Bond markets defy Fed as Treasury yields spike


By Ambrose Evans-Pritchard
The Telegraph, London
Thursday, May 28, 2009

The US Federal Reserve may soon be forced to launch fresh blitz of quantitative easing whatever the consequences for the US dollar, or risk seeing economic recovery snuffed out by the latest surge in long-term borrowing costs.

Yields on 10-year Treasury bonds have risen relentlessly since March when the Fed first announced its plan to buy $300 billion (L188 billion) of US government debt directly, a move that briefly forced rates down to nearly 2.5 percent, a level thought to be the Fed's implicit target.

Yields have jumped to 3.69 percent -- after spiking as high as 3.74 percent on Wednesday -- pushing up the standard 30-year mortgage loan to 5.08 percent and lifting the borrowing cost for corporations.

"The Fed is going to have to consider doubling its purchases of Treasuries," said Ashraf Laidi, from CMC Capital Markets. "We could be nearing the end-game for the US dollar but the Fed has little choice at this point. We're in a vicious circle where any policy aimed at supporting the US economy must be at the expense of the dollar."

The US Mortgage Bankers Association yesterday highlighted the fragility of the US housing market, reporting that 12 percent of homeowners are either behind on their payments or facing foreclosure, the highest level since records began.

Almost 6 percent of "prime" borrowers are in arrears, showing how far the crisis has moved beyond the sub-prime. Most arrears are caused by job losses. The US unemployment rate has reached 8.1 percent, and is even higher under older definitions, running at 15.8 percent under Clinton-era metrics.

It is unclear why US bond yields have spiked so violently, with spillover effects on gilts and bunds. One camp of investors is worried that inflation is rearing its ugly head again: Others fear a sovereign debt crisis as overextended states loses their AAA ratings.

What is clear is that the market choked on $100 billion of US Treasury debt issued in three auctions this week, and on the knowledge that Washington must raise a further $900 billion by September. Governments around the world must fund $6 trillion of deficits this year, exhausting the capital markets.

The US is at the front of the firing line. Beijing is clearly losing its patience with the Fed's policy of printing paper, seen as a form of stealth default. There is some risk that further moves to step up quantitative easing could cause China to boycott US Treasury auctions. China and Japan together hold 23 percent of all US federal debt.

Dallas Fed chief Richard Fisher said his recent trip to Asia was an eye-opener: "Chinese government senior officials grilled me about whether or not we are going to monetise the actions of our legislature."

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