For some time the standard yield curve for US Treasury debt has seemed unusually flat. This can be unnerving, since if it gyrates into an inverted curve, oh boy. An inverted yield curve is one of the surest indicators that the economy will soon be in the toilet. Therefore, abnormal yield curves should always make one nervous.
Twist Tangles Treasury Trade in the Wall Street Journal of February 10 included a chart showing the how much of the monthly Treasury issues of 30-year bonds is being bought by the Federal Reserve. Beginning in October 2010, and since, the Federal Reserve has bought nearly all of the 30-year bonds sold by Treasury. Frightening.
Treasury bonds are sold on a market-clearing lowest bid basis – all would-be buyers submit the LOWEST interest rate they will accept. Treasury totals up the bids until it reaches that lowest bid that means all the bonds it wants to sell are sold. Higher bidders for higher interest rates get no bonds. Everyone who wins gets that all-sold rate. Treasury has a strong interest in getting the cheapest rate they can, yes?
Without the Federal Reserve buying at a very cheap rate nearly all of the 30-year bond issues, if the Treasury had to pay what arms-length bond buyers are quoting, what do you think the actual interest rate would be? Well, only Geithner, Dudley and Bernanke know that. It probably isn’t good news for Treasury.
Until recently it has been presumed in the press and by op-ed economist writings that Treasury bond interest rates were so low because of flight capital to the US, steady Chinese buying to keep the renmimbi from rising in value, or just that the US is king of the hill and special. A bit of truth to all of that, possibly for the shorter duration Treasury debt.
But lo, since October, the sucker buyer willing to buy nearly all of Uncle Sugar’s long-term debt, accepting super-cheap interest rates — has been Uncle Sugar in the guise of the Federal Reserve.
Geez. Bizarre. Starts to sound like Argentina’s central bank. Very dangerous stuff here when Uncle can’t sell his long-term debt to real buyers. Do you wonder what interest rate Uncle S—- would have to pay to a real bond buyer? An arms-length bond buyer?
Quoting Wikipedia: An inverted yield curve occurs when long-term yields fall below short-term yields. Under unusual circumstances, long-term investors will settle for lower yields now if they think the economy will slow or even decline in the future. Campbell R. Harvey’s 1986 dissertation[2] showed that an inverted yield curve accurately forecasts U.S. recessions. An inverted curve has indicated a worsening economic situation in the future 6 out of 7 times since 1970.[3] The New York Federal Reserve regards it as a valuable forecasting tool in predicting recessions two to six quarters ahead.
Finance on the Potomac is getting just too weird, thinks the Curmudgeon of Staunton.
