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Does Expiration Of Liquidity Facilities Mean A Steeper Curve?
As the Fed is ever-so-gradually shifting toward a tightening posture, many have wondered what will Bernanke's actions mean for the bond curve. With various liquidity facilities set to expire this month, and the recent discount rate hike already having been priced in, there has so far not been a muted response by the bond market, although over the past few days we have seen an odd tendency, albeit minor, for curve tightening. We say odd, because as Morgan Stanley points out, the Fed's actions, coupled with an unwillingness to actually hike rates, should be one benefiting ongoing steepening. Then again, the problem with that logic is that at this point going steep is like buying Greek CDS today: it pretty much means sloppy hundreds, with very few greater fools left over (and without the opportunity to arb a naked-short position via another nearly busted GGB auction). The silver lining is that at least the government will not go after you with an arrest warrant: after all the government wants nothing else more than a vertical yield curve. A brief analysis by MS details the argument for why steepening makes all the sense in the current environment where the long-end is looking increasingly shaky courtesy of marginal liquidity contraction, all the while risk-flaring episodes such as those in Dubai and Greece will likely keep the short-end well bid for months, if not years, to come.
The end of easing, bizarrely, may keep front-end rates low. The disruptive impact that the expiration of liquidity facilities globally brings to the market will continue for the time being. In Exhibit 2, a graphic we’ve shown before, the inner counter-clockwise cycle represents a model of deleveraging as central banks were hiking rates during 2004-06 to remove liquidity and promote orderly deleveraging. The outer clockwise rotating cycle that started in late 2007 illustrates the addition of liquidity as a counter force to what became a rapid and disorderly period of deleveraging that culminated in the subprime crisis.
But can the market sustain itself without public-sector help? It may be too close to call, and this is why central banks may be reluctant to hike rates and could end up keeping them lower for longer. We expect to see periods of stress in the market that will keep central bankers from meaningfully hiking rates. Yesterday it was Dubai, today it is Greece, and tomorrow it may be some place else. As we see it, the market is far from being stable enough to bear a meaningful withdrawal of liquidity in the form of rate hikes from central banks. However, we do expect that liquidity facilities will expire – and since those facilities supported longer-term assets, we see this as akin to central banks hiking from the back-end first. Put this all together, and we see steeper curves and higher rates. Namely, we like owning front-end forward rates and being short back-end forwards against it. Bizarrely, the end of easing may keep front-end rates lower for longer.
While the logic is sound, the one thing about this market is that it hates logic. And the other thing is that no matter how convincing the argument, absent material marginal buyers, the trade will fizzle. We merely need to look at China's recent UST purchasing patterns, whose recent lack of desire to roll Bills (in essence offloading short-dated paper) is likely a greater concern to the trading community than the Fed's end of MBS purchasing (it is one thing to no longer "buy", at least overtly, it is something very different to sell). Yet the biggest risk, in our view, is that just as everyone was putting the steepener trade on at about the same time as accounts were buying sovereign CDS, not in January, but in August of last year, so now the more prudent money-managers are unwinding and possibly entering duration-neutral flattening positions. Yet, if sovereign CDS trading is experiencing unprecedented witch hunts, wait until the 3-second political attention span turns to those unpatriotic hedge funds who dare to put flatteners on. In a normal world, we would laught this caution off. Alas, we live in a world that is anything but.
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Somehow, I think the helicopter will not be retired in the near term.
It will be refueled without landing until it becomes the most expensive lawn mower ever.
lol iol lol
Most amusing comment award
it is quite clear that the bond market will not tolerate any upside view of economic numbers, namely the "view" that UE may be falling. What it also means is the FED is trapped in lower rate mode becasue any sign of "real" strength the BV's (bond vigilantes) will attack viciously. So, we in for an unjustified "extended" loose monetary policy which leads to more likely "Stagflation" which nobody seems to want to talk about.
...after all the government wants nothing else more than a vertical yield curve.
er, don't you mean gubbermint sachs? The gubmint has the brain of a twatisaurus rex.
They will just dream up more shit to piss away taxpayer money and spike commodities around the world.
After they have destroyed the ecomony with $4.00/gallon gas, oppressive tax rates will take over to finish off whatever consumers have left in their pockets.
...sweet
IT WON'T MEAN SHIT
THEY WILL NOT STOP MANIPULATING EVERYTHING
THEY WILL NOT STOP MANIPULATING EVERYTHING
THEY WILL NOT STOP MANIPULATING EVERYTHING
THEY WILL NOT STOP MANIPULATING EVERYTHING
If short rates are expected to stay low for quite awhile due to uncertainty related buying then folks might as well buy longer dated bonds and hold to maturity to get some yield rather than endlessly turning over short term paper.
The idea that trillions will sit in bank accounts and money market funds earning zero interest due to a lack of economic activity driving a demand for this cash while long interest rates continue higher due to concerns about inflation getting out of hand seems a bit of a contradiction.
You got it, progressive deleveraging and deflation of real estate and continuing erosion of "common"-wealth and rising commodity prices.
http://www.youtube.com/watch?v=q5ZQH2Uzpew&feature=related
3:34
"When a larger predator accidentally bumps the Vampire Squid, it releases a cloud of confusing flash orders, and then swims away"
Not only would the long end be increasingly 'shaky' due to liquidity contraction, but also because--so far as I am led to understand--the U.S. Department of Treasury intends to roll duration towards the longer end.
But, should liquidity contraction proceed as implied by this research, we should see the short end yield creep moderately higher as well, as the value of cash would increase in value. However, we would expect the upward rate of change of yield to be higher at the long end.
A feign towards inflation, then yet another debt crisis blow bang.
Leadership. Morals. What's my cut?
short end up, long end flat or lower. because this should drop the markets keeping interest rates down. In fact the fed is causing the interest rate rise because so much money is going into commodities.
we are just ab out another market peak, but 30 year treasuries aren't
These guys are smoking crack.. The recent normalization of liquidity conditions should only affect the short end of the curve and result in mild flattening. Long-dated forward are already looking pretty high and deflationary risks are still very much with us.
The myth of China not buying Treasurys is absurd: firstly a number of researchers pointed that SAFE has been buying Treasurys through London and Hong Kong and those purchases didn't show up under China header. And lastly, the fact thatthey havent rolled their bills is probably bullish for the long end - supply of bills dried up and the curve has steepened - so I won't be surprised if they were setting up to extend out the curve. The strength of last week's auctions would clearly support that hypothesis
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