Kilde GOE (Global Economic F....)
THE PUBLIC BOND MARKET IS ON FIRE!
Global: A Tale of Two Bond Markets
Stephen Roach (New York)
The US bond market is being turned inside out. At least, that’s the case for the high-profile Treasury segment of fixed income markets, where yields at the long end of the curve have now tumbled 85 bps from their January 2000 highs of 6.75%. But the Treasury market is no longer a meaningful proxy for the broader US bond market. An extraordinary dichotomy has opened up between the public and the private bond markets in early 2000. What are the implications of this stunning development?
Two major developments have rocked the US Treasury market in the past two months: First, courtesy of America’s newfound fiscal cushion, the government has announced -- and begun to implement -- a buyback program for long-dated securities; second, senior Treasury officials are now making the case that agency paper -- debt issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Bank System -- should no longer enjoy the special premium that stems from an implicit government credit guarantee. For Treasuries, which had already begun to take on the allure of an endangered species, the diminished attractiveness of agency credit has led to a veritable feeding frenzy. The supply of "riskless" assets is getting smaller and smaller, and investors are rushing to get all they can get. The public bond market is on fire!
Not so elsewhere in fixed-income land. Yields in the private market -- especially for corporates -- have hardly budged. As a result, spreads have widened dramatically relative to Treasuries -- underscoring the dichotomy that has opened up within the bond market. Relative to lows hit on January 27, spreads of Aaa industrials (Moody’s seasoned) have gone from 99 bps to around 150 bps, whereas those for Baa industrials have gone from 155 bps to a little more than 220 bps. In both cases, this spread widening only retraces the compression that occurred in the final months of 1999. This leaves little doubt that the surge in Treasuries has been confined mainly to the public market.
The economy should be largely unaffected by this development. While an inverted yield curve typically signals a tight Fed and an imminent weakening in the economy, this time it’s different. In my view, there are no signs that monetary policy is restrictive; the ongoing vigor of the US economy speaks for itself in this regard -- as does the relatively low level of real short-term interest rates and, as Dick Berner has been noting, an accelerated pace of credit expansion. Moreover, corporate borrowing rates are down only slightly from their mid-January highs; yields for Baa industrials -- the instrument highlighted by Alan Greenspan in recent congressional testimony -- currently stand at around 8.3%, 15 bps below the highs of two months ago and only about 15 bps above those prevailing at year-end 1999.
This disparate movement between public and private bond yields is of great significance for the Fed. After all, the current monetary tightening campaign does have a purpose -- to slow down a white hot US economy. On the surface, the explosive rally in Treasuries suggests that the Fed’s efforts are backfiring. The more muted rally in corporates tempers these concerns. However, since yields on corporate have barely responded to monetary tightening, it is safe to conclude that the Fed has a good deal more work to do. Borrowing costs simply are not rising. The Fed, as a consequence, is not restricting the flow of credit.
The pyrotechnics in Treasuries, together with the sharp recent sell-off in agencies, has far-reaching implication for financial markets. That’s because there is no longer a reliable benchmark that can be used to price and value a broad array of other assets. Following the demise of the 30-year Treasury bond as the most widely accepted benchmark, three alternatives quickly surfaced as candidates for a successor -- the 10-year Treasury note, a hybrid 10-year agency yield, and 10-year bank swaps. One by one, these alternatives have been falling by the wayside. With the elimination of all marketable Treasury debt now thought to be likely by 2010, there is reason to believe that the 10-year Treasury will go the way of the 30-year. And, now, the once mighty agency alternative has fallen. That leaves bank swaps as the sole surviving candidate -- hardly a security that most investors are comfortable with. In other words, the benchmark issue is murkier than ever -- leaving ever-frothy financial markets without an anchor at precisely the time they need one. Needless to say, this complicates the task for the Federal Reserve all the more.
[This message has been edited by Gen (edited 24-03-2000).]