Why Are Primary Dealers Buying US Treasuries?

Daniel Kruger writing in BusinessWeek provides the most helpful October 17, 2011, article Central banks sell most US bonds since 2007 as funds buy

Mr. Kruger writes describing the strong buying of US Treasuries by US Dealers stating “Demand at government auctions helps show why yields are at about record lows. Treasury sold $13 billion of 30-year bonds Oct. 13 at an all-time low yield of 3.12 percent even as demand from the class of investors that includes foreign central banks was below the average for the prior 10 sales. The ratio of total bids to debt sold was 2.94 times, the most since March. Investors bid $2.98 for each of the $1.68 trillion of Treasury notes and bonds sold this year. That almost matches last year’s record $2.99 in bids when the Treasury sold $2.2 trillion, and is up from $2.56 in 2007 when the U.S. issued $581 billion in notes and bonds, government data show.”

Mr Kruger continues: “That gap suggests that there is more untapped demand that will come from U.S. investors, said Amitabh Arora, an interest rate strategist in New York at Citigroup Inc., one of 22 primary dealers that trade with the Fed. “Our indicators suggest money managers are definitely underweight” U.S. government debt, Arora said in an interview.”

I comment that the explanation of money managers are “definitely underweight” is just a smokescreen and serves as an enticement for asset managers of mutual funds to buy Treasuries. I believe that the strong purchase of Treasuries by primary dealers is simply a commitment as part of an ongoing business plan to be one with the US Federal Reserve, it’s a marriage type of relationship: it is a do or die relationship.

1) … US Treasuries are going to fall dramatically in value.  

In my article World Stands At Brink Of Credit Breakdown, I relate more concern about asset deflation, than concerned about price inflation. I am more concerned about a rising 10 Year Interest Rate, $TNX, and a rising 30 Year Interest Rate, $TYX, from deleveraging out of US Government bonds, ZROZ, EDV, TLT, caused by China retribution for being labeled as a currency manipulator, as seen in the Flattner ETF, FLAT, falling, and the Steepner ETF, STPP, rising; and about disinvesting out of World Government Bonds, BWX, and Emerging Market Bonds, EMB, caused by debt deflation, that is, falling world currencies, DBV, and falling emerging market currencies, CEW. The 10 30 Yield Curve, $TNX:$TYX, is steepening, opening the door for bond vigilantes to start capital depletion of US Treasuries. The world is passing through peak credit as is seen in total bonds, BND, falling lower. Lee Adler writes in Financial Sense Foreign Central Banks Selling US Treasuries At Unprecedented Levels. And Tyler Durden reports 30 Year Bond Prices At Record Low Yield As China Flees, Direct Purchases Soar.

I am concerned about investors in US Treasury bond funds, as yields rise, then the value of the funds will fall. Debt deflation, that is deflation, in the US Treasury Bond funds, is coming soon.

And I am even more concerned about Money Market Funds, MMFs as they are between a rock and a hard place: the managers want safety and need safety, but are ever seeking yield to maintain customer base, which exposes them to buying high yield French bank debt. I see the very real possibility, as US Treasury yields continue to increase caused by a flight by China, that the MMFs wil  break the buck and that there will be a run on the MMFs.

Mr Kruger continues “Demand from U.S. banks has also underpinned Treasuries. Customer deposits at U.S. lenders have exceeded loans since December 2008, reaching a record $1.61 trillion in September, Fed data show. The wider gap and the deteriorating U.S. economy is prompting banks to buy Treasuries, according to Akira Takei, general manager of the international fixed-income investment department at Mizuho Asset Management Co. in Tokyo. Banks’ holdings of Treasuries and government-related debt totaled $1.67 trillion last month, approaching the record $1.69 trillion reached in May.”

“There’s potentially substantial demand for Treasuries” which will emerge over time, said Takei, whose company manages the equivalent of $43 billion. “Bank lending is clearly not rising, whereas deposits keep coming in, and most funds are parked in cash.”

Mr Kruger started his article by relating “International central banks are selling the most Treasuries since the credit crisis began just as institutional investors load up on U.S. government bonds.”

“The Federal Reserve said its holdings of U.S. government debt on behalf of central bankers and institutional investors outside America has plunged $76.5 billion in the last seven weeks, the most since August 2007. At the same time, bond mutual funds are adding Treasuries, banks have increased their holdings 45 percent in the past five years and the Fed has added $656 billion to its balance sheet this year.”

“Rather than a referendum on the U.S.’s $1.3 trillion budget deficit and rising debt burden, sales by foreign policy makers may have more to do with supporting their currencies after the Brazilian real weakened 9.8 percent and Taiwan’s dollar lost 4.7 percent against the U.S. dollar since June. With economists forecasting inflation slowing to 2.1 percent in 2012 from 3.1 percent this year and the Fed’s commitment to keeping interest rates near zero, investors say the demand that pushed government bond yields to record lows last month will be sustained.”

2) … Will price inflation come? Price inflation if it does come will from  manufactuers and retailers creating it to stay in business to offset falling demand. In this sense demand destruction creates inflation.

The Milton Friedman Free To Choose floating currency regime died in September as the US Dollar, $USD, rose and the world’s currencies, DBV, and emerging market currencies, CEW, and commodity currencies, CCX, turned lower with copper, JJC, and the Chinese Financials, CHIX. The Copper Bubble finally burst as in China they relied on ponzi credit, that is ponzi financing. Deflation in China Financials, CHIX, China Infrastructure, CHIX, China Materials, CHIM, Copper, JJC, and Base Metals, DBB, will be ongoing.  In the US they relied on ponzi loan programs, these were securitized by Mortgage REITS, REM, such as Annaly Capital Managment, NLY,  and sold as Mortgage Backed Bonds, MBB, as part of an ongoing GSE program to support debt ownership, that is loan owernership, which had the result of increasing moral hazard.

Irvine Renter in article Payment affordability in Irvine hits an 11-year high writes people used Ponzi loan programs to lower their monthly payments and ostensibly lower their cost of ownership. While they did lower their payments for a time, the terms of these loans were not stable. At some point, they needed to recast to fully amortizing loans which would be paid off. The “payment shock” of this recast was a timebomb waiting to blow up a family’s balance sheet. Most of these loans have already blown up, and the borrowers are waiting in shadow inventory for lenders to clear them out. And relates, the amend pretend and extend policy amoung linders has created a multi billion dollar problem in 2012.

People sought ways to defuse the recast bomb by a process known as “serial refinancing.” Right before the bomb was due to go off, people assumed they would be able to refinance into a new loan and reset the clock. Most borrowers believed these financing terms would always be available, so they had little risk of being around for the explosion. As we all know now, these borrowers were all wrong.

When considering the cost of ownership for calculations of payment affordability, the cost of an amortizing mortgage must be considered. Interest-only and negative amortization loans artificially lower the cost of ownership, but these methods are not sustainable.

Amortizing adjustable-rate mortgages are also a dangerous product. People select them because they carry a lower interest rate, and the payments are marginally more affordable. These loans work great when interest rates are falling, but when interest rates rise, loan payments go up, and the savings from early payments is more than made up for by increasing costs later on.

The real danger with an ARM loan is embedded into obscure terms of the promissory note. The loan is written with a contract interest rate that changes periodically. There is a contractual limit as to how high the interest rate can go. Unfortunately, affordability is only measured against the contract interest rate. If interest rates rise, the payments could very easily become unaffordable, and the borrowers could face the same problems with default and foreclosure many are dealing with today.

The worst part about ARMs is that the additional risk is not necessary. Fixed-rate mortgages also allow for refinancing when interest rates drop. Borrowers simply refinance into a new loan. There is no need to use ARMs to capture the benefit of falling interest rates.

Of course, despite the problems with ARMs, many people will still use them and assume the government will bail them out if the going gets tough. It’s hard to argue with a borrower who believes that. So far, the government has shown every sign of bailing out even the most foolish of borrower behavior.

It’s very difficult to predict what will happen with interest rates and inflation. We are at the bottom of the interest rate cycle now, and higher rates and higher inflation are a possible, perhaps even likely, scenario. In any case, locking in a cost of ownership lower than the cost of a comparable rental is usually a good idea. The danger being a rise in interest rates that causes further weakening of prices which makes it impossible to sell without taking a loss. Landlording becomes the logical alternative, but that isn’t for everyone.

The low interest rates and falling prices have finally pushed Irvine below rental parity. Not every house in every neighborhood, but a broad spectrum of housing options are now trading at or below rental parity. It still takes effort to find these properties, but they are common enough to warrant searching in Irvine if you are looking to buy now.

Most of the remainder of Irvine is showing falling prices and firming rents. When combined with falling interest rates, the result is improving affordability as prices fall below rental parity. We anticipate this trend will continue and reach its zenith for this year’s cycle in January. Prices over the next 6 months will generally be affordable by rental parity standards.

Prices are generally sticky on the way down, but they become much stickier when underwater owners don’t need to sell to patch a hole in their family’s balance sheet. Once prices reach rental parity, unless there is a huge influx of supply (which is still possible), prices generally don’t go much lower. Of course, rising interest rates could easily lower the value of rental parity, and eventually this will happen, but the federal reserve seems committed to preventing higher interest rates in the medium term.

My comment is that I see the interest rate on the US Ten Year Note, $TNX, rising rapidly; and there may be a influx of supply as banks my release shadow inventory.

The Australian Dollar FXA, The Euro, FXE, The Mexico Peso, FXM, The Canadian Dollar, FXC, The Indian Rupe, ICN, The British Pound Sterling, FXB, the Swedish Krona, FXS, The South African Rand, SZR, The Swiss Franc FXF, The Brazilian Real, BZF, The Japanese Yen, FXY, The New Zealand Dollar, BNZ, and the Russian Ruble, FXRU, all turned lower on exhaustion of Quantitative Easing, European Sovereign Debt angst, and on competitive currency devaluation, largely from the bursting of Copper Bubble.  I provide this Finviz Screener for those interested in establishing a portfolio of tradeable currencies.

With falling currencies, commodity prices will turn lower and the current nascient price inflation and PPI price inflation abate.

There will be little demand for the EFSF monetary authority bonds. Investors recognize that this is not a sovereign authority, that it does not have sovereign debt authority, and will not purchase its bonds.  Investors recognize that this is not a sovereign authority, that it does not have sovereign debt authority, and will not purchase its bonds. Investors and the rating agencies alike recognize that creating more debt via the EFSF CDO process is actually monetization of debt, and will call interest rates higher and ratings lower. M2 in the US will be turning down, now that the flight to safety in US Treasuries is over.  There will not be any Eurozone flood of money generating price inflation.  Thus price inflation in the US is simply a view from the rear view mirror, unless like in Argentina, and Brazil, there is price inflation coming from  manufactuers and retailers creating it to stay in business to offset falling demand. In this sense demand destruction creates inflation.

3) … International central banks should have been selling currencies not buying them.

Mr. Kruger provided an important fact: “International central banks are selling the most Treasuries since the credit crisis.”

I relate that the central banks many have been using the proceeds buying currencies. If this is the case, they were catching a falling knife, as world currencies are likely going in a death spiral lower together. The banks should have been short sellers, and captured gains. And then as the currency wave up began on October 1, 2011, closed out and taken profits, and then gone long and stayed long until now, that is at least until October 14, 2011.

4) … Banks are a financial black hole

The global investment tectonic plates have shifted as on July 11, 2011, investors became aware that a debt union had formed in the EU, and sold out of the European Shares, VGK, and the European Financials, EUFN, and then on August 11, 2011 became aware that in China they placed their faith in ponzi lending.  This can be seen in the ongoing Yahoo Finance chart of VGK, EUFN, and CHIX

Chinese banks are a financial black hole. Belinda Cao and Michale Patterson of Bloomberg write   Chinese banks’ bad debt may hit 60% of equity capital, Credit Suisse says. Loan losses at Chinese banks may climb to levels equivalent to 60 percent of their equity capital as real-estate companies and local governments fail to repay debts, according to Credit Suisse Group AG.

Nonperforming loans will probably increase to 8 percent to 12 percent of total debt in the “next few years,” causing losses amounting to 40 percent to 60 percent of Chinese banks’ equity, Hong Kong-based analysts led by Sanjay Jain at Credit Suisse wrote in a research report dated Oct. 12. Jain cut 2012 and 2013 profit estimates by as much as 25 percent and maintained an “underweight” rating on the industry.

Chinese bank stocks have tumbled this year, sending the MSCI China Financials Index down as much as 43 percent, amid growing concern that slower economic growth will spur bad debts after a three-year credit boom. The retreat sent price-to- earnings ratios on bank stocks to record lows and prompted the government to begin buying shares in the four biggest lenders this week.

And in the western world Harry Wilson of the Telegraph reports RBS the ‘most vulnerable’ bank in Europe, say Credit Suisse analysts.  Royal Bank of Scotland is the “most vulnerable” bank in Europe and could be forced to raise £17bn in new money to shore up its capital ratios, more than any other major European lender, according to analysts at Credit Suisse.

5) … Currency deflation will be ongoing and will result in regional economic government being installed world wide 

The state-backed bank is already 83pc owned by the taxpayer and would likely face full nationalisation under the scenario set out by Credit Suisse, which estimates RBS might face a capital shortfall of £16.9bn in a new round of Europe-wide industry stress tests. “RBS appears to be the most vulnerable although the company has said that the methodology, especially the calculation of trading income, is especially harsh for them,” said Credit Suisse. RBS declined to comment on the Credit Suisse note.

And Lauren Tara LaCapra of Reuters reports Fitch downgrades UBS, puts other banks on review

I relate that international central banks will be unable to stem the ongoing competitive currency devaluation which is due to global soveign debt angst, inflation destruction,  unwinding yen carry trade investing, and the failure of China’s ponzi credit system with its reliance on copper as collateral. I see the major global banks BSBR, ITUB, BBD, BMA, BBVA, BFR, IBN, HDB, WF, UBS, RBS, STD, DB, LYG, seen in this Finviz Screener and this ongoing Yahoo Finance Chart, falling strongly lower.

Inflation destruction, according to Urban Dictionary is the fall in investment value that accompanies derisking and deleveraging out of investments that were formerly inflated by money flows to, and carry trade investing in, high interest paying financial institutions, profitable natural resource companies, and high growth companies. Inflation destruction commenced in Brazil Financials, BRAF, and in the high growth Chinese Small Caps, HAO, in November 2010, and in Coal Producers ANR Resources, ANR, and Arch Coal, ACI in January 2011. Inflation destruction begets more of the same as former vigilant investors turn short sellers, and carry out their attack on their former investment, by going short the 200% ETFs, such as ProShares Ultra Brazil, UBR. Inflation Destruction may precede Debt Deflation which is the contraction and crisis that follows credit expansion. One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

An inquiring mind asks, will  hyper inflation come. Simon Black of Sovereign Black, writes in Zero Hedge on social unrest. In his seminal work The Rise and Fall of the Third Reich, William Shirer recounts how the struggling Weimar Republic printed its way out of reparation debt from World War I. Out-of-control printing caused the German mark to fall from 75 per dollar in 1921, to more than 4 billion just 3-years later. Talk about chaos. After a brief period of credit-fueled economic respite, the onset of the global depression in 1929 had people in the streets clamoring for change.  Hitler’s National Socialism promised the world… and under such economic distress, people believed him. There are two important lessons here. First is that hyperinflation comes very quickly. Confidence languishes for months, even years… until one day the currency begins to slide, slowly at first, then exponentially. The second is what followed. Economic disaster begets social unrest, the two are inextricably linked. Populist rebellions and roving gangs became a constant presence in the republic. It’s at this point, when people are really hurting, they’re the most impressionable. They’re looking for somebody, anybody, to lead them out of the turmoil. What they got was a charismatic leader with a grand plan. History is full of examples of governments taking draconian action in times of economic-fueled social turmoil. Faced with terrible circumstances, people cry out for their governments to ‘do something’. Politicians happily oblige. It’s concerning right now to see the early stages of economic decline spawning populist uprisings; most are being met with unconscionable force by the police state, (as documented by Robert Wenzel and as documented by Julie Hyland) Let me be even more clear: it’s not crazy to have a plan. You’re not a lunatic for considering your international options. In a world fraught with so much uncertainty, it’s the only sane choice.

Basic material stocks and small cap stocks in carry trade investment countries, such as  BHP, KROO, VALE, BRF,COPX, ECH, KOL, will be turning lower. As will the US Small Caps, the Russell 2000, IWM, which are highly dependent upon credit funding to buy inventory, cut checks, and meet payroll.

It’s very likely that the US Dollar is seeing a soon coming bottom and will be rising from 76 or 75, as the European Sovereign Debt Crisis goes viral, possibly as soon as October 23, 2011 as Catherine Bremer and Jan Strupczewski of Reuters reported on October 15, 2011, G20 tells euro zone to fix debt crisis in eight days and Liz Alderman of the NYT, in Europeans Struggle Toward Debt Solution quotes France’s finance minister, François Baroin, saying “The results of Oct. 23 will be decisive.” So there is likely to either be a debt fix or a debt collapse; I believe the latter.

I relate that In 1974, the 300 hundred of the world’s elite met as the Club of Rome, and presented regional economic government as the solution for the chaos that would come from deleveraging and disinvesting that comes with the failure of Mr Friedman’s Free to Choose dream. Their Clarion Call, has been heard by globalists such as Angela Merkel and Nicolas Sarkozy, who in their August 2011 Communique, called for a true European economic government.

6) … Out of sovereign armageddon, a sovereign and a seignior will arise to provide a new seigniorage, that is, a new moneyness.

Sovereign armageddon, that is a credit collapse and global financial breakdown, will come out of Gotterdammerung, the clash of the gods, that is the European leaders and the investors together with the rating agencies. This will result in the loss of national debt sovereignty, and extinguishment of state fiscal spending capability.

Sovereign crisis requires a sovereign solution. One Leader, the Sovereign, and his banker, the Seignior, will arise to speak for and to the Eurozone, which will be transformed into a Federal Europe, as leaders meet in summits and wiave national sovereignty, and implement a Fiscal Union, empower the ECB as a bank, and develop a common European Treasury. Seigniorage, that is moneyness, will no longer be based upon debt, but rather will be based upon the diktat of structural reforms, austerity measures and debt servitude; people will be amazed by this, and place their faith in it, and give it their full allegiance.

MMF, creditbreakdown, breakthebuck, debtdeflation, competitivecurrencydeflation, competitivecurrencydevaluation, banknationalization, priceinflation, sovereignarmageddon, socialunrest, soveeignblack, socialunrest, ponziloans, ponzicredit, ponzifinancing,


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