Long-Dated Treasuries: Ending Action?

The price advance for US treasuries has become outstanding; almost as outstanding as the trend for most eurobonds. Technically, we are looking for "ending action" in the US long bond. As it occurs it could constrain the irresistible reaching for little to negative yield in Europe.

But before reviewing the charts we should look at the "fundamentals". There has been nothing approaching fundamental in this market. That's going back to 2005 when Chairman Greenspan became perplexed that the long bond was rallying in the face of a rising Fed Funds rate. It was called the "Conundrum" and Fed staffers wrote papers on it.

At the time, we described it as yet another example of inflation in financial assets. Bonds, which had been the victim of inflation had become a financial instrument benefiting from easy money policies. In the world of policymakers there has been one big tout and that has been the notion that whatever the central bank does it is never inflationary. The Fed's demon is the unwitting jump in the public's "inflation expectations" that "cause" inflation that central bankers see as dangerous.

It must help to have multiple degrees in Tautology.

More lately, concerns about "deflation" have been increasing. The Fed has a target of keeping CPI inflation at an arbitrary 2 percent. But concerns are not yet to the point where academics are writing papers about "deflation expectations".

It seems that the term "Gresham's Law" is not as widely circulated as during the 1970s. The law that "bad money drives out good money" was not announced by Gresham in the 16th century, but the phenomenon was named by an academic in the late 1800s. Serious inflation in consumer prices is widely unpopular, but inflation in financial assets is very popular. That's until it blows up and the consequences become widely concerning.

A huge speculation in commodities blew out and crashed in 1921. Pricing pressures were so severe that the Fed was very easy during the mid-1920s. That was to keep general price levels from falling. Instead the "lolly" went into financial speculation. The public had decided to inflate financial assets until they crashed in 1929.

US long rates recorded another secular decline, which was to the 2.5% level in 1946. Then another secular rise in long rates began and when 3% was reached policymakers understood that the cost of servicing the War debt would increase. Simple – buying bonds out of the markets would keep rates from rising above 3 percent.

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Believing this possible many fund managers stayed fully invested in long bonds. Just before the worst bear market in history.

In the mid-1960s, under the label of "Operation Twist" bond buying became very aggressive. The attempt was to keep rates from rising above 6 percent. This was a policy mania that injected huge funds into the markets when the public chose to speculate in commodities.

CPI inflation soared to 14 percent and the yield for the long bond soared to 15 percent in 1981.

Despite uninterrupted growth in money supply in 1980-1981, commodities crashed and as in 1921 speculation shifted to financial assets. We began to introduce our research to financial institutions in 1981 and the salient concept was "No matter how much the Fed prints, financial assets will outperform commodities". As the investment community was just beginning to realize that CPI inflation was "caused" by the Fed this was controversial.

With mounting violence, inflation in financial assets has continued, accompanied by central bank ambition moving beyond reckless to madness. Gresham's Law has become "Bad policy drives our good policy". Last week's move by the Swiss Central Bank is a forced step back from the brink of insanity. Others will follow. Perhaps persuaded by individual policymakers beginning to become concerned about their own reputations.

Ironically, through this many gold bugs considered Fed recklessness would drive gold to "$5,000". This notion had its last peak in September 2012 as Bernanke announced the big bond buying program.

As history has recorded, junk-bonds reached the equivalent of "$5,000" in June 2014. The NYSE may have reached the equivalent in December and long-dated treasuries are working on the equivalent now.

This researcher has been working in the financial markets for a long time. Long enough to have seen the markets before they became corrupted by ambitious academics. In 1965 I was an assistant mining analyst with Canada's premier investment dealer. CPI inflation had increased to a little over 1 percent, which was concerning. I asked the head of fixed income, who was a very dignified veteran, about the threats of inflation to bond prices.
His response was that inflation was chronic to lesser counties in Europe or South America. Canada and the US had integrity that would not succumb to the evils of inflationary policies.

Most institutions were overweight bonds, underweight equities and positioning in commodities was unthinkable. The Bank of Canada and the Federal Reserve were incorruptible.

After the Tech-Crash of 2000, the drumbeat began about commodities. Pounding the table about stocks shifted to pounding the table about copper and crude oil. Going into the secular peak in commodities in 2008 funds were advised to own up to 6 percent in commodities. At that point central bank corruption was fully understood. This mistake was to conclude that the Fed could depreciate the dollar at will.

So let's summarize policy manias and their success. From the 1940s to 1981 the policy was to prevent yields for long treasuries from rising above 3 percent. The next was the animosity to gold that culminated in selling bullion reserves all the way down to 253 in 1999.

The next grand policy blunder is pertinent to today's mania in US treasuries.

In the 1990s the big deal was the coming together of the European Economic and Monetary Union. Within this, was the Maastricht Criteria whereby agreed discipline would have the yields for different counties in Europe trading at the same levels. This was the big "Convergence" game that inspired Long Term Capital Management to push leverage to the limit. The pitch was that policymakers would seriously narrow credit spreads in Europe.

It was such a sure thing that senior central banks loaned money directly to LTCM. The Bank of Italy was so enthused as to take an equity position. All of this made the collapse and bailout so intense.

The "sure thing" was that policymakers could narrow spreads at will. Back when the key European countries were on the severe discipline of the gold standard the spreads between, for example between England and Italy were substantial. Then spreads in Europe and the US were narrowing on a seasonal move into June 1998 and the natural reversal to widening forced LTCM to default.

It took only four months to wipe out the $4.6 billion fund. City Group's stock plunged from 261 to 102.

The final part of the liquidation involved England selling the last of its gold reserve – right down to gold's low of 253.

Today's "sure thing" is that policymakers will continue to drive long rates down.

This has forced the USB to a Weekly RSI of 82.6. As noted above the secular bull market for the long bond began in September 1981 and this momentum number has only been at this level three times.

The price rise is becoming exceptional and the ChartWorks is watching for the opportunity. Often, the excesses that go with "sure things" create identifiable technical patterns.

• "Central bankers have two principal objectives: avoiding responsibility on the one hand and achieving public prestige on the other." – Milton Friedman.
• "Most bad loans are made in the good times." – Alan Greenspan, March 9, 2000.
• "Caveat: No matter how violent the reversal nor how strident the preceding enthusiasms nor how big the losses – within a week of the shock there is no one who didn't make the call." – Bob Hoye, April 14, 2000.

Written By: Bob Hoye