Gold Price Explosion on the Way - US Dollar is Doomed

If investors stop buying US Treasuries the dollar will collapse!
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Supply fears start to hit Treasuries
By Michael Mackenzie in New York and David Oakley in London

Published: March 26 2010 19:18 | Last updated: March 26 2010 19:18

The bond vigilantes are finally flexing their muscles. A long period of stability for the US government bond market showed signs of cracking this week as a lack of investor appetite for new debt sent the benchmark 10-year yield to its highest level since last June.

For more than a year, analysts have been warning that record sized debt sales by the US Treasury were at odds with a 10-year yield sitting comfortably below 4 per cent. This week, the yield on 10-year notes jumped from 3.65 per cent to a peak of 3.92 per cent on Thursday. On Friday it was 3.87 per cent.

Falling inflation, rising unemployment, the housing market slump, the Federal Reserve’s policies of a near zero overnight borrowing rate and its purchase of up to $1,700bn in bonds have all helped keep Treasury yields near historic lows.

But this week the mood shifted as yields for $118bn of new US debt were much higher than forecast, sparking overall selling of Treasuries. Sentiment also deteriorated in the UK bond market after the government’s budget ahead of a general election expected in May failed to resolve doubts over future spending and debt reduction.

The term “bond vigilantes” was coined in the 1980s when bond investors pushed up long-term yields to force central banks into taking action to curb inflation. This time, bond investors are less worried about inflation: they are fretting about huge fiscal deficits and the looming bond supply needed to finance them.

“Everyone thought we would see rising rates due to higher inflation, but it appears the bond vigilantes are demanding a higher real rate due to concerns about Treasury issuance,” says George Goncalves, head of fixed income strategy at Nomura Securities.

The fact that German Bunds have outperformed both Treasuries and gilts in recent months highlights this increasing worry over public debt. Germany’s budget deficit is much lower than the US and UK and inflation there is also expected to remain low.

“The spotlight on Greece only helped to reveal that the US’s kitchen – with Federal and state budget balances – was itself full of cockroaches,” says William O’Donnell, strategist at RBS Securities.

It hasn’t helped that the US announced a big overhaul of its healthcare system this month, adding to worries about the scale of US spending.

Moreover, the Fed completes its bond buying programme next week, leaving the market to absorb the supply of new debt on its own. Next week’s March employment report, which economists say could see 150,000 jobs created, also looms as a test for bond market sentiment.
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