Bond Bears Come Out of Hibernation

 | Feb 05, 2013 | 3:00 PM EST
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The bond bears are coming out of hibernation again. We have actually seen a steady stream of bearish bond calls over the past few years:

  • Jim Rogers and his constant announcements of having "shorted the Treasury market,"
  • Peter Schiff's hilarious forecasts of soaring interest rates because the Chinese were going to start dumping Treasuries,
  • Naseem Taleb's, "Everyone in the entire world should do themselves a favor and short Treasuries," and
  • Bill Gross and his, "Who's gonna buy them now?" warnings back in 2011.

The worries now are that the Fed is closer to reversing its accommodation and when it does, it's going to have to sell its vast holdings of Treasuries. That's not only going to collapse the market, but it's also going to unleash pandemonium. We're going to witness a disorderly decline as never seen before when panic selling ensues and there are no buyers.

The problem with these forecasts and calls is just that they're ignorant. The Fed has told us it intends to reverse policy when the unemployment rate hits 6.5%. And in case you hadn't noticed, with the unemployment rate at 7.9%, we are still a long way away from there. Even so, if you're one of these people who feels inclined to get a jump on any Fed policy reversal, you can still wait until the jobless rate crosses below, say, 7% before you start your selling. In other words there's plenty of time.

On the other hand, let's address this claim that there's going to be some tsunami of bond sales when the Fed decides to change course. This assumes that we'll ever see this happen because austerity is about to happen, making it highly doubtful that the unemployment rate will ever get to 6.5%. But I digress.

What, then, of this wall of selling? Well, it's not likely to happen and here's why. Ever since the Fed was given the authority to pay interest on reserves in 2008, the need to sell securities to drain reserves so that rates hit some target became moot. By paying interest on reserves, the Fed really has to do nothing at all. Those reserves will remain in the banking system, collecting interest, and banks will always lend out at the reserve rate -- and not below. Thanks to this change, rates are now set by mere decree of the central bank with no need to conduct a reserve drain via the selling of securities. Case closed.

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