Bear Mountain Bull

Comments from Mish on the Fed:

The Fed is looking at the “benefits” of purchasing longer-term Treasury securities. The benefit is to banks who are front running the trade. Banks can now borrow from the Fed at the discount rate of .5% and invest somewhere out on the yield curve at a higher rate.

And as long as the Fed is not going to contract credit, banks can hold to maturity and pocket “free money”. The odds of Bernanke contracting credit any time soon are essentially zero.

Bernanke hopes ZIRP (Zero Interest Rate Policy) will spur lending. But why lend in the middle of a recession with credit spreads blowing sky high and consumers walking away from mortgages, when you can borrow from the Fed at .5% and have guaranteed free money?

There is infinite demand for free money. But note that only banks can get it. Citigroup is not going to get a margin call from the Fed no matter how many treasuries it buys. You or I would get one in a flash if the rates went against us.

Shorts stepping in front of banks rushing to get free money have been trampled once again. 10 year yields are now approaching a 1 handle. Remember the cries of “bond bubble” at 5%? Don’t say you weren’t warned.

Yes, this is artificial demand. And no, this is not going to help the economy. But standing in front of a freight train does not make a lot of sense. And although the treasury trade will at some point blow sky high, that point will probably not happen until shorts give up trying.

Remember that the Fed cannot change the direction of a trend, the Fed can only juice it. The trend is for lower yields as deflation sets in. The Fed has only reinforced that trend.

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“The availability of Fed credit might deter private credit.”
“The lender of last resort becomes the lender of only resort.”

Change the word “might” to “will” in the first sentence and you have the essential idea. Bernanke wants to drive long term rates lower, but there is no incentive for banks to lend at lower rates.