Bond

Today, “bond funds” ranked with “Miss Universe” and “Lindsey Lohan” among Yahoo’s top ten search terms. Outflows from equity mutual funds over the last two years totaled $232 billion, while inflows into bond funds soared to a staggering $559 billion. The last time yields were this low in 1955, ten year bonds brought in an annual return of only 1.9% for the following decade. Are the Chinese calling the top in the market? (TBT), (TMV), (TIPS)

While there is nothing to suggest a fundamental improvement in the economy, and judging by the latest batch of data the economy is in fact continuing to deteriorate, we have so far seen a substantial sell off in bonds across the curve, with the 2s10s steepening by 11 bps (just in time for the bull flattener bandwagon to enjoy some out-of-steepener rotation pain). So what is the catalyst for the selloff? Francesco Garzarelli's note to Goldman clients titled "Forecast Reached, Risks Now Balanced", in which he implicitly advises to take profits on USTs, sent earlier may provide some clues...

Faber and Schiff on CNBC talked aobut the U.S. Treasury bubble trouble

The 10 year T-Note is currently yielding 2.5%, and the fed`s latest quantitative easing initiative is becoming counterproductive to their stated purpose of trying to stimulate the economy by encouraging more risk taking. The issue is that Mr. Ben Bernanke and the Fed governors although great academicians have failed to take account for how traders and financial markets impact and take advantage of Fed policy.

The debate over whether bonds are in a bubble is very much the topic du jour, and while some deflationists like David Rosenberg believe that not only is there no bubble, but the 10 year will soon slide inside of its all time tights at under 2.1%, others believe the 30 years bull run in Treasuries is the dumbest thing since the dot com bubble, and that if anyone is hoping to make money, it should be on the countertrend. Two such Treasury bears are Marc Faber and Peter Schiff, both of whom were on CNBC tonight, and both were dissecting what in their view is the fallacy of the long-UST trade. As for the Faber-Schiff view, no surprise: Peter encapsulates it best: "the bond market is the mother of all bubbles right now, and when it bursts the losses will dwarf the combined losses of the stock market bubble and the real estate bubble. There is no way for the government to pay this money back." And echoing a topic Zero Hedge has been warning on extensively, namely the maturity of trillions in short-term debt that rolls every month, Schiff notes: "I am afraid is that when people realize we can't pay this money back, we aren't going to be able to roll over all this short-term debt. And so it's not just paying the interest, we are going to have to retire the principal." Peter Schiff is correct that inflating our way out of this debt bubble is a lose-lose proposition. Schiff also notes the stupidity of crowds, by highlighting that 10 years ago everyone was chasing risk, by piling into stock market funds, followed by everyone knows what. The outcome for bond investors is clear: "this decade is going to be the worst decade for bonds in US history. Bond holders are going to get wiped out. Either the government is going to default, or it is going to inflate, but either way the people holding the bonds, are holding the bag."

Need a 100 year inflation outlook? The market has spoken, and courtesy of the liquidity glut, it appears the outlook a century down the line, is for a 5.95% inflation give or take (yes, yes, we know this is not scientific: we are hoping the soon to be released 100 Year swap spreads will give a better read). One wonders what happens to this yield if the Fed's trillions in free money sloshing around the markets are eliminated.

Full pricing grid, courtesy of sole manager (and recent deflationist) Goldman Sachs:

Norfolk Southern Corp "NSC" Baa1/BBB+/BBB+ (s/s/s) upsized USD250m (up from $100m) 100y reopening of 6.00% March 2105 sr fixed rate notes launched at 5.95%. GS (sole books). Co-mgrs: Barclays.  UOP: GCP. Pricing today.   Original USD300m issue priced March 7 2005 (6.00% at 100).

As more and more pundits, and amateurs, debate the endless futility of the bond bubble, as in does one exist or are nominal rates, in addition to swap spreads, going negative, the one real asset - gold - is surging to highs last seen in early July. Of course the bond debate is silly: it merely indicates a flight to safety in a time when stocks continue to live in a fantasy neverland of "timid" inflation, when the reality is accelerating deflation for levered goods, and rising inflation for goods "for the rest of us." As for those who never see a bond auction failure (and no, explaining the dynamics of a ponzi dutch auction is neither necessary nor sufficient), they will be absolutely correct- until they are wrong. And since we have gotten to a quantized state where even a rise in rates (due to the Fed's stance on liquidity) is virtually equivalent to a failed auction, the distance from the base orbital to the energized level, to keep the quantum analogy, is far closer than most believe. But such is the way in a ponzi non-gold standard system, in which endless credit is chasing extremely finite cash flows. Ssince we have now moved past the point where incremental debt creation can fund viable, cash flow generating assets, any incremental debt serves no role save for window dressing. Whether or not there is a formal announcement by the UST of a failed auction is irrelevant. In the meantime, gold is brushing all these pointless discussions aside and doing its thing. However, gold likes to keep it complicated, and has once again inverted its 120 day correlation with stocks, hitting the lowest level since March 2009. In other words, if stocks are correlation to inflation, gold is now a deflation benefiting asset. Which is also wrong, as gold merely is seen increasingly as an alternative to the great alchemy experiment in the bottom of the 9th being conducted by the Central Banks of the world, which is the last hope to preserve the status quo. In other words, gold is merely the hedge to whether either side in the bond bubble debate is right.

Is the Mother of all bubbles about to pop?

Irish CDS, which recently was trading wide of 300, tightened materially after the country, most likely with a very direct ECB intervention, managed to place two €0.75 billion auctions, the first a 4% due 1/15/2014, and the second: 5% due 10/18/2020. The Bid To Cover on the first was 5.4, compared to a BTC of 3.1 at the last auction held in May, explained simply by the surge in the rate from 3.11% to 3.627%. The 2020, however, saw the BTC drop from 3.0 to 2.4 as the yield dropped from 5.537% to 5.386%. In other words, the ECB overbid for the near maturity, and likely just put in for a token amount. And for some odd reason, CDS traders see this latest central bank intervention to extend and pretend as a favorable development, and have decided to run away from Irish risk for the time being. The question of how long the ECB can continue this charade is relevant: after all the Fed has just one country to deal with. And continuing with Ireland, the country's central bank stated that the net cost of Anglo-Irish to the government may be €22-25 billion, even as it cleared up hypocritically that capital raising via taxing banks' excessive reliance on short-term borrowings would be preferable. Of course, the central bank should keep its mouth shut, and be happy that the ECB will continue to support any part of the curve, as in its absence the country would be long insolvent.

The surge in the 10 Year has just gone full retard. In the meantime, behind the scenes of Wall Street's rates desks there are some serious Tijuana donkey shows going on.

Today's Treasury International Capital data had some unpleasant disclosures about the flow and size of international capital flows. The gross headline number of inflows was as expected higher, coming in at $44.4 billion, consisting of $33.9 billion in net foreign purchases of long-term securities ($16.6 billion purchases by private investors and 17.3 billion by official institutions), as well as $10.4 billion in sales of foreign securities by US individuals. This brought total foreign holdings of US securities to just over $4 trillion for the first time ever, or $4,009 billion. So far so good, however looking at the composition of purchases, it appears that foreigners were frontrunning the Fed already in June - they bought $33.3 billion in LT Treasuries, and $18.2 billion in agencies, precisely the categories that the Fed would be monetizing, even as they sold $13.5 billion in corporate bonds (the highest amount since January 2010), and $4.1 billion in corporate stocks, the most since July 2008. What are foreigners seeing that all the mutual funds are also seeing (with 14 straight outflows from domestic equity funds), yet the HFT, Primary Dealer group is so stubbornly ignoring? Most importantly: Chinese Treasury holdings dropped to a 1 year+ low of $843.7 billion, following reductions in both long-term and short-term treasurys. China now has almost $100 billion less in USTs compared to the peak of $940 billion in July 2009. One wonders what China is buying with the sale/maturity proceeds.

Kurt Brouwer highlights something that may substantiate the claims of those who claim there is a treasury bubble in the forming. Using the suddenly all too popular ICI data (which we have been presenting for well over a year), JPMorgan has tallied the total flows into stocks in advance of the tech bubble (April 1998 through March 2000) and compared it to the period since the Lehman collapse (July 2008 through June 2010), the result is surprising: there has been over $50 billion more allocated to bonds in the past 2 year period ($476 billion), than to stocks in advance of the biggest market bubble pop before the housing/credit bubble popped in 2007/8. Is this indicative of anything more than just everyone going on the same side of the trade? Not at all, however even that in itself should be sufficient for bond bulls to reconsider pushing every last cent of capital into what at least on the surface has all the makings of a an even bigger bubble than tech stocks in 2000.

Just in case there was any confusion which way SocGen's Albert Edwards may be leaning after the recent however many percent rally in the AUDJPY, sometimes known affectionately as stocks, it is hereby resolved: "My views on the outlook could not be clearer. They may be wrong, but at least they are clear. We still call for sub-2% 10y bond yields and equities below March 2009 lows." In other words, according to AE the market is well over 50% overvalued.

Even as stocks continue pricing in QE2 (presumably some time in the next 2 years), bonds keep on laughing. The $38 billion in 2 Year Bonds just auctioned off at a 0.665% high yield, the lowest yield for a 2 Year primary issue. The bid to cover came in at 3.33, compared to 3.45 previously, and 3.15 average. Indirect participation plunged to 32.8%,compared to 41.41% previously. As the directs took down "just" 13.5%, the Primary Dealers ended up taking down a majority of the $38 billion bond auction, or 53.7%. The recycling of cheap Fed money has now fully arrived, and with an Discount Window to 2 year arb of 0.4% (0.66% - 0.25%), it shows just how bad things must be for the PDs.

With global economic activity picking up steam, and global equity markets humming along, the only question I have is how long before we see a significant backup in global bond yields? More importantly, are pensions and other institutional investors prepared for a big bond hiccup? We'll find out soon enough.