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Thursday, October 9, 2008

Bond Market Rumblings

The financial panic is now global, there are multiple countries experiencing dramatic if not unprecedented dislocation in their financial markets. Riots, currency collapses, stock markets halted, US states running out of money, falling oil prices threatening countries, etc.
Unfortunately for the USA, we are also entering into the next phase.

What is happening in the USA (and world) is a "flight to safety", translation, into US Federal Bonds or other fixed-income highly secure sources. But people are not buying "30 year bonds" at these low interest rates and long commitments. People are purchasing short-term bonds.

What happened today is the government went to sell some long term debt bonds, and there wasn't enough buyers at the announced rate. The government had to pay 40 bp above the announced rate.

Cause? It is unclear, part of the blame could be the US announced the sale last-minute.
Also theorized that since the US government started to buy/back commercial paper. That paper pays higher interest rates than the Fed's own bonds. So, if you want fixed income, the large money is going to deal with commercial-backed fed paper.
Further, those who still want Federal long term debt bonds, (2-10-30 year), want more interest to better compete with commercial paper and to be better compensated for the "risk" the USA is taking onto it's balance sheet.

Whatever the cause, the fed having to raise rates 40bp above announced rate to sell long term bonds is not normal.

Why does this matter? For a single day event, it doesn't matter, we can all chalk it up to "crazy financial markets". But if our creditors start to demand better compensation and the rising rates for US debt continues, it could trigger an all out collapse aka 1929 stock market collapse.

And to add fuel to the fire, the government has to sell 700 billion dollars in fed paper immediately to be able to dole money out to companies. As taxpayers, we all knew that 700 billion would not be the cost, but much higher. One form will be higher interest rates, which means cost to service debt higher, which translates into cost for the federal government and all of us for borrowing.

For now its a wait and see. But bonds may turn from boring, to become the main event.
(image source)

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