After a whole lot of people got caught flatfooted expecting the Fed to buy 30 Years as per Goldman's recent client recommendation, the long-end of the curve has gotten crushed, even as the belly was exploded. This is driven by the FRBNY's announcement that the bulk of purchases would be focused in the 4-10 year bucket and not further. Our take is that this is a bluff - the Fed will be forced to bid up the 10% of the marketable security portfolio that is beyond the 10 year point (as we demonstrated yesterday in the full maturity spread). As a reference we highlight the 35% SOMA limit which is most limiting to 10 Year plus issues. But for now, the Fed's attempt to bring back the bank carry trade is working, and as the table and chart below shows the yield change in the belly compared to the long end is simply stunning.
The 5s30s is at an all time record, as there is now almost no space for yield collapse to the left of the 5 year. Well, there is. But first it will make the curve flatter.
The question of how long this ploy will succeed will be answered by how long China is willing to see the trade off between its dollar indexed collapse in its holdings be offset by actual price appreciation. As recently Indirect Bidders have been most active in the 7 year and further area, China is certainly not seeing much love as a result of QE2 for now. Furthermore, very soon not even the 30 Year price rise will offset the dollar adjusted drop, especially if the dumping in the 30 Year persists. Also very soon, China, Europe and Russia will say enough, and offer a commodity backed SDR-alternative, which the regions will have an implicit understanding will be the next reserve currency. Until then, keep on frontrunning the Fed, as after that it is pretty much game over for the Chairman.
h/t John Lohman and Credit Trader