* This post was written in 2011 before Mr. Roche founded Monetary Realism, which was formed due to several disagreements Mr. Roche and many other former MMT proponents had with the school of thought.  For more info on the difference in views please see here.  For more on MR’s views please see here.


The “surge” in yields this week has many pointing to the end of QE2 as the beginning of the awakening of the bond vigilantes or even the beginning of the collapse of the mythical “bond bubble”.  But I went to find this “surge” in yields or “collapse” in the bond market and I had to pull out the trusty magnifying glass again.  As you can see below, Treasury yields are surging so much that you have to magnify the move by 10X just to see it on a long-term chart.

More hilarious is the fact that yields aren’t surging due to some bond vigilantes or fears that we are Greece as some fret over the debt ceiling.  Yields are surging at the same time equities surge, the risk on trade re-emerges and investors realize that the end of QE2 doesn’t mean the end of the world (most hyperinflationists still have no idea why this is even hilarious).

Just one week ago I said this was no time to panic about Greece, debt ceilings or even the macro picture (yet):

“Personally, I don’t think we need to panic just yet.  The China slow-down is far from overshooting to the downside and the Europeans simply can’t afford to let the situation spiral out of control.  There is too much to lose.   The European politicians have invested too much time and money into this Euro project to allow it to just crumble now.  China is a much bigger question mark.  Their economy is a black box of central planning and irrational government intervention.  One thing is certain – inflation almost always resolves itself in the form of recession.

The question now is how deep will the Chinese economy slide and how much will it hurt US corporations?   I think buy and hold investors are silly to wait around and find out.  In the meantime, I think the markets look more attractive than they did in May when I said we should all be hedging risk and/or selling.

…So, while I was bearish a few weeks ago I have moved towards a more bullish posture now. So, just to be clear, I am not long-term bullish, but I am short-term bullish.”

Investors were overreacting to all the bad news and becoming excessively negative.  This week’s very tiny move in yields is not a sign of the end of days.  It’s just a sign that too many big ____ swingin’ bond traders got caught flat footed.  So put that magnifying glass away and wipe off your forehead.  This is as much a non-event as the end of QE2.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  1. The best thing about the end of QE2, besides the fact that it’s ending of course, is going to be the hyper-inflationists, who believe “the USA is done”, explanations of the “bond vigilantes” who never show up….

    Time will tell.

  2. Cullen, is there any way we can access your market calls more easily? Your macro calls have been mostly spot on, but it’s the market calls that tie it all together and you don’t give them enough publicity. I am sure you have your reasons, but you’ve made some incredible market calls over the last few years and I am sure readers would benefit from increased detail. Thanks.

  3. They key will be the US muni bond market. That market WILL derail the Treasury market in the next months.

    Never heard of the socalled “”bond vigilantes”” ? They have been sleeping at the switch for the last 30 years but it seems they’re awake/awakening now.

    And when interest rates are going up by 0.25% across the board then the FED isn’t able to “”stimulate”” anything any more. Then the FED will have a negative cashflow.

  4. I have to keep some things close to the vest. The vagueness in my commentary on the buys and sells is intentional. Not that anyone would “figure out” my signals anyway, but I have to keep some things secret. Sorry.

  5. hilarious. this “collapse” in the 10y UST in the last week was all of 2.36% in price.

  6. how will the muni market “derail” Treasurys, Willy? and to what degree? another 2-3% sell off?

  7. Woke up just this week did they? Doesn’t look like a response that’s all that vigilante-like to me, a term which seems to be used to explain any sell-off these days. The sell-off looks more like the unwind of a rally caused by excessive fear, related to the US economic data in particular, and accelerated as uncertainty about Greece intensified, finished off with the shorts capitulating. Yields can’t collapse in a straight line, so a week of partial unwind isn’t the end of the world. The data simply argue for continued low yields. Bond vigilantes of decades past responded to high inflation and monetary accomodation of it. If there are any vigilantes around, I think they’re too smart to get too short, given demand-side inflation is very low, and the Fed-inspired supply-side ‘blip’ in inflation is over. Further, real short rates are consistent with the state of the output gap (definitely not the case in 2003-4).

  8. (Insert respectfully understanding but also sad face emoticon, here).

  9. The 10yr has fallen 3pts and the 30yr has fallen 3pts in price. Devastating I know. We used to get those kind of moves in an hour back in ’08-09, not a week. This move will be muted in the coming days and will most likely reverse out when Greece, Spain, Italy, (name a country) has issues again.

  10. QE is not ending. Its on pace for 300B a year in reinvestment from run off MBS and treausires.

    QE will never leave us

  11. Nottpc- yes….your spot on.
    QE is like herpes.
    And Ben Bernanke is the whore who gives it too you

  12. If you are referring to me, I think you have me confused with someone else. I have only made a handful of post on this site.

    The bonds are in a current short term downtrend at minimum. Do you know exactly where this down trend with stop? Is your crystal ball that good? If you don’t know where it will end, your entire post above is irrelevant. If you do, please let me know so I can profit from it.

  13. “Rates are controlled by the Fed.”
    Also, can you please explain how the Fed controlls the curve to cause an inverted yield curve.

  14. I should have said “control rates” instead of “controls the curve”.

  15. Long rates are really just an extension of short rates. The Fed doesn’t directly control long rates (as in, they don’t actually go in and set rates as they explicitly do at the short end), but long rates are an extension of Fed policy which is an extension of the Fed’s perception of inflation and economic strength. The bond market truly doesn’t “fight the Fed”. That’s why we see an 88% correlation between long rates and Fed policy. There is obviously a private market out there where bond investors are setting rates, but they don’t deviate too far from what the Fed is generally projecting. And if the Fed wanted to set long rates they absolutely could.

    An inverted yield curve occurs when the central bank wants to slow the economy. And the long end of the curve is happy to accommodate. In my opinion, the fact that curves invert actually corroborates the idea above that the Fed controls long rates. When the Fed is raising rates to match long rates they are basically saying “this is our effort to put a halt on credit expansion”. Long bond investors are happy to accommodate that Fed outlook and essentially bet on the Fed succeeding. Which they generally do (often times causing recession) and making those long bond investors look smart….

    Does that make sense?

  16. Cullen, I’ll direct you to the Fullwiler reply to your linked post:

    “Embedded in your analysis here, though not explicitly stated, is that the inflation expectations are largely based on the expected Fed reaction function. That’s the main reason all the inflation measures have such high correlations.”

    correlation does not equal direct causation. perhaps rates and Fed policy are both caused by economic conditions, and in turn inflation expectations? it’s a dangerous leap you make here.

  17. Fed can buy and sell as many Tsys as needed to hit any target long term rate. The only constraint on that is political.
    Not to mention that there is no need to issue long term debt at all.

  18. Since you’re ‘short-term bullish’, why do you feel the need to use a 50 year (!) chart to prove there was no ‘surge’ in yields?

  19. Because so much of the commentary is revolving around a “collapse of the bond market”, which implies a rather historical event, best tested against a longer term chart.

  20. I don’t disagree, but a 30 bp move is not bad on a percentage basis! And have you seen the percentage move in the 2yr yield?

  21. I’m no technical expert, but noticed distinct similarities in pattern and price levels on the TLT chart between the period 6/9/2008-10/27/08 & 1/31/11-today. In 2008 it preceded a 32% run up to $122.26. There is probably no relevance from a technical standpoint, but just wondered if there were opinions on this.

  22. “which implies a rather historical event”

    I have not validated the below comment by ZH. But, do you consider the below a historic event?

    Zerohegde said, “Epic Bond Rout Leads To Biggest Weekly Percentage Surge In 5 Year Yield In History”

  23. The key phrase is “percentage surge”. As I mentioned above, the move is indeed large on a “percentage” basis, but we are coming off an extremely low base.

  24. We saw the same in late 2010. When yields went up then with some delay the muni bond market got hit as well.

    The US sheeple have been pouring A LOT OF money into the muni bond market in the last 2 months, because interest payments are tax exempt and interest payments on Treasuries are not.

    More over, the muni bondmarket is (much) more illiquid than the Treasury. So, if the muni bond market(s) REALLY get hit severely then the financial pain WILL be immense. And that vanished wealth WILL increase deficits at the federal level. And I don’t know how much longer the muni bond market will remain upright. The charts are truly scary and vulnerable.

  25. When I combine a lot of graphs then I think A LOT OF speculators were short the equity markets and were forced to cover. Pushing stockmarkets higher and perhaps sell their T-bonds.

    But then explain to me: Why was the 3-month T-bill rate down and the silver-gold ratio down as well ?

  26. I wouldn’t pay too much attention to the T-bill rate as it is in a world of its own due to a technical squeeze. Institutions require tbills for collateral and will pay almost anything to get them at this point. They will even pay negative yields.

  27. By negative yield, I mean institutions are willing to pay above par for T-bills.

  28. No, In times of financial stress (like a recession) people will flee to the most liquid item and that’s T-bills. So, if investors would have thought that the US is on the verge of a new economic then they would have fled out of T-bills (again).

  29. Interest rates DO matter.
    In 1981 total US federal debt was about $ 1 trillion. If rates would have gone up across the board by 1% then interest payments would have gone up by $ 10 billion. But now with the federal debt at $ 14 trillion a rise of 1% across the board will cost the Treasury an additional $ 140 billion.

    Here’s another dilemma for investors. With T-bill rates this low there’s no penalty for withdrawing your money from the bank and putting it in the mattrass.

    More over, I guess a lot of speculators were long the 30 year and the 10 year future. With such a dip in the futures a lot of speculators have been burned and were forced to liquidate. Hence the spike in interest rates. But I don’t think those “”longs”” will return (in droves) any time soon.

  30. Here’s a much more plausible explanation why interest rates spiked up. When I read the article correctly then this is a situation of “”The US government won’t pay””. If this doesn’t wake the bond vigilantes then I don’t know what will. And those “”bond vigilantes”” are nowadays “”investors”” abroad.

    The US has been running Current Account Deficits since the mid 1960s EVERY YEAR and that resulted in the US becoming a net debtor to the rest of the world since the late 1970s/early 1980s. Before that they were a net creditor to the world. And that’s the reason why the US is, in two ways, dependent on the kindness of strangers. If those strangers pull the plug on the US then the US is toast. Whether our TPC likes it or not.

  31. Come off it. Your “kind foreign investors” (and I assume you mean the large holders of Treasury bonds such as China) are pretty much buying as a consequence of their own trade surpluses with the US. Simple as that. They generate the dollars, they invest them. The alternative for the Chinese (in particular) is that they are generating such capital deficits by holding their currency well below fair value. If it were not so, they wouldn’t have the dollars to invest. Why should China “pull the plug” on its very own economic model, especially given the risks involved in terms of growth, social unrest and so on?

  32. William, it was clearly not flight-to-safety investors that sent t-bill yields into negative territory. It was technical banking issues. If it were a FTS, Treasury yields would have dropped across the curve. They did not.

  33. Technical issue ? Yes, the graph of the 10 year and the 30 year were looking “”tired”” and went up too much too fast. But the muni bond market looks tired as well. And the muni bond market will – IMO – tear down the T-bond market.

  34. Agreed, the chinese will hurt their own economy when they start selling their USD denominated holdings. But they ditched a large chunk of their Agency paper holdings in the 4th quarter of 2010. And that was precisely the timeframe when US interest rates started to go up. The same happened in the second half of 2008. So, they acted like what any other investor would do when the value of their holdings go down in value: SELL !

    When the negative sides of holding T-bonds outweigh the positive sides then they WILL sell their USD denominated holdings. And one of those negative sides is US meddling in e.g. Aghanistan.

    Remember, like TPC has said, they can hold their reserves in cash.

    Moreover, the chinese are issueing Yuan denominated debt in order to facilitate their trade with Asia (e.g. Russia) without the USD. And that on its own reduces the demand for T-bonds.

  35. Equities had a long run and needed a catalyst for a pullback,which was the soft patch,end of QE2 and Greece.Greece has disappeared for the moment and the remaining problems can’t compete with the expectation of strong earnings.So people are selling treasuries and buying equities.Seems simple to me but yet so many complicated theories.Sure,things are different this time,with the probability of debt-induced economic collapse…just joking. Is it possible a fear bubble needs to be unwound? Not saying “The Big Short II” can’t happen but that doesn’t seem to be the play at hand.