Bond Vigilantes Ride Again

Hey There Income Hunters,


As I’m fond of noting, the Fed can talk a big game …


But a group of so-called “bond vigilantes” knows how to push their buttons.


Aside from being a bad-ass name, bond vigilantes is a term coined in the early 1980s for a group of investors who sell bonds in protest of fiscal or monetary policy — particularly if central banks are seen as lacking in effectiveness — increasing yields in the process.


However, today I think there is a modern twist, which is to protest monetary policy in all cases … 


Because right now there are three areas of the market that the Fed is concerned about and all three are being challenged …


At this point, new-age bond vigilantes must be keeping Federal Reserve Chairman Jerome “J-Pow” Powell and Treasury Secretary Janet Yellen up at night.


There are a number of inside developments that are key to understanding when major flow changes could be ahead …


1. US Treasury Bill Rates Go Negative


This is a knee-jerk reaction to Janet Yellen’s draw-down of more than $1 trillion in Treasury balances held in the Treasury Government Account (TGA) at the Fed.


The funds were burning a hole in Yellen’s pocket and she had to inject them into the system by the end of March…. 


She accomplished the drawdown halting the issuance of US T-Bills and just let the maturing bills, meaning bills issued three and six months ago, mature and pay investors their proceeds:



The issue is this: foreigners use T-Bills as an investment vehicle to maintain operational liquidity in dollars …


Halting issuance forces them to instead sell dollars, and the dollar appears to be putting in a high based on the Invesco DB US Dollar Index Bullish Fund (Ticker: UUP).



UUP is a liquid dollar index ETF, if you are interested in gaining exposure to the dollar…


I am looking to purchase UUP 25 strike puts on a bounce in UUP stock to 25.


2. The Treasury Repo Market Rates Go Negative…


The repo market is where all holders of US Treasury securities go for funding.


You see, Treasuries are the highest-rated collateral, so Treasuries holders rely on the repo market to borrow funds via collateralizing their loan with the Treasuries they own …


When there are problems in the repo market, they usually cause collateral damage in other markets, as well, so this must be carefully watched.


I’ll go into more detail on this market Wednesday morning during Power Income LIVE at 9 a.m.


Repo rates went negative because last month the Fed did not extend the exemption on supplementary leverage ratio (SLR) …


Without the exemption, banks have a capital requirement on financing transactions (repo trades). The SLR charge to banks can decrease the amount of collateral they provide by 30-40% …



SLR also forces banks to hold capital against their deposits so they may desire negative rates to dissuade customers from depositing funds, thus avoiding the SLR charge. 


3. Negative Returns Continue to Hurt the Long End of the Curve


On top of yields holding below inflation, prices are dropping, which delivers a negative real return to bondholders.


However, iShares 20 Plus Year Treasury Bond ETF (Ticker: TLT) prices held fairly well yesterday considering the strong employment report on Friday. And we don’t have any bond supply this week, so 10-year yields may hold below 1.75% for a few days… 


Next week, we’ll get 10-year and 30-year auctions, plus the forecast is for good news on the economy. A stronger economy and higher inflation gets the bond vigilantes all fired up… 


So, by next week we should see higher rates in 10-years and lower prices in TLT:



I am short 100 shares of TLT and will hold them looking for a break higher to 1.8% in 10-years to close the position:



Bring it Home


I think another chainsaw was just tossed to Jerome Powell as an add-on to his juggling act…  


Don’t get me wrong, issues are positive for stocks because they force investors holding bonds to take on more risk in order to earn a better return.


Nobody likes negative returns, so it will be interesting to see the response from Fed officials over the coming days.


Until then …


Live and Trade With Passion My Friends,

Griff

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