Mea Culpa: The Fed is not going to buy treasuries
Judging from recent events, the bond vigilantes are right to suspect that Ben Bernanke is all talk and no action when it comes to keeping long-term rates low. If you recall, I had actually believed the Fed would support bonds because it was concerned about long-term interest rates. This is part of the reason I believed that Treasuries would rise despite being in bubble territory but it looks unlikely.
The Federal Reserve is looking increasingly unlikely to purchase long-term U.S. Treasury securities any time soon, as the central bank gears up to launch a different program aimed at jumpstarting the market for consumer loans.
Federal Reserve Chairman Ben Bernanke raised the idea of purchasing Treasury bonds in November and the Fed has tipped its hand to the possibility of such purchases in its last two policy statements.
Such a move could help to bring down long-term interest rates, something that could indirectly help consumers and businesses since many loans are benchmarked to Treasury yields.
But Mr. Bernanke notably left the idea out of his testimony to the House Banking Committee Tuesday.
Fed officials could be preoccupied by a new program aimed at jumpstarting consumer loan markets, an effort being coordinated with the Treasury Department. That program represents an enormous commitment by the Fed. The Term Asset-backed Securities Loan Facility, which will help finance asset backed securities tied to consumer loans, could result in as much as $1 trillion in new Fed loans, a huge expansion in its balance sheet.
Now, if the U.S. federal government massively increases spending and the Feral Reserve does not buy long-dated treasuries, that is bearish for bonds. Buying junk assets like asset backed-securities will artificially prop up their prices by lowering their spread to treasuries but will have zero impact on the steepness of the yield curve.
Bernanke had warned that he was NOT repeating the Japanese experiment of quantitative easing when he spoke at the LSE (London School of Economics) in January. He said the Fed was focusing on the asset side of the balance sheet – what I would call qualitative easing (see my post from Jan. 13th on this).
The evidence is piling up that Bernanke is not going to buy Treasuries. I’ll leave it to Ambrose Evans-Pritchard to tell us what this means:
The yield on 10-year US Treasury bonds – the world’s benchmark cost of capital – has jumped from 2pc to 3pc since Christmas despite efforts to talk the rate down.
This level will asphyxiate the US economy if allowed to persist, as Fed chair Ben Bernanke must know. The US is already in deflation. Core prices – stripping out energy – fell at an annual rate of 2pc in the fourth quarter. Wages are following. IBM, Chrysler, General Motors, and YRC, have all begun to cut pay.
The “real” cost of capital is rising as the slump deepens. This is textbook debt deflation. It was not supposed to happen. The Bernanke doctrine assumes that the Fed can bring down the whole structure of interest costs, first by slashing the Fed Funds rate to zero, and then by making a “credible threat” to buy Treasuries outright with printed money.
Mr Bernanke has been repeating this threat since early December. But talk is cheap. As the Fed hesitates, real yields climb ever higher. Plainly, the markets do not regard Fed rhetoric as “credible” at all.
Shorting Treasuries was a lot better bet than I had anticipated.
PS. – Bill Gross is all over this one.
Fed Looking Unlikely to Buy Treasurys – Real-Time Economics, WSJ
Bond market calls Fed’s bluff as global economy falls apart – Ambrose Evans-Pritchard, Telegraph
Gross Bought Mortgages, Sold U.S. Debt Last Month – Bloomberg.com
Real Treasury Yields Moving Lower – EconomPic Data