Self Fulfilling Prophecy: The Bond Trade

asiablues's picture

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sbenard's picture

Good and insightful article. I think he's right here.

However, I want to correct something. Commodity prices are not universally falling as was implied. I trade commodities for a living, and it is true that some are falling. However, many, perhaps most, are rising. Most commodity indexes are heavily weighted toward energy, and especially crude oil (some are weighted 80% toward crude), so they appear to be falling despite that many components of the indexes are rising.

Falling: natural gas, cocoa, orange juice, crude oil

Rising: corn, soybeans, wheat, oats, rice, coffee, sugar, cotton, cattle, hogs (some are near their highs of the year)

Do we really want to stimulate commodity prices MORE, when so many are rising and near their highs?

mephisto's picture

I've said this before on ZH but it bears repeating. Bubbles are always parabolic, always super-exponential.

Ie the growth rate increases in time as you approach the critical point. If you see a linear chart, like the one above a lot of other bond price charts are, thats unlikely to be a bubble with a sharp pop at the end. (Bund, Gilt charts are similar).

Personally I'm trading the trend, buying and,yes, selling bond futures. It has worked well for months. Because of the linear charts, I'm not worried by the chance of a bond collapse. There is no bubble, just strong demand.

A Proud Canadian's picture

Wouldn't another difference be that bubbles have no restrictions on ceiling...just need a fresh supply of Greater Fools to keep growing?  Bonds have a "top" dictated by the price which pays zero interest.  We had negative rates in very short term bonds recently but, for people to crowd into buying zero coupon 10 years or even tipping them over to negative would certainly be a distinct psychological marker if not ceiling.

Azannoth's picture

They should(maybe they will) pass a law requiring every1 to take out an 100k loan, they did it with health insurance why not with loans ;-P

Azannoth's picture

Oh wait, by running 1.5 'Trillion deficits they are already doing this! And they get to spend the money too?!


Wow I did not fully appreciate the insidious genious of the politicians

boeing747's picture

Looks like Ben is repeating the same mistake of 1st Great Depression: removing liquidity from market. Most of money included those he printed end up in T-bills, stockes and houses, oh some of money are under cement pavement near 'Put America to work' sign. Real economy is drying up.

Tic tock's picture

My take on the situation is that equities and commodities are hiving off from threat of hyperinflation, but there is a lot of speculative capital that is undecided, which is in Bonds. In that respect, the Fed and various other central banks, have displayed a willingness to preserve some stability. we have to see if prices can adjust to clear the market..that means, what are those low-latency AIs' going to do next? 

Assetman's picture

The author does a pretty good job in linking the trend trade, but really misses two important points:

(1) the Fed WANTS a trend trade to develop in Treasuries.  If Turbo Timmy is pleading for low coupon and long duration so he can raise his $ trillions for the tar pit, you find creative way to do so.  Of course, the blatant front running that came in conjunction with the QE-Lite announcement wasn't necessarily "creative".

(2) it's just as important to remember that the Fed facilitated the trend trade in the equity markets as well.  The author conveniently forgets the myserious runs toward the close or the weekend ES futures lovefest that happened for well over a year.

So what are we left with?  In the equity markets, the silly incentives to spark a trend trade worked pretty well in conjunction with fiscal stimulus.  But the manipulation ended up strengthing the hand of HFT's-- at the expense of fundamental investors.  Somehow, the PhD's conveniently forgot that fundamentals mattered.  Well, now that they've stalled for many companies, they do.  Why in the HELL would fundamental investors get back in after losing in a stacked casino?

As for the bond market, the deeper that the Fed gets into QE and balance sheet expansion-- the tougher it will be to dig themselves out of the situation.  Perhaps the one thing they think they have left at their disposal is the opportunity to dump their (and their banking buddies) purchased Treasuries on the world when the global equity markets go into a tailspin.

For now, the Fed is creating plenty of demand, and the unstable economies in Japan, the UK, and the PIIGS are providing ample sources for continued safety trades.  A massive QE2 action could come before an equity adjustment in an attempt to rise all risk assets... but why do so if cash flows are collapsing?  The QE would need to be targeted at increasing corporate cash flows, unless they want HFT to be 100% of the market.

merehuman's picture

funny thing if electricity should fail or  a breakdown would cause the printing machine to fail..woophsy. What economy

AUD's picture

As long as central banks both purchase outright & repo 'governments' in preference to anything else the trend will continue... until it doesn't.

At some point gold will move into backwardation, then it's really over.

Fishhawk's picture

The Fed is having to print over half the government's budget this year and from now on until the collapse.  Rising interest rates would signal that inflation is coming, and would increase the cost of servicing the debt to an untenable level, thus requiring even more printing, etc, which quickly blows up into a Zimbabwe type hyperinflation.  Thus any unintended side effects (collateral damage) is irrelevant; if the interest rates start to rise, the wheels come off and the whole Ponzi collapses.  This is the corner that the Fed has painted itself into.  Chu is being entirely too kind in assuming that the Fed even contemplates the consequences of its actions, since it doesn't actually have any choices left.

Mercury's picture

The counterproductive-ness of the trend trade isn't nearly as bad as what will happen when managers want out of the trend trade.  And The Fed probably won't be able to finesse how orderly or quickly that trade unwinds.

fxrxexexdxoxmx's picture

How come everyone wants to blame the FED? They are there to help and protect us. They only desire to create a fair and safe environment for the citizens to pursue all the freedoms our capitalist economy provides. The FED loves you. The FED needs YOU. Without the FED there is no real YOU.

Nevermind's picture

The law of unintended consequences: The Emperor Bernanke keeps interest income at zero and therefore MANY consumers have yet another reason NOT to consume, because they want to preserve principal. 

Mitchman's picture

I don't think it is as easy as it looks.  People will not return to risk assets like equities until they are assured that equities are not the rigged game that they are.  With HFT accounting for at least 70% of trading, the explanation of the huge retail outflows out of equity funds is not rocket science.  The whole theory of the FED "forcing" people into risk assets has been a miserable failure thus far and, as bond prices show, has been a total disaster.

Any attempt by the FED to stop the secular trends in the economy and in society are dommed to the same outcome as King Canute's efforts to stem the tide.

Robslob's picture

Oh yeah...another thing that would make people want to take on risk is actually having a JOB so they might have extra money to spend that of course wasn't governement money stolen from those who are already working would help...then there is the economy...

masterinchancery's picture

Reality is even simpler: the Fed needs to go away and not come back.

Market Analyst's picture

I wish somebody would send this piece to the fed, and have them read this article.

Nolsgrad's picture

interesting, what if we get stuck here at super low yields though?