Let's say the Fed can influence long-term rates. The long bond price depends on expectations. I don't buy any of them when long-term rates are going up -- which I expect as long as the world-wide capital shortage lasts and the world-wide tech stock boom continues. Short-term rates are controlled not by expectations but by reality. If a bank needs reserves to meet the daily fed requirements, it must sell (or repo) some of its short-term federal paper or fed funds (other banks' reserves). It has no choice. It simply must. It can't afford to care what the market interest rate may be. In a sustained demand for reserves, it may tickle its short-term or even long-term investments. Ordinarily, it trades reserves and short-term treasury paper. The short-term rate is the result of this higgling in the market. When the fed wants to tighten, it sells Treasuries (always short) and slops up liquidity. When it wants to expand the money supply, it buys Treasuries, and this affects the Fed Funds rate. But remember, the Fed usually has no short-term or long-term interest rate targets. It has soft monetary targets. Read their minutes.
One never sees the 30 bond in the fed's calculations. Officially, the fed doesn't care (at least since 1951 except for a brief period in the sixties. What it is is what it is.
Now amazingly, bond traders have a range of T-30 yields available. If one consistently buys the highest yield 25yr-to-30yr bond, and sells the lowest yields he can beat the 30 year yield by up to 10 basis points. Done daily, one can live on this with a modest bond portfolio and eat beefsteak everyday. That's one way the big guys make their billions. The "slightly used bonds" are magic. I am not ready to mess with them again because of my long-term views, but if th time ever comes, you need to understand this. Note that you can margin bonds up to 90 percent of their value, thus control a million with $100,000. Miss a turning point and you are dead, but ride the curve and bring in mucho dinero. That's how the big traders in Chicago make their bread (but they are margined 100 per cent) by their sponsors.
These guys in the bond pit generate the bond yield. Yet they claim they are mere observers of the passing crowd. A modern example of the miracle of loaves and fishes.
Obviously the outcomes are the result of many interacting forces. The Treasury spends and refunds (always trying to stretch out the maturity of the debt). The fed moves the money supply according to their notion of the economy's needs. The businesses borrow long if it is cheap, or the funding margin is high, or sulk if the interest rate is too high. Most of the big techs owe nothing long, except the concessionary economic development bonds used to bribe them into locating in Puerto Rico or Oregon, or some such place. The Japanese and Americans play at the yen-carry trade -- hedged when it pays, or unhedged when they must. (The Japanese own on the average 25% of the net U.S. public debt.) The SSTF gobbles up debt voraciously. Hedge funds play Russian dollar debt. Brady bonds and agency bonds surve and wane, paying always a premium. Wall Street securitizes everything it can, and dumps the results on the bored public. About 2000 equations should do for a sector model.
More and more financial institutions have said bonds are too dangerous to play with, and have moved maximally into S&P-like Index funds. But the temptation to overweight the big techs is powerful. Every investor wants just a little more the the Four Horsemen than the S&P 500 discipline allows. So they buy more, and purchase non-market puts from the companies.
So the damned thing rolls on! Uncomprehended. Fussed at. Manipulated. Worried over. A mighty engine to power the world. A mystery! Yowzah! |
