The Wile E. Coyote Moment: US Treasury Yields Spikes!

Last night, the yield of 10 year US treasury spiked to the highest level in 16 months.

The recent streak of bond losses/ yield gains has been amazing, according to the Bloomberg:

Yields on 10-year U.S. Treasuries have advanced for six weeks, the longest stretch in four years.

Yields of US treasuries have been climbing almost across the maturity spectrum. This is with the exception of the 3 and 6 month T-Bills. The increase in the longer end has been in double digits over the month.

The ensuing response: a tumult in Emerging Market stock and bond markets

Example today: Singaporean bonds has been reportedly getting slammed. From the same article:

The price of Singapore’s 3.125 percent note due in September 2022 tumbled to S$110.42 as of 2:41 p.m. local time from S$110.98 June 7, based on data compiled by Bloomberg and supplied by the Monetary Authority of Singapore. The yield rose six basis points, or 0.06 percentage point, to 1.89 percent. It was the highest level since Aug. 2, 2011, based on the MAS data.

And so with the ongoing carnage of ASEAN equity markets as of this writing.

The Bespoke invest notes that there has been increases in US default risks of major US banks and brokers. But they downplay this as “still very low relative to where they've been trading over the past couple of years.” Of course reference point matters. But what may seem as relatively “very low” could also become “very high” in the future. Such observation can be called the anchoring bias.

As I pointed out last Sunday, underneath the surging US stock markets and aside from the tremors being experienced by most emerging markets, some segments of the US financial markets has also been adversely impacted by recent turmoil in the US (and global) bond markets.

Media has been awash with the adverse ramifications of the rioting bond markets. High yields funds has posted the biggest record outflows, US credit default swaps rises to a two month high along with deepening losses from junk-bond exchange-traded funds and carry trades endures from deepening losses.

The US financial markets appear to be in a Wile E. Coyote moment: buoyant stocks amidst as the seeming deterioration in interest rate sensitive industries or sectors and of the narrowing positive market breadth of world markets.

It is also important to point out that a sustained rise in yields in the bond markets will bring to fore counterparty and market risks from the interest rate sensitive derivatives markets as I explained last month.

IN the US, according to the US OCC, 80% of the $223 trillion notional derivatives markets have been concentrated in interest rate products as of the fourth quarter of 2012

So the humongous derivatives markets would seem as highly vulnerable to the ongoing bedlam in the interest rate markets.

Money Market’s Mike Larson eloquently summarized of the the risks of the implosion of the US bond bubble last January.

To understand how huge this is, let’s first add up the value of all the stocks of all the listed companies on all the exchanges in the United States: That’s $25.8 trillion, according to the Fed.

Plus, to make sure we’re not missing anything, let’s also add up the value of stock futures, stock options and other stock instruments: According to the U.S. Comptroller of the Currency, that’s another $2 trillion.

Total equities in America: $27.8 trillion.

Now, let’s do the same for bonds and other debt instruments:

The total outstanding debt right now is $55.3 trillion. And that’s already twice as big as all the stock markets combined.

But it’s just the tip of the iceberg. Because in addition, U.S. banks hold a whopping $179 trillion in derivatives that are based on bonds and the like. Grand total of bonds and debt instruments: $234.3 trillion.

That’s 8.4 times the size of all U.S. stock markets combined!

The plain truth is that today’s debt bubble dwarfs the bubble in tech stocks and the bubble in housing stocks combined.

At the peak of the tech stock bubble in 2000, the entire Nasdaq index was worth $5 trillion.

At the peak of the housing bubble in 2007, the entire real estate and financial sectors were worth $8 trillion.

But today’s market in actual debt instruments is $55.3 trillion: That’s FOUR times larger than the tech stock bubble and the housing bubble COMBINED!

Rising rates signifies lethal mix with, or a contradiction to, low interest rate dependent asset bubbles: elevated asset markets which has been edificed around a colossally leveraged system.

Again it is important to reiterate that a persistence or an intensification of this trend magnifies the risks of a Wile E. Coyote moment: a devastating financial market accident.

Caveat emptor.

Video: Peter Schiff: This time it is different, it will be a lot worse

This time is different, it will be a lot worse, says Peter Schiff speaking at the 2013 Las Vegas MoneyShow. 

Mr Schiff's talk covers a wide range of interrelated topics from today's deja vu of 2006 in terms of steroid induced market euphoria, the bond market ponzi scheme, the Fed exit's bluff, manipulation of price inflation and growth statistics, runaway inflation and hyperinflation and the gold bubble (a bubble which ironically hardly anybody from Wall Street owns). (hat tip Lewrockwell.com)

Bankers Warn US Federal Reserve of Bubbles in Farmlands and Student Loans, More Signs of US Asset Bubbles

Aside from record high stock markets underpinned by exploding net margin debt, there are many side-effects from the Fed’s bubble blowing policies.

Bankers themselves are now warning the US Federal Reserve of asset bubbles evident in farmland and in student loans

From Bloomberg:

A Federal Reserve (TREFTOTL) panel of bankers warned policy makers in February that record stimulus was pushing financial institutions to take on more credit risk and creating a “bubble” in the price of U.S. farmland.

“The margin pressures that the low-rate environment has put on financial institutions, coupled with dramatically increased compliance and other infrastructure costs, have caused many to seek higher returns by accepting greater interest-rate or credit risk,” the bankers said on Feb. 8, following a Federal Open Market Committee meeting on Jan. 29-30.

the farmland bubble chart courtesy of the Zero Hedge

More on the farmland bubble

The panel also said in February that farmland valuations posed an asset-price bubble caused by unusually low interest rates, echoing concerns expressed by Kansas City Fed President Esther George.

“Agricultural land prices are veering further from what makes sense,” according to minutes of the council’s Feb. 8 gathering. “Members believe the run-up in agriculture land prices is a bubble resulting from persistently low interest rates.”

The Fed pledged to hold the benchmark interest rate at zero until the unemployment rate falls to 6.5 percent, as long as inflation expectations don’t exceed 2.5 percent. The U.S. central bank has also engaged in three rounds of bond purchases, known as quantitative easing.

Data compiled by the regional Fed banks have documented a rapid run-up in farmland prices, particularly across the Midwest’s Corn Belt. The Kansas City Fed said irrigated cropland in its district rose 30 percent during 2012, while the Chicago Fed reported a 16 percent increase.

The panel of bankers is appointed by regional Fed banks and dates to the founding of the central bank in 1913. Bloomberg obtained minutes from the quarterly meetings from May 2011 until February.

Student loan bubble chart from the Zero Hedge

Now the student loan bubble

At a meeting in February 2012, the council said “growth in student-loan debt, to nearly $1 trillion, now exceeds credit-card outstandings and has parallels to the housing crisis.”

Student lending shares features of the housing crisis including “significant growth of subsidized lending in pursuit of a social good,” in this case higher education instead of expanded home ownership, the council said.

Bubbles have been ballooning in many areas.

Corporate bonds has likewise been exploding.

From another Bloomberg article:

Sales of bonds from the U.S. to Europe and Asia exceeded 2012’s pace after offerings surged this month to at least $318 billion, compared with $205.3 billion in the similar period last year, Bloomberg data show. Issuance lagged last year’s pace during the first quarter, falling 7.6 percent behind a record $1.174 trillion in the first three months of 2012.

A lot of these bond issuance have been used as vehicles to buyback on stocks in response to tax policies and the cheap money environment that has led to the record levels.

This is why both the US bond markets and stock markets are becoming intertwined.

And more signs of the tightening relationship between stock market and bonds: the bond fund hybrids

From the Wall Street Journal

The number of bond funds that own stocks has surged to its highest point in at least 18 years, another sign that typically conservative investors are taking bigger risks to boost returns.

Regulators generally allow funds to hold a mix of assets, but the scale of bond funds' shift into stocks is unusual, fund experts said, and could expose investors to unexpected losses.

In all, 352 mutual funds that are classified by Morningstar Inc. as bond funds held stocks as of their last reporting date, up from 312 at the end of 2012 and 283 in the first quarter of 2012, according to the investment-research firm.

The rush into stocks illustrates the dilemma bond investors face. The bond market has rallied for much of the last 30 years, and yields, which move in the opposite direction of prices, stand near record lows.

Tightening interdependence of stocks and bonds makes both asset classes equally vulnerable to market shocks.

The deepening of inflationary boom has led credit swaps falling into 5 year lows which are signs of increasing complacency.

Collateralized debt obligations (CDOs) “bad boys of the financial crisis of 2008” according to the Wharton Knowledge, have also been making coming back.

There are many more signs of bubbles being blown. So it would be naïve or downright silly to suggest or proclaim that there has been “no-side effects” from Fed Policies.

Remember inflationary booms leads to deflationary bust. And a bust will likely spur the US Federal Reserve to double or more the $85 billion a month in bond purchases which may expand to include other assets. 

All these means two things: more bubbles or a currency collapse.

US Debt at $16 Trillion, a Precarious Confidence Game

Great stuff from Sovereign Man’s Simon Black,

If you haven’t heard yet, the United States of America just hit $16 trillion in debt yesterday. On a gross, nominal basis, this makes the US, by far, the greatest debtor in the history of the world.

It took the United States government over 200 years to accumulate its first trillion dollars of debt. It took only 286 days to accumulate the most recent trillion dollars of debt. 200 years vs. 286 days. This portends two key points:

1. Anyone who thinks that inflation doesn’t exist is a complete idiot;

2. To say that the trend is unsustainable is a massive understatement.

At an average interest rate of 2.130%, Uncle Sam will shuffle $340 billion out the door just in interest payments this year… and it’s a number that’s only going up. To put it in context, China owns so much US debt that the INTEREST INCOME they receive from the Treasury Department is nearly enough to fund their entire military budget.

It’s rather disgusting when you think about it.

Many mainstream observers (who largely are apologists of the government) argue that because US debt is denominated in the domestic currency, this has been nothing to worry about, as the US Federal Reserve can do the bidding.

Well they are to be proven eventually wrong, because economic reality will prevail. Again Simon Black

History is full of examples of superpowers bucking under the weight of their debt. This is not the first time that it’s happened, and it won’t be the last.

Sovereign debt is a giant confidence game. Investors buy bonds on the belief that governments can (and will) pay. When that confidence is chipped away, the cost of capital becomes debilitating. And people tend to notice a $16 trillion debt burden.

This is banana republic stuff, plain and simple… and smart, thinking people ought to be planning on capital controls, wage and price controls, pension confiscation, and selective default. Because the next trillion will be here before you know it.

Include political and other social controls, banana republic stuff…like totally.

David Stockman: The US Federal Reserve is Destroying the Capital Markets

David Stockman, former Republican U.S. Congressman and director of the Office of Management and Budget, founding partner of Heartland Industrial Partners and the author of The Triumph of Politics: Why Reagan's Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy in an interview at the Gold Report has this biting message. [bold emphasis mine]

The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of "Operation Twist" is an abomination.

Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed's monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street…

I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world's financial market.

Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors – none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move.

As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades.

On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out.

If that happens, the massive repo structures – that is, debt owned by still more debt – will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked.

Read the rest here.

Many people believe that the numerous incidences of irregularities seen in financial markets emanate from unscrupulous behavior by some market agents, little has been understood that central bank policies, together policies that cater to crony capitalism, have been incentivizing or fostering such behavioral anomalies.

And importantly, the nature of capital markets have been intensely distorted to the point where conventional wisdom of its mechanics has nearly been rendered obsolete.

Either we face up to such evolving realities or suffer from our recalcitrance to adjust when the day of reckoning arrives.

Return of the Bond Vigilantes? China and Russia Blasts Debt Ceiling Bill

Back to the debt ceiling bill, foreigners as the BRICs represent as pivotal forces, whom could function as bond vigilantes (bond market investors who protests monetary or fiscal policies they consider inflationary by selling bonds, thus increasing yields) and who could substantially sway US sovereign bond prices or the direction of interest rates.

Some of these significant bond holders have reportedly criticized the debt bill.

From Bloomberg,

China, the largest foreign investor in U.S. government securities, joined Russia in criticizing American policy makers for failing to ensure borrowing is reined in after a stopgap deal to raise the nation’s debt limit.

People’s Bank of China Governor Zhou Xiaochuan said China’s central bank will monitor U.S. efforts to tackle its debt, and state-run Xinhua News Agency blasted what it called the “madcap” brinksmanship of American lawmakers. Russian Prime Minister Vladimir Putin said two days ago that the U.S. is in a way “leeching on the world economy.”

The comments reflect concern that the U.S. may lose its AAA sovereign rating after President Barack Obama and Congress put off decisions on spending cuts and tax increases to assure enactment of a boost in borrowing authority. China and Russia, holding a total $1.28 trillion of Treasuries, have lost nothing so far in the wake of a rally in the securities this year.

“It’s probably frustration more than anything else for China,” said Brian Jackson, a senior strategist at Royal Bank of Canada in Hong Kong. While the nation has concerns, “they realize there’s not a lot of options for them out there and so they need to keep buying Treasuries.”

China held $1.16 trillion of Treasuries as of May, U.S. Treasury Department data show. The nation has accumulated the holdings as a by-product of holding down the value of its currency, a policy U.S. officials have said gives China an unfair advantage in trade.

Apparently these have not just been political talk but appear to have been accompanied by action

Charts from yardeni.com

Foreign appetite for US bonds has been on a decline, with China accounting for the gist.

As earlier discussed, the local savers through private banks have been shackled by various regulations particularly the Basel Accords, which compels the banking industry to divert these savings to finance government expenditures. This has been called as Financial Repression by some experts. Once the bond market unravels, many of the private sector money tied due to such regulations will get burned.

Yet with the debt ceiling bill currently lifted to $16.5 trillion, and where the US Federal Reserve has taken over the bulk of the financing of the ballooning US deficits via the QE 2.0 from declining interests from foreigners, the $64 gazillion question is ‘will the US government allow interest rates to go up which increases the risks of popping the banking system’s ultra fragile balance sheets?’

Graphic above from PIMCO’s Bill Gross

I don’t think so.

And it has been part of the central banking dogma or quasi operating manual to inflate the system when some form of distress emerges.

This can be exemplified by the actions of the SNB on the Swiss Franc and the BoJ on the Yen during the past 24 hours. And that’s why, given the mounting risks of a bond auction failure, sluggish asset markets and the desire to keep interest rates at current levels or ‘Zero bound’, we should expect the next round of asset purchases by the US Fed to happen soon.

And this is also why fissures on the US dollar system continue to widen.

From another Bloomberg article

The committee of bond dealers and investors that advises the U.S. Treasury said the dollar’s status as the world’s reserve currency “appears to be slipping” in quarterly feedback presented to the government.

The Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Pacific Investment Management Co., said the outperformance of haven currencies and those from emerging nations has aided in the debasement of the dollar’s reserve status, according to comments included in discussion charts presented ahead of the quarterly refunding. The Treasury published the documents today.

“The idea of a reserve currency is that it is built on strength, not typically that it is ‘best among poor choices’,” page 35 of the presentation made by one committee member said. “The fact that there are not currently viable alternatives to the U.S. dollar is a hollow victory and perhaps portends a deteriorating fate.”

What is unsustainable won’t last. The bond vigilantes are lurking around the corner and substantially higher interest rates will be the future. That’s what record gold prices have been admonishing us.

For now, profit from political folly.

(hat tip Dr. Antony Mueller)