Monday, May 5, 2014

Is This The Reason For The Relentless Treasury Bid?

Over the weekend, Bloomberg had an interesting piece about two of the main reasons why while stocks continue to rise to new all time highs, the expected selling in bonds - because in a normal world, what is good for stocks should be bad for bonds - isn't materializing, and instead earlier this morning the 10 Year tumbled to the lowest since February, while last week the 30 Year retraced 50% of its post-Taper Tantrum slide, or in short a complete disconnect between stocks and bonds.
In a world awash with U.S. government bonds, buyers of the longest-term Treasuries are facing a potential shortage of supply.

Excluding those held by the Federal Reserve, Treasuries due in 10 years or more account for just 5 percent of the $12.1 trillion market for U.S. debt. New rules designed to plug shortfalls at pension funds may now triple their purchases of longer-dated Treasuries, creating $300 billion in extra demand over the next two years that would equal almost half the $642 billion outstanding, Bank of Nova Scotia estimates.

“It’s driven by a scarcity and liquidity valuation,” Guy Haselmann, an interest-rate strategist at Bank of Nova Scotia, one of the 22 primary dealers that trade with the Fed, said in an April 28 telephone interview from New York. “The pressure on the long-end will be for lower yields.”

Fixed-income demand has “far outpaced the supply,” Brett Cornwell, vice president of fixed-income at Callan Associates, an adviser to pension funds with $2 trillion of assets, said by telephone from San Francisco on May 1. “We should continue to see this de-risking of corporate pension plans.”

Pensions that closed deficits are pouring into Treasuries and exiting stocks to reduce volatility after a provision in the Budget Act of 2013 raised the amount underfunded plans are required to pay in insurance premiums over the next two years. It also imposed stiffer fees on those with shortfalls.

In the next 12 months alone, buying from private pensions will create $150 billion in demand for longer-maturity Treasuries, based on Bank of Nova Scotia’s estimates.
Interesting... but certainly nothing new to Zero Hedge readers. After all, we have been explaining until blue in the face for well over a year, that it is the Fed's sequestration of "high quality collateral" through trillions in QE (in effect monetizing the deficit through duration-risk exposure) and the illiquidity risks it generates that explains the Fed's eagerness to commence, and continue, tapering as the amount of available bonds to the private market has simply collapsed, especially at the longer end.
First recall from our August piece on "What The Fed Owns: Complete Treasury Holdings Breakdown"
As everyone knows (since the data is public), in the most recent week the Fed's balance sheet rose to a record $3.646 trillion, an increase of $61 billion in the past week, and a record increase of $813 billion over the past year, a whopping 30% rise in the balance sheet in 12 short months. What may not be known is the exact distribution of Fed Treasury holdings by maturity. So without further ado, here it is. Of note, observe that what once was a predominantly 'short-end' balance sheet (consisting mostly of no-coupon, money equivalent Bills), has become almost entirely a "5 and over" current coupon carry affair. Which also is why the Fed now takes over the entire bond market at a rate of 0.25% per week.

Perhaps the best source of real, actionable financial information, at least as sourced by Wall Street itself, comes in the form of the appendix to the quarterly Treasury Borrowing Advisory Committee (TBAC, aka the Goldman-JPM chaired supercommittee that really runs the world) presentation published as part of the Treasury's refunding data dump. These have informed us in the past about Goldman's view on floaters, as well as Credit Suisse's view on the massive and deteriorating shortage across "high quality collateral." This quarter was no different, only this time the indirect author of  the TBAC's section on fixed-income market liquidity was none other than Citi's Matt King, whose style is well known to all who frequent these pages simply because we cover his reports consistently. The topic: liquidity. Or rather the absolute lack thereof, despite what the HFT lobby would like.

... [D]espite what various new "technology" lobbies, such as the HFT's, all of which are merely peddling legal millisecond frontrunning services, the TBAC's conclusion is the opposite: be afraid, be very afraid. Because just when you need liquidity it will be gone.

First, how does one define liquidity? Here is how the smartest guys in the room (and Matt King truly is one of the smartest guy) do:

As the chart points out, the biggest falacy constantly perpetuated by market naivists, that liquidity and volume (in this case in fixed income) are one and the same, is absolutely wrong. Of course, in equity markets it is far worse because while volumes are crashing, liquidity is far worse.


In other words, while the Fed, and the TBAC, both lament the scarcity of quality collateral and liquidity in non-Fed backstopped security markets, it is the Fed's continued presence in the (TSY) market in the first place, that is making a mockery of bond market liquidity and quality collateral procurement. And without faith in a stable credit marketplace, there is no way that a credit-based instrument can ever truly become the much needed "high quality collateral" to displace the Fed's monthly injection of infinitely funigble and repoable reserves (most benefiting foreign banks).
The most important chart that nobody at the Fed seems to pay any attention to, and certainly none of the economists who urge the Fed to accelerate its monetization of Treasury paper, is shown below: it shows the Fed's total holdings of the entire bond market expressed in 10 Year equivalents (because as a reminder to the Krugmans and Bullards of the world a 3 Year is not the same as a 30 Year). As we, and the TBAC, have been pounding the table over the past year (herehere and here as a sample), the amount of securities that the Fed can absorb without crushing the liquidity in the "deepest" bond market in the world is rapidly declining, and specifically now that the Fed has refused to taper, it is absorbingover 0.3% of all Ten Year Equivalents, also known as "High Quality Collateral", from the private sector every week. The total number as per the most recent weekly update is now a whopping 33.18%, up from 32.85% the week before. Or, said otherwise, the Fed now owns a third of the entire US bond market.

The following statement and chart from the RBS' Drew Brick pretty much explains it all: "QE has seen the Fed extend its dominion on the US curve away from the short-end and into longer duration paper is patent, too. On a rolling six-month average, in fact, the Fed is now responsible for monetizing a record 70% of all net supply measured in 10y equivalents. This represents a reliance on the Fed that is greater than ever before in history!"

And who can forget, from July when "expert" economists were absolutely certain there would be no tapering after the "Taper Tantrum", that "Fed Tapering Assured As Treasury Projects 30% Slide In Annual Funding (And Monetization) Needs."
As for the Pension Fund bid that too was covered in "Here Comes The Next Great Rotation: Out Of Stocks And Into Bonds":
... if the great rotation out of bonds into stocks was the story of 2013, it now appears that 2014 will see another great rotation - a mirror image one, out of stocks and back into bonds, driven on one hand, of course, by the Fed which will continue to monetize the bulk of net duration issuance for the foreseeable future, but more importantly, by some $16 trillion in corporate pension assets which after (almost) recovering their post-crisis high water market are once again, will now phase out their risky holdings in favor of safe (Treasury) exposure.  As Scotiabank's Guy Haselmann explains, "The rationale is quite simply that the cost/benefit equation changes as the plans’ funding status improves. In other words, the upside for a firm with a fully-funded plan is less rewarding than for an under-funded plan."

Needless to say, the Fed, which is doing everything in its power to push marginal buyers out of a bond purchasing decision and instead to chase Ponzi risk into equities, will not be happy, especially since QE is tapering, and suddenly instead of everyone frontrunning the Fed, the momentum chasers will proceed to scramble after the largest marginal players around - pension funds, which however will be engaging in precisely the opposite behavior as the Fed!
So yes, interesting, but nothing new or surprising and certainly nothing that hasn't been known for over a year.
Which begs the question: while stocks no longer eflect anything except some momentum ignition algo in the USDJPY, and simply go along the path of least Fed resistance, even though the Fed is now actively shutting down its stock goosing machinery, if only for the time being, just like it did after QE1 and QE2 (and everyone knows what happened next), bonds at least on the surface are far more rational. Or were before central-planning.
Which is why we are disturbed - if indeed Bloomberg's report is seen as "news" for bond market managers then things are really far more broken than even we expected, and not even the bond market has any discounting capacity left. We are not that pessimistic - while stocks are merely a policy vehicle and a "report card" for the administration (since the economy's ongoing contraction has to be explained away by snowfall in the winter), the bond market is sufficiently large than not even the Fed can unilaterally dominate it. At least not yet, while the Fed holds "only" 35% of all 10 year equivalents (check back in 3-5 years when the Fed is at its SOMA limit for every CUSIP).
All that said, we agree that there is a bid for Treasurys, but we disagree that the bid is the result of either the collapse in private market supply, or the Pension unrotation - both things that have been known and priced in long ago.
What is far more likely, and what the rumor has been for the past month or so, is that none other than Japan is now allocating its own assets under management into US bonds, particularly into the 10Y+ part of the curve, just as it, together with other yield chasers, have succeeded in extracting every ounce of yield out of the Spanish bond yield, today trading at a ridiculous 2.98%, 100 bps below where it started the year.
Our only question is what type of event could force the GPIF and other fixed income asset allocators to finally stop buying bonds - because if not even the "cheerful" perspective of the US recovery, for 288K jobs certainly is that unless of course one actually reads the writing between the line, can lessen the bid (certainly facilitated by the Ukraine civil war), then we are at a loss what could halt this buying juggernaut into an asset class that the Fed and its central bank peers loathe with a passion, and are hoping will slid back to the mid-3% soon, or else the narrative about some recovery will be completely crushed.