Bond Market Lunacy - Yields Lower With 4.3% Unemployment Rate Than When 10% - by Michael Carino, Greenwich Endeavors

Get out the strait jackets and dole them out to all bond managers justifying today’s levels of yields. Yields are lower than at the depths of the great recession with a 10% unemployment rate.  Any bond manager trying to justify the levels of rates today should be fired.  The employment market is healthy and tight, GDP is above the long run average and inflation is right on target with the headline numbers running above target.  The only justification for investing in bonds at these eye popping levels should be due to poorly thought out mandates requiring such insane investing. 

Employment grew at a healthy clip of 138k which is enough to keep the unemployment rate ticking down.  The unemployment rate just hit a new low of 4.3%!  Yet the bond market rallied and rates dropped more than when most employment numbers come out with a minus sign in front of it.

The Fed’s decade long campaign to manipulate rates to dangerously low levels has created a casino like environment in US Treasury Market.  The problem is there are 4 or 5 casinos and no gamblers sitting at the tables any more.  When you add up the daily trading volume of cash and futures Treasury trading, the daily volume reaches 1 trillion.  There are 14 trillion Treasuries issued.  Half are owned by foreigners and 4 Trillion by the Fed.  This leaves 3 Trillion in the hands of the rest of us.  And 1/3 of this value turns over daily.  This is such a manipulated and nationally dangerous position; the industry needs to be corrected.  But as is typical, it will take an unfortunate financial catastrophe before this gets looked into. And even then, the conclusions will miss the point on purpose.

Why is it that such a glaring problem of manipulation in the Treasury market goes uncorrected?  The answer lies in nothing more than greed.  Since the manipulation is in the direction of the market being overpriced to low yields, investors are losing trillions in interest but the government benefits with hundreds of billions saved in interest payments.  These hundreds of billions saved acts as a huge incentive to turn a blind eye to the manipulation taking place.  It also acts as an incentive to never correctly place blame on the parties doing the manipulation.  Rather the subterfuge of placing blame on the wrong parties ensures this practice will continue in the future.

Manipulation in Treasuries is a paramount problem but not because of the losses that occur in the Treasury market during the normalization from positions unwinding with a parabolic move higher in yields.  Yes, bond market losses could be in the Trillions if rates normalized.  But more catastrophic is that HUNDREDS of TRILLIONS of bonds across the globe use the Treasury market as a benchmark to set yields and prices.  These hundreds of trillions of bonds are grossly mispriced due to the manipulation taking place in the Treasury market.

My last article invoked a reader to comment that the Treasury market was not manipulated, rather price discovery sets yields.  Unfortunately, this individual does not understand who is trading the Treasury market in such a high volume that 1 Trillion trades daily.  How can 1 trillion trade with such limited available float, and still there is limited volatility?   Worse, out of the 1 trillion that trades daily, 80% of those trades done by 4 or 5 firms.  And limited volatility?  Are they trading amongst each other?  More likely, are they trading with themselves, creating the volume and setting prices where they see fit?  Price discovery is when a market place of buyers and sellers come together and collectively set prices from non-collusive trading.  When 4 or 5 participants represent the reflective thought process on value in the bond market, this is by far anything than a market place setting prices.  It is a consortium - monopolistic or oligopolistic at best - that controls a market place.  How can so few parties have such a controlling function on hundreds of Trillions in global bonds?  Hundreds of Trillions – let that sink in – by very few???

If anyone cared to correct this, it’s easy.  Make it mandatory for participants that are 5 or 10% of the daily volume to make their trading public?  Make the most liquid and supposedly safest market in the world transparent.  Sound crazy?  It’s easy.  But it would bring to a crashing halt the daily manipulation. The end result would be a normalization of yields where true investors that care to hold bonds over the long term set prices that reflect adequate compensation for the embedded risks.  But higher interest rates mean higher expense for the government and less cash going to partisan projects.  Such a conflict of interest assures a blind eye will be turned and incorrect excuses made when the bond market melts down.  

The melt down will come.  As the Fed continues to raise rates making cash such a comparable yield without the risks, slowly investors will leave the bond market. The Fed will be winding down their holdings and more supply from the government issuance will be forthcoming.  All it takes is one of the bond manipulating consortium participants to take a step back and the resulting volatility will put an end to these practices.  Unfortunately, it will be with painful results for the bond market.

My goal is to make sure that those who want to understand the dynamics in the bond market do so without blinders on.  I know when the next bond market debacle hits, excuses will be plenty.  But the seeds of these bond market crises are definitely sowed in the Treasury market.  Watching a manipulated Treasury market rally back to yields below that of the financial crisis after a healthy employment number makes me want to shout out warning alarms to the world just like I did in 2007.  I just hope more than a couple are listening this time.

by Michael Carino, 6/4/17

Michael Carino is the CEO of Greenwich Endeavors, a financial service firm, and has been a fund manager and owner for more than 20 years.  He has positions that benefit from a normalized bond market and higher yields.  Do you?