There were three Treasury bond sales last week. There was one short-term bond sale with a maturity date of two years and two bonds sales with long terms—five or more years. The short-term sale went adequately, but the long-term sale was missing something. Our nation investors, like China, Japan and Korea, were absent—all of them. It sent the message: “Why buy long-term U. S. Treasury bonds when the prices are going down?”
In this era of spiraling debt, the sale of Treasury bonds is a key indicator in the confidence the world has in our economy. Bonds have an inverse relationship with profit. Low bond prices give high yields and high bond prices give low yields. Profit or yield is why someone or, more to the point, some country would buy U.S. Treasury bonds. We use the sale of those bonds, to finance our debt. For the government, it is ideal to have high prices and low yields. High yields increase the cost of servicing our debt and increase the deficit.
There has always been a big demand for our Treasuries. Buyers of the bonds are loaning us money. They get a solid return on their investment and a safe commodity while the U.S. gets dollars to finance its deficits.
Following the lack of interest in the recent Treasury auction, a Financial Times reporter wrote, “The bond vigilantes are finally flexing their muscles. A long period of stability for the U.S. government bond market showed signs of cracking this week as a lack of investor appetite for new debt sent the benchmark 10-year yield to its highest level since last June.” Remember that inverse reaction, a high yield means low Treasury bond prices and higher deficits. That begs the question, “What happens when America’s credit becomes Third World?”
David P. Day, registered investment advisor and former commodities broker, said, “What happens if China quits buying Treasuries? We saw a little bit of that last week, it was chaos in the bond market.” The absence of our foreign “partners” in the two long-term sales last week means they think they can get a better yield if they don’t bank on us long term. They are betting that the price of future bonds will be heading down, increasing their profit.
The speculation centered mostly on the absence of China. Did it reflect that things are heating up in our trade markets, the friction between their currency and our currency or it could be a Chinese dare?
“They [the Chinese] should diversify their investments and maybe that is what they are signaling. As an advisor and if China was my client, I’d be advising them to have more than U. S. Treasury bonds,” Day said.
Day said there are two things to remember when looking at the “bond chaos.” When the sale opened, the Treasury had to open at a higher yield than in the open market just five minutes before. Also, the “bid to cover,” which is the number of bids for one dollar of Treasury bonds, was below average. The bidders just weren’t out there on the long-term bond sales last week.
Who is buying? American banks are. They are buying Treasury bonds with low prices and high yields. The troubles is, if they can get a “guaranteed” rate from the Treasury, then why take the “risk” of lending money to people and small businesses? Our own government’s reckless spending and the financing of that spending is making it more profitable for banks to keep their money and not lend it out in the communities.
As a side note, buried in Obamacare is the provision to take over the student loan program. The government will get money from the Treasury at 3.8% and they plan to loan it out at 6.8%—that shows you where they think the market is going. Much higher interest rates to borrowers could stifle economic recovery.
One bright spot is the relative strength of the dollar. The instability in Europe (PIIGS-Portugal, Ireland, Italy and Greece are facing the prospects of bankruptcy), has caused the value of the dollar to go up. Right now, there is a huge demand for the dollar. Japan is in deflation, no one wants the yen. “Even Goldman Sachs changed their analysis Monday and said we have seen the bottom of the dollar,” Day said. This could make demand for treasuries higher.
Here are the things to watch. Will we reach a one-to-one ratio on our debt to our GDP? We have about $12 trillion in debt and our GDP is at the $14 trillion plus range, so this benchmark could come soon. In addition, most believe if the servicing of a nation’s debt is more than 3% of GDP, you are in trouble. We are currently approaching 4% and there’s no end in sight if we add a trillion dollars to the deficit every year as projected. “We may get downgraded, if we do, no one will want our treasuries,” Day said.
The only hope is cutting spending. Taxation won’t make the markets secure. But there is still hope: the best way to increase revenue is to get more people back to work. The jobs numbers will be released on Friday, which is a holiday on Wall Street and for most of the Christian world, and they may be good for a change.
So watch the Treasury bond sales and who shows up to play.