US Treasury Signals Interest Rate Rise?

Monday, October 26, 2009

Red flagMost of the US Government’s $1.9 trillion in borrowing to pay for emergency programs has been through short-term securities issuance. This morning, Bloomberg reports that is about to change in a big way. The US Treasury is going to issue many more long-term bonds to move the average maturity on all US Government debt from 49 months to 72 months – 4 years to 6 years. (Bloomberg.com – “Geithner Widens Bills-to-Bonds Gap With New Sales.”) The many implications are significant and not good for bondholders…

Here are conclusions we can make from the announcement:

The sheer size of the move (an estimated $600 billion in new 10-30 year US Treasury bonds over the next year) should be a depressant on US government bond prices.

The US Treasury’s shift indicates that the emergency spending deficits will not be paid off anytime soon. Many had hoped that, when economic conditions improved, increased tax revenues and reduced spending would allow the excess debt to be paid off. If not, the fear is inflation, producing higher interest rates and lower bond prices.

Because the US Treasury and the Federal Reserve tend to support one another, this shift probably means the Fed’s long-term and mortgage bond buying programs are at an end. Looking at the Fed’s current balance sheet supports that notion – it has little room left without making the significant move of increasing their over-sized total assets above last year’s financial emergency peak. (See “Ben Bernanke Discusses Fed Balance Sheet Tomorrow” and dark/medium blue areas in updated graph below.)

Fed BS 10-22

Source: Federal Reserve Bank of St. Louis, “U.S. Financial Data,” October 22, 2009

The US Treasury’s announcement occurs at the same time investment analysts and economists are thinking the Fed may signal (with semantics) a move away from keeping short-term rates near zero. This would be appropriate given US and worldwide improvements. (The Federal Reserve Board announces its intentions next week – Thursday, November 5, at 2:15 EST.)

Other items that support the negative implications are:

It appears the corporate bond issuance indicator worked again. Corporations are historically savvy, often signaling an interest rate low by issuing heavily. This year’s record issuance looks like they may have captured the low rates once again.

Current bond returns could produce negative bond news and forecasts. For example, Merrill Lynch says this year’s bond losses could be the largest since at least 1978.

Price drops and downbeat news could cause investors to reverse their recent record bond purchases and start looking for alternatives. Two possibilities: short-term/money market funds, if their yields rise significantly, and stocks, if they continue to perform well.

For now, bonds continue to look like an investment to avoid.

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