« BACK  |  PRINT

RS

FRONT PAGE CONTRIBUTOR

Bond Markets Showing Some Very Strange Action

Unexplained Disruption

By: Francis Cianfrocca (Diary)  |  October 10th, 2008 at 08:08 AM  | 

RESIZE: AAA

This post will be brief, as duty calls. You don’t need me to point out the broad carnage in financial markets this morning. It’s going to be a tough day.

Margin calls will drive a lot of selling. We may get a brief respite rally after all of the weaker hands get washed out. Time frame for this would be the next several weeks.

No news in capital markets. Everything is still locked up tighter than a drum.

The most disturbing new sign this morning is in the bond market. US Treasury debt has not rallied strongly this week, as you expect it to when times are tough everywhere else. The very front end of the yield curve is sharply lower, with T-bill rates again nearing historic lows.

But farther out the curve, Treasury securities are mostly flat to lower. In some cases, yield spreads between Treasuries and swap interest rates at equivalent points on the yield curve have become negative.

That is portentous and hard to explain. It could be nothing. It could be the market trying to digest a lot of new and unusually-structured issuance by the Treasury this week.

Or it could be the start of a global deflation. Pray that we’re not seeing the latter.

-Francis Cianfrocca

Tags: , , , , , ,

COMMENTS

POSTING RULES  |  LOGIN TO COMMENT  |  REGISTER TODAY
  • MrSandman

    First the equities than the treasuries.

    Good night Irene.

  • nlj

    I don’t know how we don’t see global deflation at this point.

  • Strelnikov

    On her show this morning she says she wants McCain to show America his team to address the financial panic: Romney (why not Forbes?) and Giuliani were mentioned as prime members to restore confidence and show that the perpetrators, if they have broken laws, will be prosecuted, as he promised at the Wisconsin rally yesterday.

    She remarked that this comment received the greatest reaction from the crowd: any mention of bipartisanship allowed us to hear the crickets in the grass.

    As we have said:
    McCain should also come out and say specifically what he will do and what the W Administration should do in its last months: e.g. immediate tax cut to below 20% to help businesses, along with a matching 20% cut in government spending, with the explanation that the American people should be allowed to keep more of their money during such a panic and not be sending it to bureaucrats with a socialist economy.

  • finalage

    and greed is going to get us out of this. Not more government! We need to change the incentives in the economy. Not only should the banks be recapitalized, but the economy needs to be recapitalized! We need big cuts in the marginal rates on all capital, like capital gains, business capital gains, corporate taxes, repatriated taxes, death taxes, dividend taxes, business expensing and the top rate on income. All these rates must be cut to create the greed that will get us out of this mess.

  • skey

    that the auctions to set the prices and start the unwinding of the Lehman CDS’s were going to be today, CDS’s on $400b of debt. Might that have something to do with the market tanking?

  • JG

    As I said in these pages over a year ago in a heated arguement with Neil Stevens, we are on the precipice of worldwide deflation, which will either be of the good or bad variety. I can elaborate further, but I am probably still banned.

  • streetwise

    classes are really into it, a fascination which I suspect will cease should Barack Obama be elected president.

    I have put up a blurb on the Depression at The Minority Report

    Check it out and feel free to join our open thread on money matters. Vent to your heart’s content!

    • blackhedd

      The Fannie/Freddie conservatorship probably set off a lot more CDS defaults than the LEH bankruptcy did.

      Keep in mind that in most cases, a CDS payout isn’t all that large, especially in relation to the nominal value of the contract.

  • wsjreader

    But farther out the curve, Treasury securities are mostly flat to lower. In some cases, yield spreads between Treasuries and swap interest rates at equivalent points on the yield curve have become negative.

    I’m a bit confused. Which parameters do you usually use to gauge inflation/deflation possibilities?

    I checked treasury yield curve, the curve has actually steepened considerably as the short end is pulled down to near zero and long end(1,2, 5+ years) is relatively flat. A steep yield curve generally means inflationary pressure in the long run. If you were talking about libor-swap spread, I believe that curve is very skewed at the moment, no firm conclusion should be drawn from it. It’s kind of funny some talking heads are touting the idea of ‘super inflation’. I actually tend to agree to some degree. The market is very volatile. Two months from now, we may indeed need to worry about ‘super inflation’ as tremedous US dollar capital inflow artificially boosted by safe heaven seekers may simply evaporate overnight.

    On the other hand, there’s also a possibility of deflation if the global economy dips deep into recession, and the saving/borrowing habit of American consumers have a fundamental change as a result of this crisis.

    I won’t rule either possiblity out.

  • wsjreader

    I checked treasury yield curve, the curve has actually steepened considerably as the short end is pulled down to near zero and long end(1,2, 5+ years) is relatively flat. A steep yield curve generally means inflationary pressure in the long run. If you were talking about libor-swap spread, I believe that curve is very skewed at the moment, no firm conclusion should be drawn from it. It’s kind of funny some talking heads are touting the idea of ‘super inflation’. I actually tend to agree to some degree. The market is very volatile. Two months from now, we may indeed need to worry about ‘super inflation’ as tremedous US dollar capital inflow artificially boosted by safe heaven seekers may simply evaporate overnight.

    On the other hand, there’s also a possibility of deflation if the global economy dips deep into recession, and the saving/borrowing habit of American consumers have a fundamental change as a result of this crisis.

    I won’t rule either possiblity out

    • kingfish

      Denninger has been nailing this all week. A bunch of Lehman CDO’s expired yesterday as well. Right now I trust his observations more than I do Paulson or someone on CNBC

  • finalage

    Crisis! We need to change the incentives in the economy to boost investment and economic activity. Look at this article by Jonah Goldberg
    We can’t increase government any larger to cover this crisis without permanently crippling our economy. We need to cut taxes across the board on capital. On capital gains, dividends, business capital gains, business expensing, the death tax, the top rate, repatriated taxes, etc. Those taxes are egregious anyway, but getting them out of the way can boost economic activity and the stock market. Relying on the Fed to cut rates to the level they were that precipitated this crisis will have no effect. We need fiscal policy that changes incentives!

    • QueenOfCups

      This is judgment day, month, year.

      Though the mills of God grind slowly,
      Yet they grind exceeding small;
      Though with patience he stands waiting,
      With exactness grinds he all.

      And we should be thankful he does. Look at the depth of the depravity of this situation, specifically the people who caused the problem are in charge of the cure, and tell me it does not require the mills of God to grind exceedingly small.

      The stench of the corruption has finally reached the heavens.

      • blackhedd

        So far, there are more similarities than differences.

        • blackhedd

          To you, a steepening curve signals heightened inflation expectations. To me, that feels like about 5% of what’s going on here. Maybe less.

          Steepening can happen because the front end drops, the back end rises, or both. If you expect strong inflation, then why is the 30-year still yielding 4%, even as the Treasury has been issuing huge in the belly of the curve?

          And if you expect that capital will flee from Treasuries two months from now, tell me where you expect it to go. It doesn’t just “evaporate.”

          And don’t say “gold.” There’s not nearly enough gold in the world for that.

  • Old_Crow

    believes the man behind the curtain any longer (or what liabilities another banker is holding). Another bailout, regardless of size isn’t going to solve this – at best it will offer temporary respite. Don’t expect a solution as long as the same folks (Dodd, Frank, Schumer, Obama) who were instrumental in causing this – are removed from the solution. Perhaps hauling a few Senators off in handcuffs from the Capitol building (along with a few CEO’s) will give the markets some sense of closure.

    I would have more sympathy for the bankers if the LTCM crash hadn’t occurred. How many times can you use the excuse that “the models didn’t forecast the international contagion between banks” and still keep a straight face? When the market started to unravel at the speed of internet, the underlying assumptions to the financial models became invalid (just like during LTCM). Only this time it’s larger and more severe.

    No now we are adrift in an unknown sea, firing cannons filled with taxpayer bailout money blindly into the darkness.

    This too will fail.

    Any further efforts will fail until we make changes to the underlying problems that caused this mess. Congress needs radically changes (a majority of members sent packing, future limitations to policy areas it can be allowed to tinker in). Additionally, dozens and dozens of banks and financial institutions need to fail.

    It’s going to be dark for quite some time. It’s time to have faith in something besides government and the markets.

    • wsjreader

      I don’t have the answer whether there will be massive capital exodus in a few months, a few quarters etc. I do firmly believe that without capital control, the so-called ‘hot money’ behaves like virus. It can destroy a small country’s financial system overnight as we’re witnessing the collapse of Iceland whose banking system is absurdly levered by foreign capital, the plunge of Aussie/NZ dollars which prospered on carry trade and the collapse of emerging markets such as Russia/Indonesia…

      You would argue that US is a totally different animal as there’s simply no alternative to USD. However, I would argue that the day of reckoning is coming closer and closer when the country is on heavy dose of depending on China/Japan to cover its deficit. It may stop overnight. The truth is we usually don’t know or don’t care until the bubble bursts and it will probably be too late.

      • streetwise
  • Rod_Patrick

    With the government intervention in the subprime market, the entire financial market will no longer function with an “invisible hand”. The principle has been broken and we are now witnessing

    The global market that nolonger corrects itself.

    This means that we are now forced to save every segment of the entire financial market, and that is based on our earlier solution, i.e., bailout.

    If the government follows every trail of market distress (as the market crash as a trickling effect), we will end up into a so-called “government-controlled” market, a main component of Eastern European socialism.

    Sadly, the Democrat-controlled Congress and the Democrat-influenced Bush Administration will be too “proud” to admit their mistakes.

    The Democrats’ solution has never solved the problem (the lack of capability of the people to pay their mortgages). Same problem exists.

    Funny, McCain proposal, if scrutinized, is more correct: Backing up the people, not the financial institutions. It’s not “pseudo-socialism”, it’s populism necessary in a time of financial crisis.

    • streetwise

      Here’s a piece that I look forward to reading:

      bernanke

  • The_Gadfly

    The markets aren’t making any sense because of the large forces being brought to bear on all sides. The market as a whole was overleveraged because the financials were overleveraged and real estate prices were decoupled from reality. So it wants a major contraction because the leveraged effect that raises profits is now raising loses instead. Counter-balancing that, the fed, and a good chunk of the world markets, are trying to undo the credit freeze. This tends to want to drive the market up. Half the financial advisers are saying sit tight, this too shall pass; the other half are screaming the sky is falling. The ever (un)reliable MSM is touting the sky is falling advisers because they believe that will help Obama win the election. That scares people and they sell. Some big money financiers smell the opportunity to buy really cheap because when others panic there is usually a good opportunity to make money if you have the cash. There are so many of these conflicting forces that no rational mind can figure out what is going to happen next, and there are no mathematical models to go to in place of that rational mind.

    So what we are down to is faith: faith in the free market economy, faith in our fellow Americans to hold up their end of the bargain and work to support their families, faith in Congress, faith in our financial leaders, faith in the President and his advisors, faith that God will see us safely through to the other side. Of course, most of these have been under constant attack for the last 30-50 years and aren’t doing particularly well at the moment for the population at large. Right now I’m down to faith in just three on that list, one of which is wavering, and the other of which the ones I’ve lost faith in seem to be intent on killing. This is the sort of crisis we need a Ronald Reagan for. Not because he was smart enough to solve it; he’d be the first to tell you he wasn’t. But because he’d still give the same answer he did after the “great” crash of 87: “the markets go up, the markets go down,” and then he’d shrug his shoulders and smile. And as he did that, our faith in all of the above would return, and we’d get through it, just like we did in 1987.

    • finalage

      people up who are in the real economy also requires job creation. Right now we have a credit contagion and a recession. The recession will not help McCain’s plan, absent some real growth measures taken to boost the incentives to work and invest.

  • Leverkuhn

    Hey there blackhedd! Long time no blog. Listen, I have two questions for you, and I hope you take the time to answer them.

    First, I’ve read that prices, including prices on oil and food have begun to nudge downward. The decline in the price of crude oil has been particularly noticeable, and I’m beginning to see that at the pump (I’m paying under $3.40 per gallon for the first time in a long time). Could all this be a sign of the deflation of which you speak? If so, couldn’t that be at least a mixed blessing for the low-income people, and people with fixed incomes?

    Second, how are you doing? I know you’re one of those financial types who’ve been taking it on the chin recently, and I just wondered how you personally were holding up. Ordinarily I don’t care much about the Wall Street / big business crowd, especially during times like these, but I’d be very disappointed if you ended up flying off the top of a building somewhere. Those “postcards from the ledge” blogs you wrote a couple weeks ago kind of had me worried.

    Hey, if you ever need to get away from it all, come down to Louisiana. Some crawfish, po boys, some hot boudin balls, and some LSU football might be just what you need. Take care man.

    • Rod_Patrick

      We need all kinds of support to address poverty. But that must start with the people. Not from the Government.

      Bailing out the people must be temporary. And people must learn to pay the Government. That’s how Reagan solved the financial crisis during his terms as President and it really did work effectively.

      Jobs, small business, investment promotions, tax cuts, and educational trainings, and in some way, “wise and responsible spending both by the people and the government ” should be promoted and included in a very holistic manner. In fact, these are “real physical assets/outputs” that actually support and strengthen the financial market…bailout plan of the Dems are superficial.

      It may also be necessary to reduce the daily family expenditure in electricity/heating and car/auto fuels. These items are also eating up the budget of the people and weaken their capacity to pay for mortgages and loans. And only Sarah Palin has a good track record of implementing a “physical/real” program towards a more energy independence. Domestic oil and gas development, even at its conceptual stage, has been effective to bring down the oil prices. Funny, but no one is reporting the positive impacts of Drill Baby Drill battle of the conservatives, now being pushed primarily by Newt. Palin’s natgas project will make heating fuels and bring down gas prices to the people in 2-5 years. ANWR (a small slivery land area) is our best chance to produce domestic oil at shortest time possible…say 3-6 years from now.

      McCain and Sarah have started to emphasize on these things, which have been partly discussed in the recent rallies of John and Sarah.

      I have opposed the bailout plan by the Bush/Dem Congress tandem. And I was first to get mad of McCain upon hearing his ADDITIONAL BAILOUT PLAN. Then I have studied the details (it’s in his website), I found it to be very populist and relatively close in addressing the problem of the people about mortgages…not just a solution for the institutions and corporate entities in the mortgage and credit business.

  • billcurtiss

    I was taught that the yield curve for US Treasuries represents the riskless rate across the range of maturities.

    Basically, the treasury yield curve should be the lowest interest rate obtainable for each maturity. Your saying that there are now instruments trading at rates LOWER than treasuries indicates to me a loss of confidence in the US as a borrower.

    You might check to see either which country or countries are connected to the swaps you describe. Doing so will give a clue as to the new center of “riskless” finance.

    • Rod_Patrick

      McCain is actually offering a solution to the problem.

      He has pre-conditions for his bailout:

      1. The beneficiary must those who continue to live in their homes. In contrast, the Paulsen/Dem Plan is guaranteeing the corporations and GSEs, which cannot distinguish those who have been already evicted from those who are still have their homes.

      2. The family must still have their original contract, and not yet tainted by fraudulent acts of the realtors and mortgage companies. This ensures that the money of the government will only save the people and not the dishonest companies and realtors.

      3. The family/person has already put forward some sort of initial payment and have some track record of diligently paying their mortgages until such time that financial problems (may be work related) have hingered to continue their payment. This separates good but unfortunate families from families who acquired their contract through “affirmative action” like the one being promoted by Obama during his ACORN days in Chicago.

      What I have not heard in the discussion of sub-prime market is this:

      Abadonment and eviction of the distressed families were the real reasons why the values of the properties were lowered. Besides psychological impacts to potential buyers, the USUAL STRATEGIES OF GSES/corporate entities IS TO IMMEDIATELY LOWER THE VALUE OF THE PROPERTY for “Re-sale”, triggering the undue lowering the value of sub-prime stock prices in the last couple of years. Housing market is unique and cannot be directly compared to other financial/commodity markets.

      For me, McCain’s strategy is more appealing and more responsible… a balance of populism and fiscal conservatism.

      • Flagstaff

        Might we have been better off if the restrictions on short selling had not been implemented? Then the short selling would have started at higher levels, perhaps still diving things down to the current point, maybe farther, but It seems I’ve heard that large down volume is necessary to bring this kind of thing to an end.

        Deflation.

        I have been a believer that printing excess money will cause inflation, the opposite of deflation.

        Immediate tax rate reductions, bringing about the need for more immediate deficit financing (borrowing), accompanied by more cash infusion into the economy, should counter deflation with inflation. And we know that inflation hurts lenders and helps borrowers; deflation, the reverse. Also, lower corporate rates and capital gains rates should stimulate the economy, which it needs.

        I have heard that banks now have plenty of liquidity, but are still refusing to lend. Are they waiting for deflation to take hold to make their cash more valuable?

        Yet the Treasury apparently is issuing debt at historic low rates. People are willing to loan to the government with little demand for a return, an obvious flight to safety. Seems like a fine opportunity for the Feds to both borrow and to print money as well. Maybe it’s time to re-issue long bonds and lock in these low rates.

        I realize this is far too simplistic, but what is the flaw in the logic?

        How much of this whole event is the result of big investors (individuals and non-public financial institutions), and how much due to small-investor individuals selling stocks and mutual funds within their IRA’s and 401k’s? If it’s primarily the latter, I’d guess the stock market recovery will be very, very slow.

        • MrSandman

          I’ll just be over here shorting virtually everything until the bankers start to hit the sidewalks.

          • Marcus_Traianus

            Ah, it must be pretty crowded in that socialist circus clown car.

            I shorted this market long ago, but selective, sagacious buying is key to restoring your wealth and our markets.

            GM at 4 and BAC at 19? I was in at those levels. Oh, I forgot your busy dodging.

          • MrSandman

            Buy away.

            :)

          • MrSandman

            you should at least get it right….

            I said, “shorting nearly everything”.

            Cheers

          • Strelnikov

            If you have any spare cash not earning much interest from a bank, now is the time to buy stocks!

            Only somebody severely misinformed would be selling during a panic!?!

            My son, the MBA in FInance, says start buying next week! High tech stocks, basics like food, oil companies, etc.

          • MrSandman

            I can’t even quote myself properly.

            …”shorting virtually everything”….

            Whatever.

            LOL

          • birdmojo

            Also buying more bullets, whiskey, and protein (soup, jerky, etc).

            I figure… hey. I’ll be covered either way.

          • Marcus_Traianus

            FO was under 40 at one point; A steal.

            ATK in the 75-76 range? A steal.

            Guns and Whiskey do pay, sometimes.

          • streetwise
          • MrSandman

            I also bought some GE for the IRA.

            I sold off the last of my SKF, SDS, TWM today.
            What a ride. :)

            I’m guessing we haven’t seen the bottom yet…but I do think its much closer.

            Even when the markets stabilize somewhat that doesn’t fix the credit markets. If that isn’t addressed in a meaningful way soon the unemployment could get real ugly real fast.

            It’s going to be a somber holiday season.

  • Alberta

    Maybe somebody here can tell me Im crazy.

    I dont understand what we are doing that is different from what Japan did. The 700 bill plus the Trillion in Fed added liquidity is essentially a money gift, no? For simple sake, lets say we are buying something that is worth 1 dollar and are paying 100 for it, knowing full well its worth a dollar. We are giving the financials free money. Isnt this what they did in Japan? The only difference I can see is that in America, we are doing it at an earler stage then when they did it in Japan.

    Didnt this stategy create a liquidity trap in Japan? Why are we following it?

    • markreiboldt

      on the GOP side wants to raise taxes, but let me tell you that from an economics perspective, tax cuts are not going to solve this crisis. Indeed, they could even make it worse. Again, please don’t think I am for tax increases, and also understand that I am not saying we need increases in taxes, but cutting taxes isn’t going to do anything for the crisis. I don’t need to go into the economics here, but there are two main things: 1) there is a lag in the impact of tax cuts and the transmission effect to the economy; and, 2) decreases taxes can actually be destabilizing during an economic downturn, rather than a viable stabililzation policy. Also, there are many reasons why fiscal stabilization is very destabilizing. All that said, the point is that fiscal policy isn’t going to solve the crisis.

      I also want to respond to the previous points about the yield curve and measuring inflation. In markets like this, the yield curve isn’t going to accurately project short-term inflation trends. You’ll be better off following week-to-week CPI indicators. However, speaking of the yield curve, I conducted a study about three or four months ago wherein I used the yield curve (and the traditional probit model approach) to project recession. I projected a roughly 30% chance we’d be in a recession by Q209. Clearly, I wasn’t considering the impact of widescale systemic failure. The point here is that the timeline for the market decline has been moved up considerably. That’s not a big shocker after the past couple of weeks we’ve had, but the point is that we’re moving through it. The sooner we hit the bottom, the sooner we’ll start recovering. So, that lends to the point that there’s a good chance we’re nearing the bottom of this market. That doesn’t mean it’s time to buy (in a general sense; I’ve been buying all kinds of things, but you don’t want to hear about my butterfly spreads and covered calls), but it’s typically the case that the worst hits right near the bottom.

      • PaRep

        .