Are Bank Purchases Of 10 And 30 Year Treasuries Indicative Of Trouble?

Tyler Durden's picture

One of the notable observations in recent Treasury auctions has been the increasing participation by commercial banks in taking down 10 and 30 Year Treasury auctions - traditionally two parts on the curve banks have historically avoided like the plague. We present some observations on why this may be happening as well as some troubling conclusions, both of which indicate trouble, namely that liquidity is and has been the name of the game for the past 13 months, and that commercial banks, or presumably some of the smarter money around, are seeing economic distress ahead.

Here are the preliminary observations from Morgan Stanley, the one outlier bank which sees rates jumping to 5.5% by the end of the year, and 4.5% by the end of June (by way of context):

Historically, commercial banks tended to purchase Treasuries in the 2-5y sector, with little interest beyond that. This has been because banks are in the business of taking on risk, not parking their cash in a risk-free asset. And in a post-recession world (e.g.,
loan demand is down, net issuance of MBS is negligible), banks have tended to purchase in this sector as a way to earn net interest margin (NIM) while waiting for a recovery, with little need to take on additional interest rate risk beyond that.

However, recent auction data indicates that commercial banks – defined by the Treasury to include “…banks, savings and loan associations, credit unions, and commercial bank investment accounts” and wholly separate from broker / dealers – have, for whatever reason, started to purchase Treasuries in the back end. Beginning with the February auctions, banks bought $2.7 billion 30s, and in March auctions bought $2.6 billion 10s and $3.1 billion 30s (April allocation data is not yet available). Prior to this, banks had never bought more than $1.6 billion and $0.4 billion in the 10y and 30y auctions, respectively. We do want to stress that buying 10s and 30s is very atypical for banks and is something we do not expect to catch on going forward. Exhibit 4 demonstrates this recent trend in the auction allocations for 10s (middle) and 30s (right):

Why is this occurring? We find MS' explanations both compelling and troubling.

A number of explanations have been discussed for this latest trend, and while each topic could lend itself to a lengthy discussion, below we only briefly highlight the issues. Possible explanations, all of which indicate that the market is increasingly detached from reality - a recurring theme on Zero Hedge, include:

  1. Banks are increasingly bearish on the economy and, similar to Japan, are willing to buy longer-dated Treasuries. We point out that this conflicts with the continued improvement in bank earnings (e.g., JPM reported 1Q10 EPS of $0.74, beating the MS estimate of $0.48 and consensus of $0.65). According to our banking analyst Betsy Graseck, this is leading banks to position for a “less bad” consumer and rising rates, not falling rates.
  2. Lack of alternative securities supply leads to a purchase of Treasuries. The option-adjusted duration (OAD) of a current-coupon MBS is 6.2 years, nearly an exact match to the 6.17-year duration of the 7y Treasury. Therefore, we would have expected banks to possibly purchase 7s as a substitute for the lack of MBS supply, while the bank bid continues to be nonexistent in the 7y auctions (Exhibit 4 – Left).
  3. Deposits continue to flow in and need to be invested. The rise in deposits has to be invested – a fair point. We argue that banks are much more likely to invest in the 2-5y sector where they can still earn a high NIM. Banks might be able to forecast the level of  fed funds out a few years (and hence project their NIM), but out to 30 years? Not at all likely, in our view.
  4. Adoption of FAS 166/167 means banks are taking on low-duration card loans and could be trying to extend the duration of their securities portfolio to offset this. The need to re-extend the average duration of their assets, banks could use a barbell strategy by buying 30s. But given that their actual exposure did not change – they were always exposed to low duration loans, just previously off balance sheet – why make the cosmetic change now? In any case, this would seem to point to a one-off event.
  5. Reallocation to long duration / away from short duration is an implicit flattener hedge. A possible explanation goes back to what we know is true today: the yield curve is steep and NIM is at its all-time high. So while banks could park their cash in the traditional 2-5y sector, a few may be underweighting this sector and buying 30s instead. This functions as an implicit flattener – underweighting front end / overweighting back end – and helps hedge their reinvestment risk.
  6. Back-end swap spreads are inverted, making longer-dated Treasuriesattractive. Continued inversion of back-end swap spread – although we do not think they revert anytime – also makes back-end Treasuries more attractive to receiving swaps. This adds to the point directly above, making it more attractive to buy back-end Treasuries than receive 30y fixed.

Net, we stress that we need more data before we can conclude if this is indeed a start of a new trend or that it’s even important to the level of back-end rates. After all, 30y yields have continued to trend higher even despite these auction allocations (Exhibit 5). We also stress that the total amount of Treasury purchases by banks continues to pale in comparison to supply, and despite this recent oddity, 30y yields continue to trend upwards. Therefore, we do not anticipate changing our core call for higher rates and steeper curves based on this recent auction-allocation data.


Flatteners? Excess Liquidity? Gloomy economic outlook? The presented potential culprits are all glaring red signs that either the fundamentals are in overdrive and the market has overshot the bounceback, or that the fundamentals are completely irrelevant, as liquidity prevails, and nothing really matters, except for the actions of the Fed: a primary theme on the pages of this blog. It seems that by presenting the liquidity theme as an increasingly prevalent one to pervert economic reality, major banks such as Morgan Stanley are slowly sending a message to the Fed - yes, Ben, it is blatantly obvious that there is a bubble. Yet nothing matters until Goldman confirms this. And we know that Hatzius' golden boys don't see a rate hike until 2012. In which case the risk/return profile of an equity investment, where "regulatory" risk now prevails in the shape of what side of the bed Bernanke wakes on, is congruent to that of "investing" one's money in the craps tables at the near bankrupt MGM Mirage (which due to its massive short interest was upgraded from Buy to Conviction Buy earlier this week by Goldman). Judging by how much fun trading has become, we would recommend that everyone go to Vegas stat. At least the drinks will be comped...

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rawsienna's picture

They are selling Agency MBS against it and buying long treasuries (selling 20% risk weighting going into zero risk weighting) - mtgs are very tight to treasuries and on an after tax risk adjusted basis, treasuries much cheaper.

jm's picture

About point 6.  The big guys got their asses kicked in IRS trading at the tail end of last year.

I've wondered if those losses led to position closes. 


MsCreant's picture

What if the banks are insolvent and Ben needs the treasuries "bought" so he makes the banks "buy" them somehow? Blackmail, like, "pretend to buy these or we shut you down." Keep kiting the checks in a complicated circulatory system that keeps many balls up in the air and none landing long enough to catch an honest auditor's eye.

AccreditedEYE's picture

Indeed. any rise in rates destroys the mirage of recovery as the US/Fed created debt ponzi will implode. Trying to have cake and eat it too? It can only last for so long..

egdeh orez's picture

What if the banks are just doing this to keep the rates low, in order to appease the government / fed, so that they won't induce a stock market plunge to increase demand for their debt (i.e. flight to safety)?

Has anyone addressed the likelihood of that?

Ned Zeppelin's picture

The only source left of QE is the $1.2 trillion or so of "reserves" that were printed by the Fed and handed over to the banks. I've been waiting for this to show up. Order has been given to start using those reserves to buy Treasuries. The Fed is running out of offshore accounts to use to acquire them from the PDs with freshly printed money.  The ultimate counterfeiting operation. They can't use all of the reserves without drawing too much attention to it, so we 'll see how it unfolds. 

Implicit simplicit's picture

The banks and the fed are in an oligarchial duet. The tune is supported by various debt instruments and quant easing synthesizers. The song is complicated, fragile and dischordant because of the weakness of the sound system currency, the extended stock market musicians, and the dishonest goverment conductor. The song is actually a derivative of a real song that strikes a dischordant note to many. When will it stop? Only when the musicians refuse to play and the the indigent slaves  shout "I really don't mind if I sit this one out, because my words are but a whisper and your deafness a shout"

floydian slip's picture

I may make you feel but I can't make you think.


Great Song/Album!

Music keeps me alive.



snowball777's picture

So you ride yourselves over the fieldsand you make all your animal dealsand your wise BEN don't know how it feels to be thick as a BRIC.

lucky 81's picture

its all smoke and mirrors til when? what are they extending for? the world is broke with and money is drying up. both parties are in pocket  and obedient so mid terms don't matter to them, only the politicians. Are we headed for another planned 'great distraction'? 

maybe the new $100 bill will be the trigger for collapse and reissue. That would buy them another 3-4 months i guess. 2010 will be a year for the books.

Gromit's picture

Banks prefer to lend to Fed at 4 instead of customers at 10.

hedgeless_horseman's picture

All of this funny business in the markets should drive thoughtful investors to disintermediation:

1. In finance, withdrawal of funds from intermediary financial institutions, such as banks and savings and loan associations, in order to invest them directly.

2. Generally, removing the middleman or intermediary.

Of course, disintermediation is bad for governments selling debt and all financial firms, but often very good for small businesses needing capital. I am suprised to not read more about disintermediation here, and on similiar blogs, apart from advice to buy gold and take posession. Micro lending in your own community, angel investing, and even certain types of municipal debt offerings are good topics for consideration.

FreeStateYank's picture

I've been thinking about this very topic and wondering when people would start doing this. Difficult for traditional mortgages as deductiblity requires an annual document from an 'approved' lender. For Mom & Pop businesses, it makes perfect sense to hit up a bunch of friends and family and pay them an annual percentage. F/F who don't trust the borrower won't lend to them, reducing the risk, somewhat, of non-performing loans.

MsCreant's picture

We really are screwed. There are too many things that they are doing for the likes of a schmuckett like me to keep track of and protest. It's like they deliberately want us to fail. 


Meanwhile, if I am a business, I can see why it is easier, patriotic or not, to go elsewhere. Sickening.

FischerBlack's picture

Banks are in the business of lending money. And there's only one creditworthy borrower left who wants to lever up right now. And that's your Uncle Sam. Makes sense to me.

digilante's picture

Exactly. A Primary Dealer can borrow short term from Uncle Sam @ 0.25% and lend it back long at abt 4.63%. They can then use that TBond as collateral (96% worth) for another short term loan at 0.25%. Wash-Rinse-Repeat. Do this 5 times and you are making > 20%. Do it 10 times and you are probably close to 40% returns. Will it all come crashing down in a big festering pile someday? Quite likely. Just not tomorrow.

berlinjames02's picture

I encourage everyone to read the Economist article: "Banking on the Banks" from Oct 17th 2009.

The article doesn't provide any new information. Rather it discusses the symbiotic nature between banks and government whereby governments issue debt, and banks plow deposits into the bonds- "like two drunks leaning against each other to stay upright". It even mentions the possibility for governments to require banks holding more government bonds.

I believe this is already occurring now that the Fed has stopped purchases. The two drunks are tied together. Banks realize their loan portfolios are dependent on low interest rates. Thus, they won't shoot themselves in the foot by letting rates rise. If they need more money, Uncle Ben will print up some new, redesigned C-notes. Every one wins. (Except granny, who just filled out an application to be a greeter at Walmart. Who cares? With Obama-care, she probably won't last too long any way.)


cbaba's picture

Well the Fed and the big banks are same entities.

of course they will buy long term bonds to decrease short term rates.

see this to learn who are the owners of FED:

AccreditedEYE's picture

and who thought convergence was just for hedge funds and private equity? :)

magis00's picture

Interesting to note that "Mr. James Paul Warburg, whose family co-founded the Federal Reserve, testified before the Senate in 1950 that 'we shall have world government; the question is whether through conquest or consent.'"  Wasn't there some sort of social-political upheaval happening about then, too?  Something about red .... red states, blue states?  No, no, that wasn't it.  All feels vaguely familiar though.

bullandbearwise's picture

Classic "pushing on a string." With $4 needed to generate $1 of GDP, business is no longer worth investing in. Like parents feeding on their young, government debt just gets circulated back to hold up the government.

TimmyM's picture

If MS wanted to know why banks are buying Treasuries they should have asked some bankers. I talk to bankers so let me clue you in.

There is no loan demand. When government props up asset prices, loan customers avoid the capital formation process and do not borrow to invest above the market clearing price. Borrowers are also smart enough to see through the Keynesian folly and do not believe private traction has been achieved.

FDIC just extended the TAG (Treasury Asset Guarantee) program whereby deposit insurance on commercial accounts is unlimited. There is little incentive for commercial depositors to move to MMFs or repos in a ZIRP world. Heck, Citi is paying .65% on a presently TAG guaranteed MMA. I do believe the TAG extension caps the MMA rate at .25% in June. Also, retail customers have less faith in MMFs and still get the larger $250,000 FDIC limit. This liquidity needs to be invested.

Banks do not trust GSE paper like they used to. They are also growing weary of the deteriorating credit quality of municipal securities. They will not buy private label MBS and they believe the pricing on agency MBS remains skewed by QE and the buffer QE extension of GSE balance sheet caps being lifted.

Treasuries do not impact capital ratios with their 0% risk weighting. Capital ratios are important when you float along in FASB 157 wonderland. They are liquid, they are repoable and pledgeable to public deposits. But most importantly no CYA banker bureaucrat ever got fired for buying Treasuries.



Paladin en passant's picture

Thanks for some bits of real information.

Augustus's picture


Something other than a numb nuts conspiracy theory generated by rage music is very nice to read.

MsCreant's picture

Do you honestly believe the banking system is solvent? If you don't, then how is it being propped up? Careful. Any answer to that question takes you into conspiracy land. If you think everything is just fine, sorry to bother you.

TimmyM's picture

Only idealistically is bank solvency as simple as assets minus liabilities. In practice, solvency is a matter of appearance and liquidity. Even a bank that arguably has some decent capital can be insolvent practically if it is viewed as insolvent.

The guise of solvency is in of itself solvency. Bank solvency is akin to declaring the mystery of faith at mass. Institutional forces promoting stability will support the scam of solvency to its own end.

The most important question to me is what are the unintended consequences of propping up excess lending capacity in the name of promoting the appearance of solvency? Excess lending capacity compresses margins for the responsible operators and socializes the losses of the bad operators across the industry. Coupled with TBTF a system exists that promotes consolidation into large poorly managed banks. But it also inefficiently creates too much credit and makes borrowers operate with more than optimal leverage and with artificially high priced assets.

MsCreant's picture

Solvency is subjective, to a point. There is a point where the story won't wash anymore. Contracts, margin calls, are kickable, obdurate, realities. Just ask Greece. I agree with the spirit of your post and find myself stunned daily that things keep going on as they did the day before. The players got the mark to market rules suspended. That seemed to help tremendously with the solvency story line (appearances, as you say). But there is a point where the numbers don't work any more. The last paragraph of your post is about this idea. Getting the rules changed like that is a demonstration of the conspiracy of which I speak. Haphazard, perhaps, a bunch of lobbyists that meet at a congress critter's office and discover they have the same interests, by accident, and decide to team up, or somehting more sinister.

The point I am trying to make is "Yes, solvency is a social construction, until it isn't." The "propping up" has consequences in the real world that cascade through the sytem and trickle down into the living rooms of individual lives. Losing your job, going on foodstamps, getting displaced from your home, this is real.

Takingbets's picture

I second that thank you for posting this real time info. :-)

pooplagrande's picture


US Gov "We'll print a bunch of cash and give it to you for buy up a bunch of our debt to keep rates low and make everything look okay...take the leftovers and pump up every asset to the moon. Now don't say a thing about it and we'll all ride this bitch on outta here...otherwise, we'll both be fucked...thanks!"


Benthamite's picture

Who cares?  Dow 3.6E10!!!!!!!!!!!!!

Mark Beck's picture

"and nothing really matters, except for the actions of the Fed"

The actions of the FED are the recovery. Without the FED you have no way to pay for stimulus, or bailouts or entitlements. At this time our central bank exists for one reason only, fund government through QE.


Why would anyone buy a 10 Year Bond from the US? To move capital into long term sovereign debt at this time has got to be blind to current events.

The US does not have the investment in place to produce the amount of growth needed to dig out of our debt hole. The magnitude of waste and spending has impoverished the nation. Growth through real labor is finite, and in the end, the states will need every penny.


At this time, the effects of government inefficiencies, both fiscally and monetarily, when compared to the capacity of costs on labor, cannot generate a net gain. For debtor nation like the US, you cannot be irresponsible in the use of capital. Ultimately, you are not in control of your own fate, unless your plan is to default.

All that has to happen is the appetite for sovereign debt to wane and the FED would be forced to monetize our debt in order to fund government. The problem is one of market capacity, and not one of rates. Who are they, to think that there will always be buyers of US debt in the magnitudes needed for the next 10 months, let alone 10 years?


Investment in debt fundementally requires trust. The trust is all but ended for the current administration, our banking system and the FED. 

Mark Beck

Augustus's picture

+ + + + +


What is comming is a new version of Trust.

You will be able to Trust that the IRS will be there to confiscate everything.

whatsinaname's picture

I have as little reason to believe MS as I have to believe GS. I am trading TBt & TLT and its risk free (tongue in cheek).

whatsinaname's picture

and sometimes TBF as well.

Attitude_Check's picture

Perfectly reasonable investment -- if you think large-scale deflation is coming in the next 5 years or so.  Then any other loan will generally fail, assets will be worth MUCH LESS, and the assumption is the Government will honor their bonds at face.  Of course that past assumption may not be so good -- but maybe it's the best of what is available.

Ned Zeppelin's picture

I hear that theory and get it, but how would the government pay the coupons with a severely depressed tax base? I think deflation spells trouble for the government more than anything else.

floydian slip's picture
This is Important ... By: Marty Chenard | Thu, Apr 22, 2010

If is wasn't so important, I wouldn't mention it a second time. But it is very important, and could be a "game changer" if we break above this long term resistance in the next few weeks ... so, please keep an eye on it.

What is it?

It is the 30 year bond yields ... symbol: TYX. Our comments are below ...Bernanke and everyone in the White House will try to stop this from happening. If they can't, there will be real trouble ahead for the economy. Right now, the 30 year yields are at a MAJOR, 15 year testing 

Below is an updated chart (as of 8:40 AM this morning) showing a 17 year down trend on 30 year bond yields. Its resistance line has had 7 touch points.

We are now at number 7, and international investors want to be paid higher interest for what they perceive to be an environment with much higher risks. That pressure makes this current test a MAJOR testing point.

Bernanke is sweating right now, because if he can't be successful at keeping interest rates down, the housing market will take another turn for the worse and foreclosures will keep rising. (Bernanke is trying to be very proactive in driving rates down right now. There is a lot of international pressure for higher rates coming in, so it will not be as easy as he thinks.)

If we break above the resistance line shown, we can expect interest rates to rise to a level that would increase monthly mortgage costs by 20% to 25% this year.

This could be one of the most significant events seen during the past few years.

Kina's picture

Ben may well have gotten better results actually using a helicopter raining cash down on the consumers. Still would have found its way to the banks one way or another, trickle up.

Chartist's picture

I believe it is absolutely indicative of trouble ahead....The consumer is still deleveraging, Europe seems to be coming apart from the seams and China has a realestate bubble on its hands.....HMOs seem to be indicating that the worst of reform, for them, is still coming and GS seems to be on the precipice of a meltdown towards $40, by my estimation.....SPX 525 remains my two-year target.