May 16th 2011 – Who’s going to buy all those Treasuries?

As we approach the June deadline for the end of the Fed’s quantitative easing program, the markets are telling us that QE3 is becoming a very remote possibility, at least in the short term, or is it all “sell in May and go away”? That bit of folklore only tends to work half the time and winning on the toss of a coin does not represent good odds.

There is no doubt that the tentative global recovery is beginning to slow and the commodity markets have taken the brunt. Surprisingly, for some, bond markets have been having a good run with 10 year Treasury yields back to 3.15% against a peak in February of 3.76%. Can we really believe that this is a flight to “quality”? The big aggressive buyer has been the Fed as indicated by the rise in their total assets as shown in the chart below courtesy of Fullermoney.

As you will see the rise has been so great that they have had to resort to mathematical notation as there is not enough room in the margin for all the “noughts”! In percentage terms the rise since QE1 has been greater than for the whole of the period from 1995 to 2008. Over the course of the next 5 years some 70% of the total current Treasury issuance will have to be repaid as a result of borrowing short rather than long as opposed to the position in the UK which is the only good thing going for the “sceptered isle” right now.

The Treasury can of course roll over these redemptions into more short term debt but who is going to buy it if the Fed decides that enough is enough? I am told that this is a very big market and for many of the serious players the agenda is to maintain the status quo rather than actually profit from the exercise. The assumption that “we have always got these issues away in the past and therefore we always will in the future” is just another form of complacency.

The Chinese and Russians are talking about an alternative to the dollar as the world’s reserve currency and with central banks around the world accumulating the barbarous relic as fast as they can the suggestion is that whatever happens gold backing will return. The Fed will tell you that there is not enough gold to cover the current issuance of fiat money. Maybe not at $1500 an ounce; but try doing the sums at $10,000!