Monday, June 14, 2010

Bond Market Jenga

As any experienced corporate leader knows, assuaging an already disinterested employee with money fails to resolve their conflict, rather, it marginalizes their concerns and effectively buys them off for a while.  Interestingly, rookie corporate leadership does not recognize this and will often times pat themselves on the back for what appears to be a problem solved.  The next year, as working conditions haven't changed, the original concerns return to the table, only this time, the leadership has lost the initiative and so the individual controls the house.  At some point, again presented with the two options:  more money, or find a new guy to stomach this horse shit, leadership finally recognizes, that the "fixes" from before were actually just patches, and something must give.

The above anecdote seems especially salient during and after reading Free Markets Show U.S. Has Tamed the Bond Vigilantes on Bloomberg.  So how did the US, in its infinite wisdom, tame the vigilantes?
While investors punish European nations from Greece to Spain for deficits by pushing up bond yields, Treasury rates of all maturities have fallen to an average of about 2 percent from 2.75 percent a year ago even as the amount of marketable debt outstanding increased 20 percent to $7.96 trillion.
The market’s advocates of fiscal discipline are being placated as Bernanke keeps benchmark interest rates at a record low, allowing them to profit from the gap between short- and long-term yields with inflation at a four-decade low. Bill Gross, the manager of the world’s biggest bond fund, said as recently as March that “bonds have seen their best days.” On June 4, he called Treasuries “attractive.”
Central banks by keeping rates near zero have basically covered the bond vigilantes in duct tape,” said Edward Yardeni, who coined the term in 1983 for investors who protest inflationary monetary or fiscal policies by selling bonds and driving up government borrowing costs.
“They have stymied them from expressing their displeasure over runaway government deficits and social welfare spending,” Yardeni said. “We are not getting any votes of protest from the bond vigilantes in the U.S. because short-term rates are so low.”
U.S. debt is forecast to about 90 percent of the economy in 2020 from 53 percent currently, according to the non-partisan Congressional Budget Office. The White House budget office projects a $1.55 trillion deficit in the year ending Sept. 30, up almost 10 percent from last year’s record.
Investors are piling into U.S. government debt, supporting President Barack Obama’s recovery efforts, because they can profit from buying longer-term government debt funded by short-term loans at lower rates in carry trades. The Fed has kept its benchmark rate for overnight loans locked in a range of zero to 0.25 percent since December 2008.
To summarize with less verbosity, the US is supporting bonds by encouraging leveraged purchasing of long term debt with free money.  They compound the underlying concerns, while buying nothing but time.  Borrowing doesn't get any cheaper unless the government paid investors to borrow money to purchase long term debt, which can only mean one thing, one day the disgruntled employee is going to come looking for that raise and the leadership has to tell them that there's no more money to give.  Then what?

Please see older blog post:  On Confidence.