Bond Markets - The Fix is In?

Bonds used to be the place where your grandma put her savings. Or more usually, she'd buy an insurance plan / annuity that would do this for her at a hefty fee. Assuming she wanted higher yields then Treasuries, this might have been a good idea and worth the insurers cut. After all the bond market is an intricate labyrinth, a place easy to make mistakes and have no idea what you're doing.

Over the past few years it's gotten way more intricate, and frighteningly unstable. It's no longer the safe place it was for old folks, or anyone else for that matter.

During last years' financial crisis, bond yields would fluctuate  50- 100 basis points or more. A basis point equals 1/100 of one percent. Normal market movements before this were 5 or so basis points. As interest rates < basis points > go up, a bonds' price goes down. A one percent move up in it's interest rate, can knock 20% off the price of some bonds.

Judge by this how unstable things were in October 2008.

Well, stability has returned to the bond markets. But not from natural market forces.Central banks, and especially the US Federal Reserve, have provided that stability by purchasing bonds when nobody else would.

According to some bond traders, there's still very few that do.

Today on September 14, the 10-year T Bond once again seemed to hit a "floor" of about 3.30%. Interest rates on other Treasuries also went up, particularly 2 year notes hitting almost 1%. Volume was low.

Banks, however, seem to have loads of liquidity, and a willingness to lend to each other. Both Libor and OIS-Libor are at record lows. Also there seems to be billions of dollars that people still want to put at the short end of Treasuries as a "safe haven".

Well, you know things are bad if people regard Bernanke as a safe haven. After all, it's his Federal Reserve that has pretty much rigged the government debt market  from falling, by picking up any excess supply with  manufactured money at a computer keystroke.

This is occurring today when some money center banks are suggesting both corporate investment and junk bonds should be going up in price, aka interest spreads narrowing. That seems strange when Treasury markets appear to be choking on an excess of supply. Even more strange when junk bond defaults have risen above 10% and Standard & Poors has downgraded $3 trillion in bond debt for the year to date. < For comparison last year was about $1.8 trillion in the same period. >

In it's very recent quarterly report, the Bank for International Settlements expects yields on world government debt to climb "substantially", due mainly, in their judgement,  to profligate government borrowing. Government debt interest rates usually provide a benchmark for other interests, particularly mortgages. According to some American home builders, mortgage interest rates are still too high at over 5%. For any meaningful housing recovery, they claim, rates should be at most 4.5%. Several money center banks would also like to see mortgage rates below 4.5%. Earlier this year they evidently piled into mortgage bonds selling at these 4.5% rates. Now they are holding them with hefty losses. Jesus, when will these guys ever learn. < When the Fed stops bailing them out? >

Some bond traders think the only thing  holding up US Treasuries is the assurance that Bernanke wont let the markets fall, and that the American government will start reducing its' deficits in the near future. Heh, who in their right mind is going to believe that. < Mind you, I said believe. Not hope. Or pray? > Of course, this is all premised on a robust economic recovery that has yet to materialize. But give it time, my friend, give it time. After all they have only been promising us this for the last two years. Or is it longer?

Eventually people are going to realize there's going to be no rescue from zombie bond land. Then interest rates will start moving up, if not from inflation, then just from the  mega weight of oversupply.

When that happens, the bottom falls out of the US economy, and by chain reaction, the world economy.

"You can fool all of the people some of the time, and some of the people all of the time, but you can't fool all of the people all of the time." - Abe Lincoln