The Fed Scares Everyone About Treasuries From Time To Time. Is It A Scam?

From time to time, the Fed and its cronies scare everyone. And maybe those who are not actually cronies, chime in. Certainly this issue of lack of liquidity is scaring people. Articles abounded in the second quarter regarding this coming liquidity crunch. 

Yet when push came to shove, China was able to unload 100 billion dollars worth of treasury bonds through Belgian dealers. No crisis there. So what is really going on? From a distance we need to distinguish two issues. 

The first issue is this fear of liquidity. Dealers in America are not making markets in treasury bonds, due to regulations forcing them to be more conservative. But the Belgian dealers had no trouble dispensing Chinese owned US treasury bonds with no liquidity problems at all. 

The second issue has to do with a shortage of bonds, due to the fact that the Fed and China and others have a bunch of them and yet bankers want to use them for collateral in clearing houses in the derivatives market. 

So, some have tried to fuse the two issues. But I think one issue is real and the other is fake. The real issue is the second issue. There is a need for treasury bonds as collateral. The fake issue is issue number one, and is really a new twist on an age old plan, to scare people to unload bonds so the clearing houses can get them and so there can appear to be less demand for the bonds than there is. 

The demand from clearing houses for more collateral in deals is new, but fear of rising interest rates is old. So, scare people with the threat of rising interest rates, and they sell these valuable bonds that can then be used for collateral. 

So, what are the telltale signs of the conspiracy. First, the Fed has one job, and one alone. Its job is to buy and sell bonds, preferably to sell them. The Fed wants to sell bonds, and stimulate the bond market so that clearing houses won't face a shortage of bonds. 

It is necessary to know that we have two threads of commentary going on at the same time. First, the Globe and Mail said we had a shortage of bond buyers. Hmmm. Wolf Richter said that everyone will head for the exists when it is time to sell these bonds out of fear. His view is that they are overleveraged. People will have to get out. 

Zero Hedge spoke of a crisis in margin calls because of CDSs, not because of treasury bonds. But Zero Hedge has warned about this liquidity problem in treasuries. Are they just reporting? Are they fooled? I don't know. Bloomberg warned of treasury liquidity drying up, however, in more than one article. 

A few months after these warnings, the Chinese decided to sell over 100 billion dollars of treasuries with no trouble at all! 

And Washington's Blog reported that there is a lawsuit filed after the "warnings"  claiming that the big banks, the dealers who suddenly didn't want to be market makers, were actually rigging the bond market, no doubt with the Fed's blessing. 

So, why would the primary dealers want to dry up liquidity? Well, it is pretty simple. They want borrowers to pay higher interest rates.  And if you don't think that this is a scam of sorts, Alan Greenspan said that very thing. He said bond investors will not stomach low interest rates for much longer. 

Does anyone really believe Greenspan? It appears that there are fewer buyers because the banks who want higher interest rates are squelching liquidity. That appears to be a classic scam. It appears to be a conspiracy.

There are obviously margin calls in markets all over the place. But that should cause a flood into treasuries and more demand for them, as well as lower interest as they go up in value. It doesn't make sense to me that treasuries will fall out of favor in this environment. 

The only way treasuries could fall out of favor is if there is so much money chasing them that they have become like commodities, like copper, or stocks, and are subject to massive margin betting. 

In crisis they have always been cover from the storm. If that is no longer true, then the Fed has allowed cornering of the bond markets, and they will no longer be doing their job to sell bonds as the most important thing they do. At that point in time, why even have them around. 

Truth is, treasury markets have been cornered before, forcing prices up and yields down. But that was before the massive demand for bonds in the derivatives markets. That demand has not abated. Therefore, rather than the markets being cornered, the dealer banks want to push down the prices of the bonds, and raise interest rates,  just the opposite effect of cornering the market has done in the past.

So, it appears that the Fed and Greenspan and the dealer banks just want to drive the price down so it doesn't look like a bubble. They know people think the high price/low yield state of the treasury markets is a bubble. But is it? I don't think it is at all. How can it be a bubble when, as Zero Hedge said, there is simply not enough treasuries to go around as collateral? Zero Hedge goes on to say that makes it a bubble. But real demand isn't a bubble, and there is real demand for these bonds. 

So, the beat goes on. Everyone says there is a treasury bond bubble while these same people say there is a shortage of these bonds as collateral. That is why I believe the shortage of bonds is real and the lack of liquidity is fake or at least manufactured by manipulators. 

Just remember, we know that the Fed scares people with the threat of higher interest rates and then never raises the rates. They know the banks have bet on low rates. That is a pretty easy scam to spot, but the treasury bond market-as-a-bubble scam is harder to uncover.

I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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Gary Anderson 7 years ago Author's comment

Author note: According to Bloomberg, there is a potential scam pushing bond prices lower and yields higher. The yields should be lower, and there is more demand for bonds than the bankers are allowing, according to the lawsuit: