Who’s Selling?
While most of the public’s attention was trained on
the recovery rally that turned into afternoon selling in the stock market
today, another big down day in T-bonds
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offering a hint of what is in store for the economy and ultimately equities
as well.
In the wake of last week’s tragic events, is it
instructive to ask who’s selling?
First, insurers are selling bonds. Unless they escape
claims payment due to “in the act of war” exemptions, insurers
will be liable for large sums. Insurers park large sums in the bond market
and will need to sell them in order to pay claims.
Second, the government is also expected to issue
(sell) large numbers of bonds to raise the money to reconstruct Lower
Manhattan and the Pentagon after last Tuesday’s devastation. The government
will also need to finance its declared “war,” security
expenditures, and possibly raise money to bail out the airlines. When the
government sells bonds, the supply of bonds increases, driving their price
lower (bond yields have an inverse relationship with their price, where lower
bond prices result in a higher yield). The government’s failure to buy back
debt as expected in September acted as a warning shot today that a large
issuance of bonds is on the horizon. The Treasury had been paying down
national debt with regular monthly repurchases up to now.
Third, the issuance of massive amounts of liquidity
is inflationary. Up to now, consistently low levels of inflation have
encouraged bond market speculation. But with the prospect of the fed funds
target interest rate dropping to as low as 2.25%
— below the inflation rate (annual CPI = 2.7%) — participants worried
about the erosion in value of long-term fixed-income instruments and sold.
Historically, inflation has reared its head every time the fed funds rate
drops below the inflation rate. So speculators or institutions fretting
about inflation eroding bonds’ value sold.
Four, bonds, which had been experiencing
flight-to-safety buying, may appear suddenly not so safe in light of recent
terrorist attacks. Playing into the question of safety, the tragic loss of
over 700 employees at one of the bond market’s largest houses, Cantor
Fitzgerald, has also disrupted liquidity and important relationships.
Traders bailed of T-bonds
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them down over two points before settling down 1 23/32 at 103 22/32.
December two-year bills
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preference for the short end of the yield curve, a sign of
uncertainty.
The December fed funds futures
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again to a new high, pricing in a “for sure” cut in the fed funds
target rate to 2.50% from the current 3.00% (the Fed cut rates
50-basis-points yesterday). The Dec. contract went even further today,
pricing in about a 10% chance of an additional .75% rate-shave to
2.25%.
What the action in the bond market implies is that
both the government and bond traders are worried about the economy in the
short-term. The government aims to pump it full of liquidity. While this
should help to re-invigorate our economy, the stimulative impact will likely
not be seen for months. In the short-run, this likely means stocks have not
yet found a bottom and that we’ll continue to see a move from the long to
the short end of the yield curve as well as a move into European asset
classes.
Tellingly, eurobonds
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highs, closing up .045 at 97.360.
A bomb scare forced traders and staff to
evacuate the New York Mercantile Exchange, just blocks from the site of the
Twin Towers disaster. New York police have reported a 1000-fold surge in the
number of bomb threats being made in New York City since last week’s attack.
The NYMEX was evacuated for approximately 30 minutes until the building was
determined to be safe to re-enter. Trading in the metals was interrupted.
Energy trading, already on a shortened schedule, began trading after the end
of the scare. Access to the NYMEX remains by ferry only.
Leading the Momentum-5
List, December gold
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after the recent terrorist attack drove the safe-haven hard metal asset up
$20 an ounce in trading Friday and Monday. Gold gave back some of those
gains today. closing down 1.8 at 289.7.
Silver
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after the re-commencement of trading this morning, adding 6.0 to 447.3.
Also at the NYMEX, energies plunged on fundamental
factors. High national inventories and the perception that the recent
tragedy will slow the economy and demand for oil and distilled fuels sent
crude down 1.11 to 27.70.
October
heating oil
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.7443. There is heavy Bush Administration pressure on OPEC to keep output
high in order to not hamper economic recovery.