In Denial: AP Report Dodges Obvious Potential Reasons For Friday Dive in U.S. Bond Prices

When you increase demand for something, its price should go up.

In the case of bonds, if the demand for them increases, their price should go up, and their effective interest-rate yield should go down.

That didn't happen on Friday when the Federal Reserve began executing its second round of "money from nothing" quantitative easing. Even though the Fed increased demand, bond prices went down and yields went up.

Why? If you read a late Friday afternoon report by the Associated Press's Matthew Craft you essentially get a bunch of blubbering "I don't know" statements (bolds after headline are mine):

Treasury prices take a dive; Interest rates jump

 

The Federal Reserve put its latest stimulus plan into action on Friday, buying government bonds in the hope of lowering long-term interest rates. But instead of sinking, interest rates jumped.

 

The yield on the 10-year Treasury hit 2.78 percent, the highest level since Sept. 10. The two-year yield, which had hovered around 0.40 percent for months, rose to 0.51 percent, a large move for that security.

 

The Fed bought its first batch of Treasurys since announcing its $600 billion plan to boost the economy last week. The central bank picked up $7.23 billion in Treasurys coming due between 2014 and 2016.

 

Buying bonds on a large scale should drive down long-term interest rates. Pushing bond prices up knocks yields down, and Treasury yields act as benchmarks for other lending rates. But Treasury prices dropped after the Fed bought its bonds, sending their yields sharply higher.

 

What happened? "It's complicated today," said Guy LeBas, chief fixed income strategist at Janney Capital Markets. "There's just a lot going on."

 

A collection of trends and events arrayed against Treasurys. Worries Ireland would default on its debt eased on Friday. LeBas said that gave European government bonds a lift while diminishing Treasurys' appeal. As Treasury yields were climbing, Ireland's 10-year bond yield dropped from 8.89 percent to 8.13 percent.

 

Foreign central banks, reliable Treasury buyers, weren't around to help, said Tom Tucci, head of Treasury trading at RBC Capital Markets.

 

... Some banks decided it was time to sell. Tucci said central banks were dropping five-year Treasurys this week, a rare sight. "That's the first time I've seen central bank sellers in I don't know how long," he said.

Geez, an eight year-old kid can come up with more creative excuses than the ones LeBas and Tucci offered. An eight year-old can also probably come up with better excuses as to why his or her former friends don't seem to want to play games together any more.

I would also hope (probably in vain) that the AP can come up with a better term that "stimulus" to describe what Bernanke is doing. How about "electronically creating money"?

Let's buy Craft, LeBas, and Tucci a couple of clues:

• One item that can heavily weigh down bond prices is inflation expectations. The beginning of Big Ben's binge constituted final confirmation that the Fed is willing to risk inflation by creating hundreds of billions of dollars out of nothing. The size of the first day buy, if kept up on each business day -- or even every other business day -- will use up the $600 billion planned amount much faster than the announced eight months (600 divided by 7.23 is about 83 days). When future inflation expectations go up, bond prices go down, and bond yields go up.
• Another factor is default risk. Bond investors need to be confident that they will get their principal back at maturity. The fact is that Big Ben's binge has been pressed into service because the administration and the current Congress have refused to do anything to get fiscal policy in order, running up the national debt by over $3 trillion since Barack Obama took office. Perhaps bond investors are losing confidence that this country will ever get its fiscal house in order. If we don't, there is a high likelihood that we will see the Mother of All Defaults occur. When perceived default risk increases, bond prices go down, and bond yields go up. Greece is paying effective double-digit rates on its government debt for a reason.

C'mon, guys -- especially the AP's Craft. One or both of the aforementioned elephants is more than likely already in the room; if not, they're knocking very loudly at the door. Why not say so? It beats the heck out of insults to our intelligence like "it's complicated," and "there's a lot going on." Zheesh.

Cross-posted at BizzyBlog.com.