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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory

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To: orkrious who wrote (26332)	2/12/2005 10:36:03 AM
From: zebra4o1	Read Replies (1) of 110194

Doug Noland – flattening yield curve hypothesis This weeks Credit Bubble Bulletin has an interesting hypothesis to explain the flattening yield curve: It’s the result of a short squeeze induced by too much of the market having hedged against higher interest rates. The idea is that the Fed’s intention to raise interest rates was well known, as long as a year ago. Seeing what was coming, people tried to hedge. But how can the entire market hedge itself ? It’s just not possible. The sellers of hedge protection need to protect themselves with ‘dynamic hedging’, creating a very volatile unstable market which can tip either way into a self-reinforcing feed back loop. For whatever reasons (central bank buying?) the market tilted toward a melt up (of long dated treasuries). Once this movement started, it turned into a massive short squeeze. Anyway, an interesting hypothesis – kind of orthogonal to the Bretton Woods II theory I guess? CFC is a good example of a big institution that tried to hedge against rising long interest rates and got spanked when the opposite thing occurred.

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