October, 2009 Archives


Bond Market Jitters

by Riaan Nel in News

Just before the Columbus Day weekend Fed Chairman, Ben Bernanke, made a speech discussing the Fed’s balance sheet and the removal of monetary stimulus. There is much angst about inflation, and the depreciation of the dollar due to the unprecedented increase in the money supply. The bond market reacted negatively to Bernanke’s comments, seeing a warning that the FOMC will increase the Federal Funds rate.

A jittery bond market is also a reaction to a lackluster 30-year Treasury bond auction last week. The way the Federal Government borrows money to fund its operations is through a US Treasury Department auction. The Federal Reserve Bank of New York functions as the intermediary in the auction. Traders bid for the bonds using a Dutch Auction method. Treasuries will be awarded to the highest bidder. Remaining Treasuries will be offered to the second highest bidder at that bidder’s price, and so on until offered Treasuries are sold. Obviously the US Treasury wants the highest possible price (and lowest possible yield).

Another factor that contributed to the sell off last week is apparent disagreement amongst Fed officials about the timing of raising the Federal Funds target rate (which is currently at a target of 0-25 basis points). Since the September 23 FOMC meeting Regional Presidents Fisher and Lacker, as well as Fed Governor, Kevin Warsh warned of rate increases. On the other hand, Atlanta Fed President, Lockhart and Vice Chairman, Donald Kohn, made statements supporting a need to maintain accommodation (Fed speak for not raising interest rates).

Short term bond rates are highly susceptible to the Federal Funds Rate, whereas longer-term bond rates, although influenced by the Federal Funds Rate, are more influenced by inflation. Generally, an increase in the Federal Funds Rate leads to lower bond market returns.

It seems to me that inflation might be contained for the moment. There is a lot of hype out there about the specter of rising inflation, but it is just not showing up in the data yet. The Fed will also likely wind down some of the other non-traditional measures employed in the wake of the 2007 Global Financial Crisis (the so-called “quantitative easing”, which can be translated as “let’s through money out of helicopters” to supply the system with liquidity, referencing a remark by Ben Bernanke in what the Fed should do when things really get bad).

Recent remarks by the Fed might be in response to large amounts of cash returning to banks. The Treasury bill market is shrinking by $185 billion as the Treasury Department winds down the Supplementary Financing Program (SFP). SFP was an emergency program launched last year by the Treasury Department to provide the Federal Reserve with funds for their extraordinary programs. SFP funds were generated through Treasury auctions. The Fed might start with large scale reverse repurchase agreements. In a reverse repo, the Fed sells Treasuries to banks, which is a way of immediately decreasing the money supply to curb inflation.

I am in agreement that the Fed might start raising the Federal Funds Rate some time in 2010. One way of measuring expectations of a rate hike is to look at Fed Fund Futures. Based on these Futures prices a rate increase is expected by April 2010. To mitigate the impact of rising interest rates on bond prices, investors might consider corporate bonds, High-Yield bond and Emerging Markets bonds. These bond types will absorb the price decline of bonds better when interest rates increase, and in the mean time they offer attractive interest income.


America in 2013

by Riaan Nel in News

A recent article appeared in Harvard Business Review by Niall Ferguson discussing the implications of the financial crisis for America.  I have studied some of Ferguson’s previous writings, and I respect his grasp on finance.  In his Harvard Business Review article he offers a conjecture of a worst-case scenario of the current economic malaise continues.


It is 2013 and Citibank and Bank of America have merged to form the government owned Citibank of America.  The merger was not a voluntary act, but was forced on them by the US Treasury.  The number of US banks has fallen by half (in 2007 there were 8,534).  More than two thirds of hedge funds were no longer in existence.  The regulatory framework imposed by Geithner imposed restrictions on executive compensation, bank capitalization and derivative trading.  Retail banking in 2013 operated like a public utility.  All financial entities, including insurance carriers, have to operate under the supervision of the “Financial Authority for the Regulation of Systemic Institutions (FARSI)!


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New Bubbles?

by Riaan Nel in News

It has been mentioned that we might be experiencing a new equities bubble, in conjunction with a bond bubble!  The argument goes something like this…

Through TARP and the Federal Reserve programs nearly $2 trillion have been pumped into the economy.  The result is banks have embarked on a stock-buying spree which is fueling this new equities bubble.  At the same time we have the government issuing more debt to finance our ballooning deficit – almost $1.9 trillion, four times last year’s average.  The issuance of more debt to fund government spending is leading to a bond bubble – or more specifically a treasurys bubble! 

Adherents to this argument maintain the current rallies in the stock and bond markets are unsustainable, and we are in for another “crash” or downturn.  This could severely constrain our nascent economic recovery.  Add to this concerns about a jobless recovery, which translates to a much slower recovery, as well as continued concerns about real estate. 

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