Summary
The short squeeze in Treasuries has been breathtaking. It kind of reminds us of how the market behaved during the spring of 2003. But don't forget what happened when the 2003 rally fizzled!
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Some brief thoughts on what's going on in the Treasury market:
* There's been a giant short squeeze in progress in the Treasury market, particularly evident if you look at what's happened to yields at the back end of the curve.
10-year 30-Year
Date Note Bond
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2004
09/23 4.02% 4.80%
09/23* 3.96% 4.76%
09/22 3.98% 4.78%
06/14@ 4.87% 5.53%
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*Intraday low.
@Recent high.
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* The immense volume of foreign central-bank purchases of Treasuries certainly has exacerbated the squeeze but are not its primary cause.
* In my view, hedge funds are the primary culprits in creating the situation. And to add some insult to the injury, I suspect many of the individual funds involved in what's happened are entities generally having an equity rather than a fixed-income orientation.
* In some important respects, the present situation reminds me of what happened during the spring of 2003, when the Fed ignited its deflation scare. The occasion was the 5/6/03 FOMC meeting. Here's an excerpt from the post-meeting statement that set off the fireworks:
"...The Committee perceives that over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal. In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals is weighted toward weakness over the foreseeable future."
* The consequences of the above:
10-year 30-Year
Date Note Bond
-----------------------
2003
05/05* 3.89% 4.80%
06/13@ 3.10% 4.17%
08/13# 4.59% --
08/14# -- 5.45%
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*Day before FOMC meet-
ing. @Lows after meet-
ing. #First highs
after meeting.
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* I thought (and communicated to clients at the time) my view that the Fed's deflation shtick, at least coming when it did, was a ruse. The time to have been a good deal more concerned about the "D" word was just about a year earlier. Instead, the May 2003 machination was in lieu of another rate cut Greenspan wanted but couldn't have. But as it relates to how open-market interest rates behaved, Greenspan got the equivalent of at least a couple quarter-point cuts in the Federal Funds Rate -- more than enough to set off the huge mortgage refi binge he so badly desired.
* Hedge funds hopped all over the Federal Reserve's May 2003 pronouncement. Thousands of hedge funds all looking for a "deflation trade," all heading into the Treasury market at the same time. But as the above table clearly shows, when things unwound, they really unwound!
* Just like I think the current situation will have the great potential of unwinding. The difference, of course, is that this time around, we have a plethora of funds short the market. So the first order of business is capitulation -- getting all those shorts covered.
* I suspect the capitulation phase is well underway. In fact, perhaps yesterday's intraday reversal in yields (see first table) suggests the process is almost over. Then, again, perhaps it is not, but the market's behavior will be a solid indicator.
* Finally, there seems to be this deep-seated belief that as long as foreign central banks continue to shovel the money into Treasuries, yields simply cannot rise. I strongly disagree. The disagreement comes from the above-stated conviction that central-bank purchases have aggravated the short squeeze, but that it is the short squeeze itself primarily responsible for the sharp drop in yields.
* Thus, when the squeeze is resolved, foreign central banks may cushion the snapback in yields, but they won't prevent it.
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