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June 10, 2015

What's Wrong with U.S. Treasuries?

The global bond market swoon wiped out $1.2 trillion in value since April. Bonds with long maturities suffered the most. The 10-year Treasury Note Price Index lost 3.2%. The 30-year yield, at 3.1% currently, is still very low, but it’s the highest since October 2014. And the 30-year Treasury Bond Price Index has dropped 9%.

“After all, the potential for losses is now greater than at any time on record, based on duration levels for $50 trillion of debt tracked by Barclays Plc.,” Bloomberg reported.

There are numerous reasons for this scenario – a very benign scenario where the greatest credit bubble in history winds down gradually, in small steps with many ups and downs that give the “smart money” time to reposition, rather than suddenly and all at once.

And today we learned of another reason.

Over the last few years, any illusions we might have nurtured that our financial markets are fair have been destroyed piece by piece by a relentless and consistent series of scandals: Libor rates, precious metals, stocks, commodities, foreign currencies…. They were all caught up in massive manipulation schemes.

A few small-fry traders were pinpointed and banks agreed to multi-billion-dollar settlements as part of the cost of doing business, denting a quarter’s worth of GAAP earnings, though “adjusted” ex-bad-items earnings remained gloriously untouched. Share prices often rallied when the settlements were announced. And CEOs went scot-free.

OK, maybe not all CEOs. Scandal-infested Deutsche Bank finally dumped its co-CEOs over the weekend.

But there was one market that folks thought was somehow above this endless sea of manipulation, and so they have confidently placed their bets, including foreign governments, thinking – nay, deluding themselves into thinking – that this market was one of the last ones to be fair: the US Treasury market.

It’s the most liquid bond market in the world. It’s huge, thanks to the debt the US government has piled up over the years: of the $18.2 trillion in outstanding Treasury debt, $5.1 trillion is held by other US government agencies, and $13.1 trillion is “held by the public.” In 2014, the Treasury Department rolled over old debt and issued new debt totaling about $7 trillion.

The Treasury takes two kinds of bids for these debt sales: non-competitive bids; and competitive bids. The latter are submitted by the New York Fed’s 22 “primary dealers” – the largest banks and broker-dealers in the US – in secret ballots, most of which are never made public.

So how tempting would it be to manipulate this monster market? Very, apparently.

Turns out, the Department of Justice smells a rat in this until now pristine Treasury market, according to the New York Post:

Justice lawyers, believed to be in the early stages of a probe, have reached out in recent months to at least three of the 22 banks that act as primary government debt dealers and requested information regarding auctions of Treasury debt, said one person close to one of the banks that received the request.   
No single bank has become the focus of the probe, it is believed, and no bank has been accused of any wrongdoing. In addition, there is no guarantee that the requests for information will turn up any evidence of manipulating Treasury auctions.
A spokesman for the DOJ on Sunday declined comment on the matter.
So details remain murky. If we ever find out who manipulated what, and at which stage of the process, it will be a while, and it will be years before the by now habitual settlements, if any, are announced, and the resounding noise of wrists getting slapped reverberates through the financial markets.

But here is the thing: If manipulation had the effect of raising the price of Treasuries, and thus lowering the yield even by a little each time, investors, pension funds, and everyone else out there looking for a “safe” investment would have overpaid. The amounts might have been small, but over the years, given the sheer dollar volume involved, if would have made some bankers very, very rich.

And now that the probe by the DOJ has started some time ago, we can assume that a finely-honed flurry of activity has broken out at these banks, where lawyers are unleashed, protective walls are erected, categorical denials are carefully drafted and reviewed for the umpteenth time, and things are said (rather than put in emails) that in effect would stop the manipulation in its tracks.

In the process, Treasury prices, left to the vagaries of the markets, which have already been spooked by the Fed’s interest-rate cacophony and other factors, are beginning to swoon from their manipulated perch.

As usual, we might only learn the answer to the manipulation scheme years after it stopped mattering, but we know one thing for sure: Treasuries have lost their oomph. And some folks are beginning to lose some real money. Read…  Bond Market, Unglued

Courtesy Wolf Richter at Wolf Street (Archive Here)  
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