Why Rate Expectations Dominates Bond Yield Fair Value Estimates — Brian Romanchuk

Although there are various attempts to downplay rate expectations as an explanation for bond yields. the reality is that they dominate any other attempt to generate a fair value estimate by using "fundamental data". (Since we cannot hope to explain every last wiggle of bond yields without having a largely content-free model, we need to look at fair value estimates.) The reasoning is rather straightforward: so long as the risk free curve slope is related to the state of the economy, bond yields are pinned down by the front of the curve, and the slope....

Bond Economics
Why Rate Expectations Dominates Bond Yield Fair Value Estimates
Brian Romanchuk

Yield Bugs — Brian Romanchuk

Joe Weisenthal has been causing a stir on Twitter discussing "yield bugs": people who have an ideological belief that bond yields out to be positive. This Bloomberg opinion piece discusses this, as well as some other comments on negative yields coming to the United States. I have not followed that debate too closely, as I initially assumed that there was not a whole lot of people who believed that bond yields ought to be positive. This is because bond yields are essentially determined by central bank expectations, and there is not a lot stopping central banks from pushing short rates to negative values....

Bond Economics
Yield Bugs
Brian Romanchuk

Brian Romanchuk — Why Cross-Currency Bond Yield Spreads Do Not Matter

I have been running into cross-market yield comparisons in the news flow in recent weeks. For example, the raw U.S. Treasury/German bund yield spread often comes up in valuation discussions.The simple rule of thumb is that one should never make such cross-currency yield comparisons; they only matter if the currency value is being pegged. Since I do not have a handy source for euro-denominated bond yields, I will use the Canada-U.S. comparison....

Bond Economics
Why Cross-Currency Bond Yield Spreads Do Not Matter
Brian Romanchuk

Bloomberg — There's a Big Drop in U.S. Treasury Debt Supply Coming in 2016

Deficit falling. Treasury issuing mostly bills owing to demand for short term.

Bloomberg Business
There's a Big Drop in U.S. Treasury Debt Supply Coming in 2016
Liz McCormick and Daniel Kruger

Detroit Dan — Something's Rotten

In a poll of 67 economists in April 2014, every single one of them predicted that the 10-year Treasury yield (U.S. government bonds) would rise in the next six months. Every one of them was extremely wrong. The 10-year yield fell sharply for six months (and has fallen even more steeply in the 7th - 9th months). I have invested my life savings in long term U.S. Treasury bonds, and saw these predictions when they were made. Yet I never seriously considered changing my position. I was somewhat intimidated, but after a bit of thought concluded that I was right to believe that the 10-year yields would move in the opposite direction of 100% of economists. My faith has been rewarded handsomely, as yields have plunged, and my investment (PRULX - a long term U.S. Treasury bond mutual fund) has soared. Either I am a freak genius, or there is something dreadfully wrong with "economists".

Mindorenyo
Something's Rotten
Detroit Dan

Bloomberg: Wall Street Bond Dealers Whipsawed on Bearish Treasuries Bet

Via Bloomberg: 

"The surprising resilience of Treasuries has investors re-calibrating forecasts for higher borrowing costs as lackluster job growth and emerging-market turmoil push yields toward 2014 lows. That’s also made the business of trading bonds, once more predictable for dealers when the Fed was buying trillions of dollars of debt to spur the economy, less profitable as new rules limit the risks they can take with their own money."

Shouldn't be "surprising" unless you don't understand the operations. Didn't anyone learn from Japan?

"While they’ve ratcheted down their forecasts this year, they predict 10-year yields will increase to 3.36 percent by the end of December. That’s more than 0.6 percentage point higher than where yields are today."“My forecast is 4 percent,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank AG, a primary dealer. “It may seem like it’s really aggressive but it’s really not.” 

4%? Uh, ok good luck with that one. 

Seems like Matt Franko's prior analysis, that bond dealers hate the low rates and want to push for higher ones, is correct.  

"The biggest dealers are seeing their earnings suffer. In the first quarter, five of the six biggest Wall Street firms reported declines in fixed-income trading revenue.New York-based JPMorgan, the biggest U.S. bond underwriter, had a 21 percent decrease from its fixed-income trading business, more than estimates from Moshe Orenbuch, an analyst at Credit Suisse, and Matt Burnell of Wells Fargo & Co. Citigroup, whose bond-trading results marred the New York-based bank’s two prior quarterly earnings, reported a 18 percent decrease in revenue from that business. Credit Suisse, the second-largest Swiss bank, had a 25 percent drop as income from rates and emerging-markets businesses fell. "

Sadly the article makes no distinction between the nature of US government paper and corporate paper. Any further thoughts?

Mark Gongloff — Krugman Trolls Deficit Hawks With One Amazing Chart

The Huffington Post
Krugman Trolls Deficit Hawks With One Amazing Chart
Mark Gongloff

Explaining the recent spike in interest rates

There’s been a lot of chatter about the recent enormous “spike” in interest rates. I want to make some comments and observations.

First, this spike, while large in percentage terms over such a short period is really tiny in nominal terms. Take a look:

Once you have a little perspective the “enormous spike” becomes a joke.

Second point:

Rates are anchored by Fed policy and that doesn’t just mean short term rates, it means rates all along the curve. Whatever the Fed funds rate is will be reflected further out. A 10-year yield is nothing more than a reflection of Fed policy over that term. And since the Fed has been very clear about its intention to keep rates low and maintain a “highly accommodative” policy stance out until 2014, there is not going to be some big move up in rates. We’ve probably already hit the upside ceiling for rates.

Third point:

The rise in rates over the past several weeks has been due to a number of things, one of them being an improving forecast for the U.S. economy AND a dissipation of fears of a European meltdown. (In my opinion, the jury is still out on both of these views.)

In addition there has also been a largely unnoticed, but fairly sharp decline, in reserve balances over the past few weeks. (See chart below.) This has been due to the Fed allowing existing positions on its balance sheet to “roll off” (i.e. proceeds from maturing securities are not reinvested) AND a large amount of bond issuance by the Federal Government this month to cover expenditures, which has not been offset yet by Fed monetary operations.

On that last point, notice the recent upturn in reserve balances on the chart below. The Fed is once again stepping in to add reserves. Bottom line, the bond selloff is probably over.

French downgrade by S&P imminent and ECB is selling bonds!

The word is that S&P will downgrade France and a number of other European countries. Market reaction has been ho-hum. French bond yields have hardly moved. Looks like people think this will play out the same way it did when S&P downgraded the US. Treasury yields fell sharply after that.

But is a downgrade of France (and other Euro nations) the same as a downgrade of the US?

Absolutely not. European countris are credit sensitive by virtue of the fact that they are not currency issuers. They do need external funding.

And here's the kicker...what has the ECB been doing in the last two weeks? Selling bonds! They've sold 50 billion euros worth of bonds in that time, reducing the size of their balance sheet.

Looks to me like investors don't know this is happening. Also looks like we're in for another round of funding crisis fears.