Fed Money Printing Triggers Bond Market Crash

By: Mike_Larson

It’s always gratifying when the mainstream media picks up on a theme you’ve been banging away at for weeks. And boy is that happening now. Just get a load of the headlines we’ve seen in recent days:

“Fresh Attack on Fed Move; GOP Economists, Lawmakers Call for Abandoning $600 Billion Bond Purchase” — Wall Street Journal, November 15

“Under Attack, Fed Officials Defend Buying of Bonds” — New York Times, November 16

“Fed officials defend $600bn stimulus” — Financial Times, November 16

“Bond Market Defies Fed; Interest Rates Rise Despite Launch of Treasury Buying as Investors Take Profits” — Wall Street Journal, November 16

The gist of these articles? That the Fed is scrambling to defend its quantitative easing policy.

Key policymakers are giving rare, on-the-record interviews about QE2′s benefits, while simultaneously trying desperately to blunt the criticism coming from foreign central bankers, domestic lawmakers, prominent economists, and more.

Fed Fighting a Losing Battle Defending the Undefendable!

My take? The Fed is right to worry. I say that because its QE2 program isn’t just not helping. It’s actually hurting the markets.

Take long-term Treasury yields …

As I’ve been pointing out recently, they’ve been rising rather than falling, and that move only gathered steam earlier this week. In fact, the yield on the 30-year Treasury bond hit 4.38 percent on Monday — the highest in six months! And ten-year yields hit a three-and-a-half-month high.

Then there’s the mortgage market …

Yields on mortgage-backed securities surged almost half a percentage point in just a handful of recent days, presaging a rise in retail mortgage rates. So much for the Fed’s policy helping homeowners.

And then there’s the municipal bond market …

It has completely imploded in the past several days. Take a look at this chart of the iShares S&P National AMT-Free Municipal Bond Fund (MUB). It’s one of the most actively traded benchmark ETFs for the municipal bond market, with more than 1,100 securities in its portfolio.

You can see it’s in freefall, with one of the sharpest declines since the credit crisis days of late 2008. MUB has now lost every penny of gains it’s made in the past 15 months … in just a few days! Long-term muni yields, which move in the opposite direction of prices, surged by the most in 18 months!

The move doesn’t stem entirely from concern about the long-term inflationary impact of Fed money-printing, or the back up in Treasury yields …

Muni investors are worried that federal support for state and local governments could wane now that the political winds are shifting in Washington. They’re also concerned that we could see a fresh upswing in issuance given deteriorating municipal finances.

But clearly, the cost of borrowing is now not only going up for Uncle Sam. It’s also rising for governments all over the country, and mortgage borrowers. And it’s starting to inch higher for corporate debtholders.

Opposition Rising in Washington — and Everywhere Else

As interest rates surge, the opposition to Bernanke’s policy intensifies.

Is it any wonder then that a large group of prominent economists just published an open letter to Ben Bernanke, begging him to stop the madness before it’s too late?

The group, which includes Michael Boskin, a former chairman of the President’s Council of Economic Advisors … Douglas Holtz-Eakin, a former director of the Congressional Budget Office … and Kevin Hassett, a former senior economist at the Fed itself, said:

“We subscribe to your statement in The Washington Post on November 4 that ‘the Federal Reserve cannot solve all the economy’s problems on its own.’ In this case, we think improvements in tax, spending and regulatory policies must take precedence in a national growth program, not further monetary stimulus.

“We disagree with the view that inflation needs to be pushed higher, and worry that another round of asset purchases, with interest rates still near zero over a year into the recovery, will distort financial markets and greatly complicate future Fed efforts to normalize monetary policy.

“The Fed’s purchase program has also met broad opposition from other central banks and we share their concerns that quantitative easing by the Fed is neither warranted nor helpful in addressing either U.S. or global economic problems.”

The rising opposition to the Fed is further evidence that the global money war I’ve been worried about is intensifying. It’s proof positive that my previous advice to stay away from both long-term Treasuries and long-term debt of any kind, including municipals, was on target.

We’ll likely see a bounce in bond prices soon, given the massive sell off. But I think this market action is a signal to take some profits off the table after the recent major run in risk assets.

Until next time,

Mike

P.S. This week on Money and Markets TV, we looked ahead to the holiday shopping season. And our panel of experts explained why it’s so important for the retail industry, the overall economy and how you can profit with ETFs.

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