The Biggest Bubble Of Them All
By Jeffrey Cooper May 29, 2013
Bearish market participants have been screaming that the bond market is the biggest bubble in financial history. They’ve been banging the table and yelling that when rates rise, servicing the existing trillions in debt is going to require even more debt issuance. This will lead to ever-higher rates and a crowding out of the private sector.
Is the last card in the current bond game about to be turned?
Tuesday, 10-year US Treasury yields (USGG10YR) made a new high for 2013 as the Dow Jones Industrial Average (INDEXDJX:.DJI) closed at a new record high (unconfirmed by the Dow Jones Transport Average (INDEXDJX:DJT)). The spread between the stock market and the price of bonds looks like Jaws.
The Federal Reserve is going to need a bigger boat. What will rising rates do to their own holdings?
My gnome high in the Appalachians tells me that the bulls and bears alike are focusing in on the 2.20% yield on the 10-year as a big inflection point. He explains that above this level, mortgage-backed securities (MBS) holders are subject to extension and duration risk, leading to an increase in hedging which in turn would lead to price gaps and significant volatility.
The kicker is that due to a shortage of Treasuries due to Bernanke & Co. and low liquidity, higher rates even from such low levels could be very disruptive.
What if a rise in rates is not orderly?
The presumption is the Fed would respond to the disarray just like the Japanese Central Bank (JCB) responded last week to backstop their market.
But what if both central banks flip their cards, and the market calls their bluff? In other words, if the Fed actually has to increase buying on a further ratchet up in rates, it could be perceived as a very negative development for all markets.
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Whistler Blowers, Insiders
The bubble goes beyond Treasuries. Most of the mortgage backed instruments that nearly destroyed the economy in 2008 are still out there. Two of the largest banks in America each own over $60 trillion worth of the things, each being many times the global GDP.
In addition, trillions of dollars owned by banks are sitting in accounts at the Fed where they earn a small interest return for the banks. It is there because no one is borrowing money. If interest rates raise and/or the economy actually does begin to recover, then that money will flow back into the economy causing inflation.
There are other things out there, too, like the growing bubble in higher end real estate, the farmland value bubble, etc.
It all boils down to this: the Fed prevented the business cycle from working and wiping out the excess capital. Instead of allowing busts to make these purges, the Fed has papered them over with funny money. As a result, there is far more money in the economy than is needed and it is leading to inflation and the massive bubbles. Eventually a bubble will be created that the Fed can’t print enough money to smooth out and all that funny money with crash the economy with a vengeance.
The Fed always since its inception corruptly interferes with capitalism. They set the interest rate and therein lies a substantial part of their power in controlling credit creation. Damn, not even that aspect of credit creation is in the hands of Federal congress, to set interest rates.
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Any “Jeff Cooper” has some BIG shoes to fill. This one seems to be doing OK.
R.I.P., Col. Cooper.