Monday, March 29, 2010

Pay Attention Redux

You might remember last week that I brought up the bond markets and suggested that it's time to start paying attention to what's happening. It turns out some people are paying attention:

Former Federal Reserve Chairman Alan Greenspan said the recent rise in Treasury yields represents a “canary in the mine” that may signal further gains in interest rates.

Higher yields reflect investor concerns over “this huge overhang of federal debt which we have never seen before,” Greenspan said in an interview today on Bloomberg Television’s “Political Capital With Al Hunt.”

“I’m very much concerned about the fiscal situation,” said Greenspan, 84, who headed the central bank from 1987 to 2006. An increase in long-term interest rates “will make the housing recovery very difficult to implement and put a dampening on capital investment as well.”

And then there's this:

The first warning was in mid February, the bad news was that led by China, foreign countries dumped U.S. Treasury bills at a record rate in December. The worry was that the weak marketplace lead to a rise in interest rates to make the bills more attractive to investors. The interest rate rise which could be the beginning of an inflationary period. According to the Treasury Department foreign holdings of U.S. Treasury bills fell by a record $53 billion in December. That topped the previous record drop of $44.5 billion in April 2009.

If we're going to continue spending like crazy, we need someone to finance our debt. If foreign investors aren't going to do it, we have issues. The message is increasingly clear to those who are willing to listen: the party is pretty much over.

Unfortunately, the Obama administration and its friends on Capitol Hill aren't listening:

The trigger for last week's sell-off was poor demand at Treasury auctions, linked to the passage of the Obama health care reform. Critics say it will add $1 trillion (£670bn) to America's debt over the next decade, a claim disputed fiercely by Democrats.

And they've got the gamed CBO report to prove it! But there's even more:
Looming over everything is the worry that markets will not be able to absorb the glut of US debt as the Fed winds down its policy of bond purchases, starting with an exit from mortgage-backed securities. It currently holds a quarter of the $5 trillion of the MBS market.

The rise in US bond yields has set off mayhem in the 10-year US swaps markets. Spreads turned negative last week, touching the lowest level in 20 years. The effect was to drive credit costs for high-grade companies such as Berkshire Hathaway below that of the US government. This may have been a technical aberration.

I sure hope it's a "technical aberration." But it seems like more of a feature than a bug.

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