable future scenarios,” he said on Wednesday.

The Fed is determined to “short-circuit” any inflationary consequence of its balance sheet growth, and is in the process of acquiring new tools to help, he said.

“We realize … we are at risk of being perceived as monetizing the fiscal largess of Congress,” Fisher said.

Exactly. And while some might argue that the higher interest rates the U.S. may be paying will inflate away unpayable debts, this is perception that if anchored among investors, can very easily take on an extremely dangerous momentum of its own.

IT’S NOT EASY BEING BRITAIN

Similarly, the Bank of England intends to buy up to 75 billion pounds of assets, mostly gilts, over three months, but similarly Britain plans to issue a record 147 billion pounds of gilts in the coming financial year. There is also the possibility of more issuance to come if an upcoming budget includes new provisions for simulative spending.

Britain was unable to sell more than 100 million pounds of 40 year gilts at the end of March, the first such failure since 1995, and had to make heavy concession at an auction earlier this week.

All in all, it’s a sort of strange mirror to the criticism that is made of temporary stimulus measures; that because taxpayers can tell they will be forced to pay in future for the goodies they are given now they may save, blunting the impact of the stimulus. In the same way, today’s bond buy backs will need to be financed via tomorrow’s taxes, bond issues or eroded via inflation, making the current path of policy a very difficult tightrope.

It may be that in a world of poor alternative investments both countries can sell their debts at reasonable prices, but along with and interacting with currency moves, it is an important vulnerability.

The bond market vigilantes, who used to enforce a rough and sometimes destructive justice, may be saddling up again.

32 comments

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This one is a no-brainer James. All the money that the economic pundits think is sitting on the side lines, it’s not there. Wealth created by inflated real estate value has been decimated because of the housing market collapse. We better take a hard look at the 1930s depression so as to get a better understanding of what is really happening now.

Posted by A | Report as abusive

Your right about that, there are economic pundits that think there is a lot of money sitting on the side lines. And yes you are right that all the growth that we have had in the last 30 years is nothing but smoke and mirrors, for the most part. However, I think you neglect to account for the billions of dollars each day that is spent on foreign oil, and the huge piles of cash that now sit in Royal safes. Piles of cash that this destructive addiction feeds, daily. Unlike the 1930 which was a series of unintended consequences, todays financial crises is the result of religious zealots, leveraging the corruptible, to propagate a fire brand breed of mythology, to promote one of the most primitive forms of human government, monarchy, or even less enlightened theocracies. The reality beyond the phantom profits, is that hoarding of wealth, and the loss of ethical and moral behavior. Something that has been promoted by institutions and people that knew better, but choose to sacrifice trust, to fulfill their own personal lust for power and control. If the West is really that shining city on the hill, then it must stop being a junkie and stop feeding and acquiescing to the worst of human behavior. Power and water and drugs to rule them all!

Posted by DrugMoney+RealEstate=Vancouver | Report as abusive

I’d enjoy seeing this fleshed out. It does look very scary. On the other hand, what people are saying reminds me of a leading technology company: they stink, big time, but sometimes they seem to stink less than the alternatives. They’re quite popular.

Posted by Pete Cann | Report as abusive

thank god the bond market has some common sense. Now if we could get some in the government we’d be OK

Posted by dcb | Report as abusive

And what is the principal alternative to sovereign debt? The sovereign commodity gold. Gold has no default risk. So if gold is a government/central bank’s prime competition, then it would try to suppress the price of gold to keep interest rates low. What happens to the cash used to purchase gold? Gold sellers face the same dilemma as all other cash holders: buy debt or buy real capital assets. But the prices of real capital assets have so distorted by previous credit-expansion (the bubbles)that buyers are unable to access risks confidently.

Why do government’s and central banks detest gold? There is no leverage in gold and its market value is easier to estimate than debt or capital assets. IMF rules prohibit using it to back a government’s currency.

Sovereign debt and capital assets are seriously mis-valued. This cascades to depress labor values. Hence, depression is baked into the global economy. What do say to bond sellers? Let them eat cake!

Posted by D. Frank Robinson | Report as abusive

Treasury needs to sell some $2 trillion of debt and Britain a record 147 billion pounds of gilts. Fed is determined to “short-circuit” any inflationary consequence of its balance sheet growth.

The big question is how the Fed is gonna “short-circuit” the inflation of the stimulus into the economy. If the balance sheet growth is nothing more than some digits in some bankers computer memory that obviously couldn’t be perceived as the decisive consequent inflationary action, could it? But to ask a hell of a lot of money from taxpayers all over the world and only filling bankers pockets and leavin the money digit sounds rather stupid don’t you think?

I mean we “perceive it as monetizing” cause it is monetizing! Fisher is double talking here or a contradictio in terminus. “We realize … we are at risk of being perceived as monetizing the fiscal largess of Congress,” Fisher said. Eating your own dog food treasuries is monetizing your dept it says in every economical book for dummies. So, let’s not thing get things mixed up here in terms of etymology.

What is Bernanke solution to the much feared Inflation? Bernanke: “the central bank must retain the flexibility to withdraw its record injection of credit into the economy to keep inflation in check when the crisis abates.

One Problem: Spend money is not easy to withdraw.and money which can be withdrawn wasn’t doing anything for the economy anyways. In fact this is “a contradictio in terminus” again! You can’t possibly have it both ways, Stimulus and Cash withdraw only if you think this money should stay digital out of the real economy streets.

Bernanke most likely is thinking in digital terms of fast counter reacting market manipulating software. Not about the real street market price of fresh Mango’s.

Or is this question merely a “keeping the public busy” buying time – stalling measure?

Posted by Youri Carma | Report as abusive

James Saft is right again. What shall we call you – Dr Seer? We can’t let Roubini get all the glory you know.

US/UK, at least at the government and financial sector levels, are addicted to bubble-driven economics. You know, the kind of bubbles where *they* are in charge of creation, destruction, and make a few bucks along the way.

These people created their amazing economic bubbles, even got themselves sucked into it, then entire country went nuts, got burned, and discovered they can’t get out of the hell hole. So now the desperate act is to smoke a bigger dose of opium-bond.

What are these people made of? Why can’t they accept the proposition that when entire country screws up big time, there is no alternative other than pay the necessary price and start from a different direction. Why can’t they give themselves the ‘GM treatment’? How dare they call themselves capitalist?

Posted by The Real Deal | Report as abusive

The situation is supposed to work itself out. The government will buy or pay off its debt – because I read it would do this – then it will sell or float more debt. It makes perfect sense. It will proceed to buy toxic debt and then sell it. The circular motion of money will create some sort of butterfly convective current effect. Like a whirling vacuum this spinning capital will suck out the negativity. Soothing balm will rain from the sky to heal our economic sores. We will regain masterhood over our financial domain. This is the sort of hard-core Disney never-never land stuff I love to see in real life.

Posted by Don | Report as abusive

I personally found this quote particularly interesting: “Demand for U.S. Treasuries… will be determined by their attractiveness relative to alternatives and they may be judged more, rather than less, attractive under most reasonable future scenarios.” I mean, one must assume some really dire future scenarios for that to remain true. The irony is that while everyone in the administration, with Obama at the top, are cheering the current market rally, the exact opposite is needed to maintain a strong demand for treasuries. Nothing like a stock market crash to drive demand for US treasuries trough the roof… Maybe the next leg down will provide them with the opportunity to issue some of that 2 trillion they need to sell this year. So stay tuned for more interesting action during the summer months.

Posted by Andre Tayakin | Report as abusive

I think that the actions the government is taking, together with the Fed Banksters is designed to fail. I refuse to believe that those in power cannot predict with some degree of accuracy the consequences of their policy. They have the best brains in the world advising them. I believe they know in advance almost exactly what will happen..they have all the economic models, which can be tested with all the variables accounted for. They know there will be increased turmoil in direct proportion to their interference. I don’t even think we can call their actions interference anymore. The government Policy is the primary driver and protagonist in not only the US economy, but the World economy. Everything is carefully planned in advance. Recessions and depressions, booms, bubbles, they are all carried out in a manner not unlike an economic experiment, or game is carried out on graduate school campus across the country. There is nothing spontaneous, there are no surprises to those behind the scenes, pulling the strings. We are passengers….like the car ride at DisneyLand.. You can turn the wheel, and change your course a few inches, but the iron rail keeps the car on the track..there is no deviation from the predetermined course that has been chosen for us by the elite bankers & powerbrokers who feel that a world wide transition from relative freedom to total control by a one world government.

Posted by Richard | Report as abusive

Richard:

You overestimate “our” leaders in government. Excessive greed got us into the present predicament, and continues to be the driving force behind all the bailouts. Markets should drive economies, not ministers, presidents, or governments. “Too big to fail” is total smoke and mirrors. Insiders, the banksters, are being protected at the expense of the rest of us all, and future generations as well… Isn’t this just proof positive of total corruption at the highest levels?

The markets are no longer the de rigeur forces of “our” capitalism, fraud and outright manipulation are at the behest of elites that profit at all costs.

We are witnessing history in the making here, as profits are protected for a select few, and loses are socialized.

As I was growing up, eons ago it seems, I was taught that taking something that didn’t belong to you was outright theft. These gents are taking from future generations to line the pockets of the “too big to fail” crowd, and that no matter how you slice it, IS THEFT.

Packaging worthless debt instruments and selling it in the marketplace as bonafide investment vehicles IS FRAUD.

Where are the MUCKRACKERS in the financial press hiding???

These guys, these banksters, these Wall Street criminals, should be investigated, their companies should be liquidated, and the wheeler dealers who created this mess should be prosecuted… period.

Markets should rule. Ethics in finance AND government should be brought back from the dustbin, and the veil should be lifted on how the markets are being manipulated, such as GOLD and SILVER, in order to protect fiat currencies like the Pound and the dollar.

In short order, when lies, when fictitious balance sheets are permitted to stand in place of the real stance of coffers, then what certainty, what economic security can individuals, shareholders, governments, or societies each have in the future?

Its more than time that we begin to call the kettle for what it is: black.

What is clear is no one in governments around the world know what they are doing. And they are playing with fire to boot. What if there is a currency melt down of all currencies across the board? What of other potential catastrophic economic events resulting from governments monetary actions that we have not considered?

It is prudent to have a part of one’s liquid assets in gold coins. And then pray this gold investment is a bad one. Did I say pray? Yes, hard to believe, but all the King’s horses and all the King’s men are not going to put Humpty Dumpty back together again.

Posted by George Hollister | Report as abusive

It is obvious that the banksters are concocting a scheme to create hyperinflation, to create profits for themselves, and to inflate away their debts. They are using American and British taxpayer dollars to manipulate the stock, bond and commodities markets, especially gold and silver. While most of us are swooning under the collapse of the dollar/pound, a few corrupt banksters, and their dogs, Bernanke, Brown and Geithner, will be partying, as the huge gold and silver that they’ve purchased OTC, after downwardly manipulating the price using smaller positions on the COMEX, starts soaring in value.

Posted by JohnMD | Report as abusive

Interesting. Governments are providing money on the cheap to effectively bankrupt financial institutions which are then expected to deploy these funds to buy government bonds used to finance the money provided to them.

Adam Smith must be rolling over in his grave.

Posted by FinanceDoc | Report as abusive

Sir,
My gawd I wish you were wrong , but in my heart I know you are wright.Prepare for a Mugabe style inflation in 3-5 years in the anglosaxon part of the world.Continental Europe and the far east just might escape this “Counterfeiting by national banks”.Africa will implode.

God bless the “Prince of Wales” and all souls onboard.
Steen Baaring

Posted by Steen Baaring | Report as abusive

To Franklin D. Robinson,

You asked why governments and central banks detest gold?

Because PRIVATELY held gold is the alternative to nationally ,counterfeited (inflated) banknotes which only they control.It is a battle for economic supremacy.

kind regards , Steen Baaring

Posted by Steen Baaring | Report as abusive

A naive technical question:

I’m surprised that it is difficult to sell inflation-protected treasuries. Doesn’t the IP factor fully protect against this possible future?

Thanks.

Posted by bobhnnnn | Report as abusive

This is in essence a class war. The ruling elite has taken not only the American political leadership as hostage, but also the American people, and, for that matter the rest of the world. The banksters have proven themselves thugs and criminals, they have robbed us blind for years and to top, they are cowards wanting others to pay them for their services.
And we are too stupid to resist, we shrug our shoulders and pay the bill!. Well, maybe not!
The only one thing that can now save your bacon is investing in gold, even though it is not going to be an obvious thing. There will be times where you will doubt, because even this road is manipulated and influenced to steer you away, (the latest salvo comes from Gordon Brown, announcing gold sales by IMF. Although he claims to be an economist, he is not the sharpest tool in the box, having blundered on previous occasions in UK goldsales).
So gold prices are also mnipulated, and you should use these times to increase you holdings of gold, and as you quit the game of fiat money, then the banksters loose the influence they have over you. Forsake the taxed “interest” on paper money. It is not even going to compensate for inflation. Stocks may give short term gains, but not if you hold on to them; for surely, the market cannot go up in these circumstances.
The stock market is a casino, the banksters are cleverer than you, the politicians are corrupt, and you would even think of siding with this lot?
Invest in gold, and hold it yourself. It will not make you rich, that will require investment and hard work, as it should, but your investment in gold cannot be deflated into oblivion, it cannot be taxed, it cannot be confiscated, tangled with or coaxed by the tax-man, and best of all, it allows you independence, it can be sold anywhere in the world, it can be given to your loved ones free of taxes. In short, it allows you to hold on to your savings.
The temptations from stocks, bonds, all sorts of investments will at times be strong, but remember, this is war. You have it, they want it. Don’t play by their rules or you will loose. Opt out, save yourself, your family, let them devour themselves and rot away.

Posted by G Kaiser | Report as abusive

The yield on the 10-year UK Gilt climbed 7bp to 3.02 per cent in the third week of March 2009. A sign that investors are nervous about buying UK government debt and asking for premium for the perceived risk

The Govt.s “controlled inflation” is being sought so as to weasel out of Oil and Chinas Walmart debts with a minimum of pain for our citizenry. Inflation is also being used to raise the purchase of our products and increase tourism. Some or these countries think they are so smart by not purchasing American products but trust me they will get it in the end. Listen to China scream and cry that the value of the dollar is going south. They should have traded honestly and fairly without all the trade barriers and copyright/patent infringements. When Inflation has done its job of leveling out trade and foreign debt it will quiet down. We are having many opportunities here to protect our assets with PMs and other inflation protection stuff so don’t cry if you are asleep at the switch as it has been said. You don’t have to lose your assets. Just pay attention!

Posted by ginsengjohn | Report as abusive

Absolutely. The bond market is reacting with a lot of sense. The only things that current policies are doing are (1)cushioning and delaying an unavoidable landing [which would not be such a bad thing if it was the only consequence] (2) playing with fire by thinking it can avoid facing market constraints [no wonder why there are growing calls for a new gold standard or its equivalent] (3)building the conditions for future inflation (4) creating interferences on a market where government issued instruments are a reference and hence putting in jeopardy the conditions of access to this market for other actors [operators may need to find new benchmarks, which will not be an easy thing]. With or without these governments’help, the global ecomomy needs to clean up the excess debt. It is painful, but no one can escape this reality call.

Posted by Pierre Henri | Report as abusive

The USA is now on the debt standard. Every time the USD drops by a penny the Chinese lose 20 billion USD. No wonder they are nervous.

Posted by Paul | Report as abusive

Governments ought to know that investors in Gilts are top notch investors and not the everyday Joe Blow looking to put his saving somewhere. ‘Buying’ back their own debt with QE and then spinning out new Gilt issues to fund new debt is not exactly a mouth watering prospect for investors.

Good luck

Posted by Greg | Report as abusive

An increase of 1 percent in sovereign bond rates has a big impact on the internal economy, but currency rate volatility can exceed 10 pct in one year.
So attracting offshore/external capital looks very expensive, and is probably exponential rather than linear as the pool of available capital is drained.
If I wanted to lend to the US/UK/Japan/Russia/… government, I would want to be redeemed in gold, not 2014 USD.
This currency debasement risk is in addition to the risk of sovereign default.
If one’s background is in statistics and computing, the arts of the economic alchemists are magic indeed.

Posted by Survivor? | Report as abusive

Its a vicious money go round: with a perceived goal of keeping the relative strength of home currency in comparison with other currencies, governments are essentially printing new currency notes, borrowing from future pool of tax collections from their citizens. Why this is not supposed to affect hyper inflation after some time, is interesting to ponder.

Problem actually lies in admitting once for all that a huge number of private institutions, especially investment banks and insurance companies, are sitting on hugely inflated, non existing (read not-mark-to-market)
asset values, which if exposed, would render them insolvent straightaway. Hence the need to keep a certain value of the currency, the strength of which would ensure the solvent status of their operation.

Governments trying to gloss over this fact is nothing short of eye popping fraud committed to its own population. Remedy lies in letting ALL those institutions that become insolvent fall and preparing the populace for huge social disturbances as a result. Unless this hard medicine is spelled out, consequences explained and followed up with mounting a military operation in-house to control the resultant anarchial situation for some time at least, no stimulus packages are going to work.

There is no alternative to hard work, honest trading and
open governance, something that has failed in toto in the current imbroglio. We all need to stay positive and hit the straps once again while keeping stringent checks and balances on those in charge of oversight. Perhaps summery long term lock-ups made mandatory for some time at least, for those found wanting in discharge of their duties. Even after all this, keep our fingers crossed: it may still come to naught! Its that serious a situation.

Kanwal

Posted by kanwal chopra | Report as abusive

Although I agree with james and most of the coments everybody seems to be blaming the obvious targets ie. bankster,inept central banks,incopetent regulators. We should start to look at ourselves, yes we all wanted rapid inc. in our properties and 30% annual gains in shares. It was as much our greed that caused the problem the obvious targets just helped us along.

Posted by glend | Report as abusive

It is obvious that Wall Street views still carry significant clout in Washington. The Banking Industry as most of us know is by all measures bankrupt. The toxic Assets have no takers at any discount level and the current strategy of finding a realistic Value is lacking in integrity. As a prelude to finding a value the Investment Banks are fraudulently inflating value by round tripping aka Circular Trading. I Buy your junk real value 5 cents for 60 cents,you buy my junk of 5 cents also for 60 cents. The securities may be different but quality is same. This way you kill two birds with one stone. The value of the junk has shot up from 5 cents to 60 cents so the difference will be shown in absolute terms as Profits for the quarter. Secondly these toxic assets will subsequently be transferred to the Government at these fraudulent values.
If you see a big spike in Profit of Banking Companies this quarter please dont rush to buy their stock,since you now know from where these fictitious Profits have come.
Real Magic with final outcome that will be nothing if not tragic.Taxpayers,please get yourself a CAN.

Posted by F.Daruwala | Report as abusive

I have an idea Victor, empty the prisons and fill them with Politicians, Bankers, and Corporate Executives. When capitalist societies around the world collapse we will have little need for them anyway.

Posted by Anubis | Report as abusive

You are missing the larger picture.
This entire “global economic crisis” is deliberate by the entity controlling the money supply. It has been coordinated for more than a decade. Its purpose is to establish new global currency, or the control of the worlds currencies, and it will be done through the floor by floor demolition of the US Dollar which the Federal Reserve and associated money controlling partners, in collusion with the elite of the US government, have been orchestrating for years by selling billions of dollars of repackaged securities labelled triple AAA (knowing full well they would implode in their banks) to get the world HEAVILY invested in the dollar to ensure collapse.
IT IS NOT ABOUT THE MONEY ! IT IS ABOUT RESTRUCTURING AND EXTENSION OF GLOBAL MONEY CONTROL !!!

To all those who hold gold:

Gold is a lovely and precious metal but is is a commodity just the same as silver or platinum. What is its uses? Other than for ornamental and jewellery use I can’t think of too many other uses. What determines its value? The same criteria that determines the value of other commodites and the fundamental equation is supply and demand.

Those who advocate gold as a basis for the monetary system are living in a dream world. The gold coins o srecurities will rest in the drawer or safe as a beacon of hope for a ‘better tomorrow’ that will not come.

If you are thinking about rushing out to get some gold to protect your yourself from a decline inthe value of your economic holdings, think again.
Although a huge slush of new money is being created and pumped into the economic pipelines when this begins to have an inflationary effect beyond what the central banks consider a ‘prudent’ level (why do they tend to use this word so much when it is evident that there is little that is ‘prudent’ about what they do?) then we will see interest rates start to climb up and possibly exceed previous highs.

Given the prevailing conditions in the ‘global economy’ it does not seem like the scenario of rising interest rates will be around too soon. First, people have to get over the credit crunch hangover and resume the process of comsuming and investing on credit and when the levels of credit consumption have hooked enough fish then the interest rate trawler will haul them in.

What will happen to gold? It will go down as investors switch to interest rate securities.

Conclusion: Trade gold just like any other investment should be traded and if you know the market then you should do vey well.

Posted by Michael | Report as abusive

I have a widget in my pocket. No one really wants to pay much for it. Hmmm… Eureka! I will borrow money to buy it from myself at the profit point I thought it was worth! OK, how does this in reality make me poorer?Because I pay tax on the profit I made on my widget, and interest on the loan which over the term will equal a large proportion of the principal when paid in full. This is essentially what the banks and the governments are doing. They only way this could possibly work is if there are massive amounts of fraud and dishonesty in the process, or I simply default on the loan I took to buy a worthless widget from myself. Hmmm… that couldn’t be happening, could it?

Posted by J | Report as abusive

J – I’m pretty sure that there are no taxes on government bonds and I don’t think its the Gov buying these bonds from themselves, its the Reserve buying them with an intent to inflate the money in circulation. The plan is for the Gov and the Fed to do this until the private sector stop deleveraging or the bond market get wise and invest elsewhere, isn’t it?

Posted by Adam | Report as abusive