Tuesday, March 18, 2014

A little more on China and treasury bonds...

Yesterday, I wrote:
China is not nearly ready to even begin to attempt to do harm to its best customer. And besides, were it to, in that fashion, its best customer would barely (if rates rose), if at all, be harmed. While we can spend lots more time on this topic, for today, suffice it to say that the global market for treasury bonds is very very deep. In essence, if China would like to sell U.S. debt, happy buyers would emerge instantly.

Let's go ahead and spend a little more time on this topic. With "if rates rose" I'm suggesting that rates might not rise if China dumped, say, a trillion worth of treasury bonds on the market. Now, that (the rates maybe not rising part) would have to be a stretch for most of us who believe we understand the bond market. Surely, that much supply hitting the market all at once would have to drive down the price (and up the yield) of treasuries, right? Well, it all depends on the timing.

Think about the Fed's QE program: Over the past couple of months the Fed has cut the demand for treasury and mortgage-backed debt by almost a quarter of a trillion, annualized (two rounds of taper). Essentially leaving a heap of bonds ($30 billion) in the market to be bid on by other buyers. Buyers who fully expect the Fed to be out of the QE business altogether by this coming fall (leaving a full trillion a year for others to deal with). Did rates spike higher like so many had predicted? Nope, rates are actually a little lower than they were when the first taper occurred. Meaning, others stepped in and picked up the slack (like I said, the market is very very deep). Of course the fact that the Treasury is borrowing less these days, and that the economy has struggled a bit to start the year, and that there's been no shortage of geopolitical angst in the world---the latter two in particular---helps out as well.

Clearly, there's no guarantee that China selling treasuries would, as many predict, kill the market for treasuries.

So then, should we be sanguine about the bond market? Can we simply sit back and expect that the world will be forever willing to lend Uncle Sam ten-year money at 2.6%? Absolutely not! Like I said, it's all about the timing. A little sustained economic acceleration, and/or inflation, would likely spook bond investors and send yields rising. Now, were China to sell into that scenario, we'd be having an entirely different conversation.

Like I suggested in a recent blog post, I am presently anything but sanguine about the bond market. It's just that China selling U.S. debt in an effort to harm its best customer, is not the worry. Here's a snippet:
The Fed, at last—by tapering QE—is attempting to wean the patient junky off the meds. It’ll be interesting to see what occurs when the bond market awakens to a combination of a brighter economy (whenever that shows up) and a clearer head. I’m not as committed to the bond-bubble-bursting notion as I was three years ago (simply because there’ve been too many “experts” calling for it), but I’m still thinking that the process of regaining equilibrium will not be a pretty sight. I.e., if you own bonds (U.S./non-U.S. corporates, governments, mortgage backed or munis) and you think you’re safe, please think again.

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