Long Bond Assassinated!
Adam Hamilton November 2, 2001 3224 Words
“At the end of the day it’s Uncle Sam effectively trying to reduce long-term interest rates.” – Paul McCulley, Pacific Investment Management Co., October 31, 2001
I could hardly believe my ears. As I was diligently working on the new November issue of our private Zeal Intelligence newsletter for our clients (this month we discuss radical-Islam’s strategic mission, the war, inflation, oil, gold, equities, the US economy, specific stock and option trades, etc), a stunning announcement leapt out of the mindless CNBC background noise.
I was not even remotely paying attention to the low-volume bubblevision perma-bullish cheerleading for the markets, but as the news hit the wires my subconscious went into shock and my head jerked up to look at the tube as if Mike Tyson had blasted me with an uppercut. I probably would have been less surprised if the talking-heads on TV had said that the DJIA had rocketed up 5,000 points in the first hour of trading!
But, alas, even as I refused to believe my eyes and ears, the talking-heads claimed that the US government was assassinating a grand old friend of traders and a stalwart pillar of the financial markets, the noble Long Bond. Although I can’t prove it, I am sure I shed a tear or two as the dire news sunk in. Halloween 2001 was certainly a dark and evil day that will live forever in financial market infamy.
The benchmark 30-Year Treasury Bond has been around since it first sprung from the womb in early 1977. In somewhat of a paradox, the Long Bond was not even 25 years old when it was cut down in its prime. The US Treasury announced the suspension of all sales of new 30-Year T-Bonds, although existing instruments can still trade until the government buys them back to retire them. The Long Bond has been eagerly watched with awe for decades, carefully monitored by big and small market players worldwide.
The Long Bond was so celebrated and watched carefully with such great affection because it was a critical bellwether for bond market future-expectations of inflation. In addition, it had three attributes unparalleled in the world of intangible financial instruments.
First, sovereign debt issued by the US government is considered “risk-free” in most financial circles, so the yield on the 30-Year T-Bonds was the ultimate long-term proxy for divining the current opinion on future inflation. As there was no default or credit risk attached to the instruments by the market, they were perceived as pure unadulterated proxies for future expectations of risk-free nominal returns, which include inflation.
Second, it was the lowest possible risk financial instrument with a time horizon decades into the future, so investors and traders could monitor the Long Bond’s movements as they tried to build inflation and “risk-free” long-term interest rates into their long-term financial models. Since we mortal humans usually live for less than a century, and our useful investment years are about half a century, the rock-solid financial commitment behind the Long Bond for three decades into the future was truly the ultimate long-term instrument in the chaotic financial arena.
Finally, in addition to having an exceedingly long time horizon in today’s short-term quarter-to-quarter feeding-frenzy of a financial melee, the Long Bonds had the advantage of, well, being bonds! The overall bond markets are larger and far more sophisticated and professional than the speculative froth of the equity markets.
Bond traders and investors are generally very knowledgeable about everything in the financial markets. They watch bonds, they watch stocks, and they carefully monitor the overall health of the US economy. Your neighbor’s bored 12-year-old kid probably isn’t going to be day-trading bonds in his spare time! Professional bond market players are held in awe by the markets as they seem to operate on a different plane than the rest of us.
These three crucial attributes made the Long Bonds unbelievably important. They were issued by the best credit risk on the planet, the US government, they covered an enormous chunk of time in the future, and they were traded by elite financial professionals who truly strive to understand markets and not just cheerlead for Wall Street puppet-masters.
The Long Bonds will be sorely missed by investors all over the world. The US Treasury’s surprise Halloween announcement that it was selling no more new 30-Year Treasury Bonds was truly extraordinary and a landmark event in the modern history of the financial markets.
The untimely demise of the hailed Long Bonds was accompanied by strange handling that stunk to the heavens of strategically-planned market manipulation and psychological warfare against investors.
First, in a tactical move that probably bubbled-up from the twisted mind of one Robert Rubin, the Long Bond assassination announcement was exquisitely timed to provide the maximum raw impact and diversionary effect.
The US Treasury made the earth-shaking announcement shortly after the new preliminary Q3 GDP numbers were released, which heralded the first official shrinking of the US economy in a decade. Rather than announcing the Long Bond sale elimination after market close or on a weekend when the huge news would have had time to be properly digested before trading, the markets’ attention was abruptly drawn to the Long Bond tidings which greatly eclipsed the recessionary worries.
Second, the announcement was sprung on the morning of the last trading day of the fiscal year for many mutual funds, which control and move vast amounts of capital. The highly disruptive mid-morning declaration of the cessation of Long Bond sales no doubt caused much scrambling among certain key funds to figure out what implications the wild bond market moves had rather than doing their normal fiscal year-end adjustments. It altered trading patterns dramatically.
Third, many big bond players on Wall Street were utterly furious because the US Treasury leaked the information to certain firms 20 minutes before the official announcement at 10:00 AM eastern time. The stunning surprise announcement sparked the biggest bond rally in history, and certain elite trading houses jumped the gun and traded on inside information to make fortunes before the rest of the world knew. As a testament to just how negligently the Treasury handled the announcement, it was posted on the Treasury’s website 15 minutes before it was actually made at 10:00 AM. Unreal!
Some Wall Street bond traders claimed that there was blatant insider trading by elite market players who sit on the Treasury Borrowing Advisory Committee. They reported that the market went insane before 10:00 AM and most traders were rushing to figure out what the heck was happening in the world. Unfortunately, the SEC would never even consider investigating the unholy alliance between certain Wall Street mega-companies and the US Treasury.
Overall, on multiple fronts the tactical timing and the handling of the tidings of the death of the Long Bonds stink to high heaven.
Why did the United States Treasury destroy the leading intangible indicator of inflation, try to manipulate markets on a month-end immediately after a dismal GDP announcement, and then selectively release the information to insiders first so they could make illicit fortunes? A couple of graphs will help us investigate these crucial questions.
First, we constructed a yield graph of the entire history of the Long Bond and superimposed that on top of the ultra-short-term Federal Funds rate that the Federal Reserve actively manipulates. The data series are weekly and are direct from the Fed. As in all studies of markets, a long-term strategic view is absolutely essential for placing current events into proper perspective.
One of the arguments that the brilliant bureaucrats at the Treasury tried to foist upon the markets to explain their atrocity was that eliminating the 30-Year T-Bond would save the taxpayers money. The idea behind this argument is that it is cheaper to borrow to finance our extravagant government spending over the shorter-term, less than 10 years, instead of going out long-term. While the interest rates are generally lower the shorter the term of a bond, this argument does not hold much water in light of the history of the Long Bond yield shown above.
On the day before the announcement, the Long Bond yield was hovering around 5.25%, which, as is readily apparent in the graph above, is not far from an all-time low yield. Our goofy Treasury, once again defying all logic, decided to throw away the opportunity to lock in multi-decade low interest rates for decades into the future. An enormous source of cheap long-term financing was scattered to the winds.
This monumental lost opportunity can perhaps best be understood in terms of a home mortgage.
Most Americans, who are rational unlike unaccountable bureaucrats sheltered from reality, love low long-term interest rates so they can lock-in favorable long-term borrowing. When interest rates are at a multi-decade low, American homeowners choose to refinance their mortgages at low long-term rates so they ultimately pay less interest to their bankers. What the US Treasury perpetrated this week was like walking away from a fixed mortgage at the lowest rates imaginable, and instead exposing itself to the vagaries of the turbulent shorter-term interest rate markets.
Would you, if you knew interest rates were at multi-decade lows, spurn a fixed mortgage and go for a risky adjustable-rate mortgage? Not a chance! Yet our silly Treasury has done just that, thrown away a stellar fixed rate opportunity and shackled our country’s future in an ARM that has nowhere to go but up over the long-term.
Now, instead of us hard-working taxpayers locking-in a super-low 5.25% payment on our government’s vast debt for decades, we are stuck with the equivalent of an adjustable-rate mortgage near record low interest rates. It is pure lunacy to cast aside rock-bottom long-term financing and fully expose oneself to the highly volatile short-term market. In the graph above note that overnight rates exceeded 20% in the early 1980s while Long Bond rates were far more stable.
When interest rates are running at multi-decade lows, prudent, rational Americans rush to get long-term loans to capture those favorable rates. Not our government though! We voters and taxpayers who pay the bills, and our children and grandchildren, should be outraged at this latest US Treasury stunt!
A second Treasury argument advanced was that because of current budget surpluses the US Treasury will not need to borrow enough money in the future to need to issue 30-Year Bonds. Apparently the Treasury minions who came up with this shallow argument do not realize that we are at war. Wars are exceedingly expensive, governments always borrow huge amounts of capital when they let slip the dogs of war. Also, US tax receipts will implode with the rapidly slowing US economy, gutting government revenue.
I did not hear the Treasury advance a single plausible argument in favor of the untimely demise of the Long Bond.
As an interesting sidenote, notice the red arrows on the graph above. They mark inverted yield curves, when short-term interest rates exceeded long-term interest rates.
Interestingly, after every inverted yield curve episode, the United States lapsed into a recession. It happened like clockwork every decade or so in the graph. For those of you who are keeping score and trying to see through Wall Street’s endless bullish propaganda, note that in 2000, when the yield curve was last inverted, the vast majority of Wall Street firms said that “this time it is different”, that the latest inverted yield curve did not mean that a recession was imminent as past inverted yield curves had heralded. Never forget that in general Wall Street is always bullish, regardless of the evidence!
The skull above, of course, marks the assassination of the Long Bond by the US Treasury. The white arrows in the graph mark other episodes in recent history when the Fed eviscerated short-term rates but the Long Bond yields took awhile to follow.
Our next graph is from the same dataset, but zooms in on only the last three years.
Once again the red arrow marks the inverted yield curve. The white arrow marks the short-term rates plunging fast while the long-term rates lag. You know what the skull means. It really was a sad, sad day that will live forever in financial market infamy, folks! Mourn the terrible loss of the Long Bond!
The crime scene becomes much more clear, however, when we note the commencement of the Greenspan Gambit. Before his New Year’s hangover had even worn off, Alan Greenspan and his command-and-control band of merry market manipulators at the Fed began the most aggressive series of Fed rate cuts in the entire sordid 88-year history of the private Federal Reserve Bank. The yellow arrow in the graph marks the first surprise inter-meeting emergency 50 basis point Fed Funds rate cut.
Wall Street widely heralded the first surprise cut as the Second Coming of the Great Bull Market, and proudly proclaimed happy days were here again because the Fed was on the case. We, and many other contrarians, laughed because market-manipulation of short-term interest rates did not address any of the underlying massive structural problems of the US equity markets and economy. We published two essays outlining the unadulterated folly of these interest rate cuts in January 2001, “The Greenspan Gambit” and “Bubbling Interest Rates”.
Unfortunately for Greenspan and his many cronies on Wall Street and in the US Treasury who don’t believe in free markets, the Long Bond refused to cooperate with the Greenspan Gambit interest rate-slashing frenzy. As we pointed out in our May essay “Revolt of the Long Bond”, Greenspan was in big trouble as the Long Bonds just laughed at his frantic efforts to re-inflate an enormous bursting equity bubble. Long Bond yields remained stubbornly high all year, much to the chagrin of the perma-bulls.
Long Bond yields are hyper-critical because 30-year mortgage rates are set off them. Because Long Bond yields would not fall for Greenspan nor give their blessings to his enormous inflationary gamble, US consumers could not get a few extra dollars a month to spend due to lower mortgage rates. You should seriously consider reading our earlier “Revolt of the Long Bond” essay to fully understand the situation and how much peril into which the Long Bond was plunging the Federal Reserve. This background is extremely important.
The Long Bonds refused to play ball with the Fed all year because bond traders were very wary of almost unprecedented money supply growth by the desperate Fed. In order to vainly attempt to re-inflate the great equity bubbles and stave off the painful but necessary post-bubble unwinding of gross speculative excesses, the Greenspan Fed has inflated our money supply enough this year to put most Banana Republic despots or even the infamous John Law to shame. (For background on historic monster-inflationist John Law, see our “Exploding Inflation” essay from February.)
The Fed was stuck between the jagged rocks of fundamental reality and the worst bust since the Great Depression. It knew long-term interest rates had to go down, but the free market wouldn’t cooperate because it discerned the Fed’s enormously dangerous inflationary course. Inflation is caused by relatively more money chasing relatively fewer goods, services, and investments. As we chronicled in our recent and popular essay “The Inflation Tsunami”, the Fed had recklessly ballooned the narrow MZM money supply by over 17% in a mere year even before the 9/11 attacks!
The Long Bond market intimately understands history and knows well that running the proverbial printing presses inevitably leads to inflation down the road as surely as winter follows summer. We believe Long Bond yields would not cooperate with the Fed and plummet because they knew that the risk of serious inflation like the late-1970s was growing every day that mad-inflationist Greenspan controlled the helm of the Fed.
The bottom line is the Long Bond would not participate in the great scam of denying inflation while at the same time the Federal Reserve was frantically flooding the US economy with new money.
After the Fed had brazenly manipulated short-term rates down by 400 basis points in 10 short months, the Long Bond had only coughed-up 12 basis points in yield. It had to go. The great bubble re-inflation scheme required lower long-term interest rates than the free market would provide. If you can’t beat ‘em, kill ‘em!
Since it wouldn’t play their dangerous game, the Federal Reserve and US Treasury decided to assassinate the noble Long Bond. If the Long Bond free-market would refuse to ignore the vast deluge of newly created money that was flooding into the US economy, then the socialist command-and-control manipulators figured they would just bury a couple 9mm slugs into its skull and toss it into the financial market dumpster.
The Long Bond was assassinated to silence a key warning sign for the impending inflationary tsunami rapidly approaching American shores!
This Federal Reserve/US Treasury episode of blatant market manipulation would alone be disturbing enough, but unfortunately it is part of a concerted campaign.
Gold, the ultimate inflation barometer, has long been actively suppressed by the US Treasury. We have written well over a dozen essays and many private newsletters on various aspects of the gold market manipulation including why it is happening, how it is being done, the evidence for the manipulation, etc. Investors all over the world are realizing that all is not as it seems in the incestuous secretive world of gold.
During Bill Clinton’s second run for President, the US Treasury got involved in dumping gold on the world market as well as enticing or strong-arming other countries’ central banks into doing the same to protect the overvalued US dollar, bolster the US equity markets, and most-importantly to camouflage gross past policy mistakes because silencing gold would eliminate the primary warning investors could look to for forewarning of impending inflation.
After gold was bound, gagged, and bagged, the US Treasury eliminated sales of the 1-Year Treasury Bill earlier this year. All interest rate percentages are ultimately distilled down to single year bases, so without the 1-Year T-Bills the “risk-free” benchmark interest rate for one year was no longer available to the markets as a baseline for measurement. Now investors are forced to interpolate between 180-Day Treasury Bills and 2-Year Treasury Notes to try and determine what the one-year “risk-free” basic interest rate should be.
Slowly but surely, the US Treasury and US Federal Reserve are obscuring the standard benchmarks that tie the equity markets down to reality. In the twisted minds of the socialist bureaucratic minions, they must reason that if they can destroy all the market instruments that are not sending the politically-correct pro-equities message, then the free markets will bend to their will. The slaying of the Long Bond was just the latest attack in this strategic campaign of financial deception.
Unfortunately for them they are badly mistaken, as history has proven innumerable times. Free markets defy all attempts to be tamed and broken by force or treachery. Each time the US Treasury or Fed shove their filthy hands into what should be free markets, the economic realities further deteriorate and the ultimate recovery is pushed further out into the future. The manipulators can temporarily obscure truth and fundamentals, but they cannot alter them.
To lovers of free markets and truth, the assassination of the Long Bond was an outrage that will not soon be forgotten.
Adam Hamilton, CPA November 2, 2001 Subscribe at www.zealllc.com/subscribe.htm