Now Start Watching Interest Rates

By: John Rubino | Mon, Apr 5, 2010
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The phase change happened almost imperceptibly. One month we're shedding jobs and agonizing over a long list of insolvent European countries and US states -- and the next month we're back in a bubble. U.S. employment has stopped shrinking and started growing. Iron ore is up 170% in the past year and oil is flirting with $85 a barrel. Hot money is back to chasing emerging market securities and junk bonds. Stocks, as a result of all this, are up pretty much everywhere and the media is full of stories declaring the Great Recession over and "normal" times just around the corner.

Score Round One for the unlimited printing press. Flooding the world with new fiat currency stopped the implosion, and it only took as long as it did because traumatized banks and hedge funds needed some time to recover from their near-death experience. But eventually they did recover, because that's the nature of free money. Sooner or later someone uses it for something and turns a profit and then, terrified of being left out, everyone else joins in and the game begins again.

Now the question is whether this baby bubble (let's call it the government debt bubble) will grow to the stature of its tech stock and housing siblings. In its favor is the fact that only a small fraction of the new reserves created by central banks have so far been put to work; when the rest hit the world's financial bloodstream, picture Uma Thurman after John Travolta stabs her in the chest with the adrenalin needle in Pulp Fiction.

On the other hand, the bond markets seem to be figuring out that they're the patsy in this scenario. The yield on 30-year US Treasuries has been creeping up for a while, and interest rates jumped across the board on Friday, when the U.S. reported those nice employment numbers.

CBOE 30-Year Yield

Since variable rate paper ranging from Prime+ loans to option ARMs are linked to Treasury yields, a spike in interest rates would choke off the bubble and send us back to 2008. And since the US, always one to choose the dumbest, riskiest alternative, has financed itself primarily with short-term paper, every Treasury auction from here on out is a potential black swan. The table below is from an October New York Times article. It's a safe bet that the numbers have gotten even bigger in the ensuing six months:

A Balloon in Short-Term IOU's Is Coming Due

And here's next week's Treasury auction schedule:

Monday: $28 billion in three-month bills and $29 billion in six month bills, $8 billion in 10-year TIPS.

Tuesday: $26 billion in one-year bills, $40 billion in three year notes.

Wednesday: $21 billion in 10-year notes.

Thursday: $13 billion in 30-year bonds.

As you can see, the US is dumping what used to be a year's worth of debt onto the market in four days. And because so much existing debt has to be rolled over continuously, we'll do the same every week for, apparently, the rest of our lives. I'll go out on a limb and give Round Two to the bond market.



John Rubino

Author: John Rubino

John Rubino

John Rubino

John Rubino edits and has authored or co-authored five books, including The Money Bubble: What To Do Before It Pops, Clean Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar and How to Profit From It, and How to Profit from the Coming Real Estate Bust. After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst. During the 1990s he was a featured columnist with and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He now writes for CFA Magazine.

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