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Thursday, June 18, 2009

D Day Next Week in Treasury Bonds

The Treasury Department will do something unprecedented next week and it may have serious ramifications for both U.S. Treasury bonds and the economy as a whole.

The Treasury announced Thursday a record $104 billion worth of bond auctions for next week, part of its herculean efforts to finance a rescue of the world's largest economy.

The sales will exceed the previous record of $101 billion set in auctions that took place in the last week of April and consist of two-year, five-year and seven-year securities. That record was matched by another $101 billion week in May.

Though next week's total was broadly in line with expectations, worries about supply have weighed on the U.S. government bond market, which will see a mammoth $2 trillion worth of new debt issued this year.

The U.S. Treasury bond has been extremely volatile ever since president Obama took over. It's gone up from a low of just over 2% yield on the ten year to as high as 4% last week. It's also gone up a full percentage point in the last month. Then, starting at the end of last week and continuing into this week, it dropped from 4% to a low of 3.62% and now it stands at 3.81%.

Now, the Treasury department plans on borrowing $104 billion just next week. It's been this record borrowing that has shot rates up since the beginning of the year. Now, the Treasury department will attempt to borrow a record for a week.

The environment for Treasury bonds couldn't be worse for a massive bond offering of the kind we will see next week. Everyone is concerned about our ballooning deficits. That's why bonds have shot up as they have. Most foreigners have nearly stopped buying our bonds entirely. The only thing holding interest rates down has been the Fed's policy of quantitative easing in which they create money in order to buy these very bonds themselves. Even the Fed won't be able to hold up the bond market on its own when $104 billion in new bonds are introduced next week.

It's hard to make a prediction about just how much the will affect treasury bonds because the totals are totally unprecedented. It's possible that this will cause a rise of 20 basis points (two tenths of a percent) or more next week. Worse than that, next week's bond offerings will likely be followed by more massive bond offerings in weeks to come. If next week goes badly, it could lead to a run on bonds that could shoot rates to 5% and worse. On the other hand, if next week's offerings go well, it will signal that the market is comfortable with new borrowing.

I would forecast a very ugly week however. As I have stated over and over, rising bond rates mean rising interest rates. Mortgage rates have already gone up nearly a full percentage point. Another half a percent would be a devastating blow to not only real estate but our economy as a whole. If these bond offerings go as badly as I suspect, it will have reverberations throughout the economy.

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