Hearye, Hearye: The Treasury Bubble is Bursting

Disclosure: This post may contain links, which I may receive compensation at no additional cost to you. Read my disclosure for more information.

It is now the beginning of the end of the treasury bubble.  As investors feared further financial decay, treasuries were the hottest security on the market.  Today, they're hardly drawing any interest and rates are slowly, but surely, creeping upward.

Bubble Burst 101

Cash was king, but cash isn't good enough for the biggest investors.  Institutions, banks and investment management companies have little interest in cash.  Cash is only guaranteed up to $250,000 by the FDIC, per account per person.  To contrast, many banks have several billion dollars that must be parked safely and in such a way that there is no risk of loss.  You could keep the money in hard cash, but there aren't enough dollars in circulation to back up the assets of one state's worth of banks, let alone a whole world's worth.  When it comes to large corporations and even larger investment banks, there is no better solution than treasuries, which like bank accounts, are backed by the government.  Consider it the FDIC of the super wealthy.

A Massive Supply

The supply of treasury bonds is exploding as the government looks for better ways to raise cash to fight off the recession.  However, the problem is that the government already has extensive amounts of debt that must be serviced on a regular basis; that debt is repaid with additional treasury issuance and then there is more debt on top of this amount.  The debt is growing faster than the money supply, and investors aren't interested in near zero returns any more.  In just one month, treasury yields on the 30 year bond soared by more than .5%, which is a lot of money when nearly a trillion will have to be borrowed this year alone.

Waning Interest

Safety is no longer number one priority; banks are well capitalized, some retail outlets are recording impressive quarterly profits, and the economy is showing that it may bounce back in 2009.  All of these factors point to lower treasury prices and higher yields as treasuries begin to compete with stocks and bonds for an equal portion of investment bank portfolios.  Waning interest is never a good phenomenon, especially amid an incredible expansion in the supply of treasury bonds.

The Fed's Response

The Federal Reserve's quantitative easing measures were meant to drop treasury rates, but there is not oversight or information regarding how much of the $300 billion allotted may have already been plunged into the treasury market.  Assuming the Fed has used up its stockpile of cash, there is little hope that rates will drop; however, as there have been very few auctions, chances are still good that the Fed has an extra supply of money in its back pocket.  As it was the ultimate goal to make credit cheaper, the Federal Reserve is unlikely to act until interest rates begin affecting the mortgage industry.

Future Quantitative Easing Likely

Further quantitative easing could change the bond game forever.  With the market as it is today, further influx of cash would only work to encourage worries about inflation.  Investors are already preparing for inflation, gold and silver continue to hold onto highs, oil is making a rebound, and bond yields are rising.  More quantitative easing would send even more investors out of bonds, afraid that their assets could be wiped away by inflation.

Leave a Comment