Thursday, April 30, 2009

Fed to Treasury Market: It is you who are mistaken

Its flying a little under the radar this morning, but the Fed just disavowed the market of the notion that they would defend the 10-year at 3%. Today's Permanent Open Market action was to buy a paltry $3 billion in 10-year and longer notes.

Here are the last several POMOs of Treasury bonds (excluding TIPs)

I color coded it by the portion of the yield curve which the Fed was buying at each action. Notice that its very clear that the Fed isn't doesn't have a soft target of 3% on the 10-year. Moreover, the Fed isn't focused on the 10-year portion of the curve at all. Most of the buyer has occurred in the 4-7 year area, which I'm assuming the Fed thinks will be most influential on consumer borrowing rates.

This leaves me tactically short the 10 and longer part of the curve, looking to re-enter (I'm still a deflation believer) at a higher yield level. Technically, I don't see any stop points between 3.07% and 3.80%, so I'll probably we waiting a bit before re-entering the long-term Treasury market.


Michael Krause said...

I put some thought into this. Perhaps the Fed is thinking ahead and has an idea that goes something like this. (all that follows is just postulation, so go with me here)

When the 1.25T from the MBS buying program is spent, they will have likely financed the next year or so of housing market purchases. I expect the 30 yr treasury will have a higher yield than the FNMA mortgage by then (almost there right now). By this time, they figure the economy should start recovering. There will be inflationary risk, since that money printed won't be in bank reserves - it will be in the broad economy.

So I say they think their next move will be to be ready to sell MBS into the open market once the entire housing crisis is over and the inflation starts. By being able to contract money supply with selling MBS instead of treasuries, they won't threaten the broad corporate funding mechanism. The only market that gets hurt is the housing market (once again) - but I postulate they'll expect it to be on much more solid footing next time around, considering the flush we are currently in the process of undergoing.

So unless the Fed starts accelerating QE anytime soon (which doesn't appear to be the agenda), I say they are already projecting their exit plan as we speak. I think 10%-12% mortgage rates in the face of 5-7% 30 year treasury yields will be the end result.

Michael H said...
This comment has been removed by the author.
Lockstep said...

Good thoughts AI.

Good thoughts Scriabinop23.

I am glad you posted on this.

Scria, FNMA may be lower than the 30yr but what gets me is that the 10yr has risen but the FNMA spread has shrunk. How long will that last?

But I don't think we get alarmed yet. I may have bailed on the $100 TLT bull put spread, but that does not mean the Fed is just going to let the 10yr or the 30yr dump. They can still jump in the market at surprise points and shock the market into inflating the price to make sure the yield falls slowly. (But the Fed has not been too nimble in any part of this crisis except in phone calls threatening CEOs)

Time to go short for sure on the 10yr and 30yr.

Term Paper said...

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David said...

The Treasury market is showing little reaction to the Federal Reserve’s forecast that interest rates will remain stable “for an extended period.”

The yield on the 10-year Treasury note, a benchmark for many consumer loans, is at 3.77 percent, up slightly from its levels before the Fed’s statement, after a two-day meeting on interest rates. Yields on Treasury bonds and notes move in the opposite direction from their price.

However, the 10-year yield is up sharply from 3.69 percent. Investors are selling bonds as fears about European debt problems are easing.

The Fed sounded more upbeat about the economy, although it said companies are still reluctant to hire.

The Fed’s key federal funds rate remains between zero and 0.25 percent