2-Year Treasuries at Record Low .21% Yield; LIBOR Exceeds 2-Year Yield; Is this Crazy?

Nearly the entire treasury yield curve is at or near record low yields as Bloomberg notes in Treasury Auctions Two-Year Notes at a Record Low Yield on Refuge Demand

The Treasury sold $35 billion of two-year notes at a record low yield of 0.22 percent as investors continue to seek the world’s safest securities as a refuge from financial market turmoil and a slowing economy.

Record Lows

The 10-year note yields dropped on Aug. 18 to the historical low of 1.97 percent. Yields on five- and seven-year notes fell that day to records of 0.79 percent and 1.31 percent.

Two-year note yields reached a record low of 0.1568 percent on Aug. 9.

The two-year note auction yield was less than the previous record low of 0.395 percent on June 27 and compared with the average forecast of 0.221 percent in a Bloomberg News survey of eight of the Fed’s primary dealers.

Bid Pattern

Indirect bidders, an investor class that includes foreign central banks, purchased 31.6 percent of the notes, compared with 27.7 percent at the July 26 offering and an average of 31.1 percent for the past 10 auctions.

Direct bidders, non-primary dealer investors that place their bids directly with the Treasury, bought 15.9 percent of the notes, versus 20 percent last month and an average of 15.1 percent at the last 10 auctions.

So much for the potty notion that foreign governments were about to dump US treasuries. Not to fear, I am sure that silly notion will be revived next week if not tomorrow.

Treasuries Invert With LIBOR

If you were waiting for the yield curve to invert before you were willing to admit the likelihood of recession, you have in inversion of sorts, not with treasury yields bur rater treasury yields to LIBOR (the rate at which banks lend to each other).

Overnight, 3-month, 6-month, and 1-year LIBOR rates exceed yield on 2-year treasuries.



The above from Bloomberg Key Rates.

Current LIBOR is .31% and that is a higher yield that treasuries all the way through 2-year, and nearly matches 3-year treasuries at .36%.

Flashback March 10, 2011: Pimco Dumps All Remaining Treasuries in Total Return Fund; Six Reasons to Fade Bill Gross

Pimco's Bill Gross has been dumping US government debt in favor of other alternatives including emerging-market opportunities. Looking ahead, I think it's more likely to be a bullish setup for treasuries than not.

First, please consider the news.

Bloomberg reports Pimco’s Gross Eliminates Government Debt From Total Return Fund

Six Reasons to Fade Pimco

I view this setup as favorable for US Government bonds. For starters there is no Pimco selling pressure, only potential buying pressure when Gross changes his mind.

Second, everyone seems to think the end of QE II will be the death of treasuries. While that could be the case, sentiment is so one-sided that I rather doubt it, especially is the global recovery stalls.

Third, the US dollar is towards the bottom of a broad range and any bounce could easily wipe out gains in higher yielding emerging-market debt.

Fourth, the global macro picture is weakening considerably with overheating in China, state government austerity measures in the US, and a renewed sovereign debt crisis in Europe on top of a supply shock in oil. Emerging markets are unlikely the place to be in such a setup.

Fifth, chasing yield means chasing risk, and that is on top of currency risk. Chasing risk is highly likely to fail again at some point, the only question is when.

Sixth, several interest rate hikes are priced in by the ECB this year. Will all those hikes come? I rather doubt it, and if the ECB doesn't hike, look for the US dollar to rally, perhaps significantly.

Nearly everyone but economist Dave Rosenberg dismissed US recession talk in March, few do so now and investors are no longer looking for gains, but rather simply a safe place to not lose money.

The US dollar did not rally yet as I had expected but the rest of what I said was spot on. Bear in mind I see no value in US treasuries now, and there was little value even then.

So are 2-year yields at .21% crazy?

Hardly.

It's the search for safe, liquid hiding places that has compressed US yields. Risk in equities heading into a recession, with Europe already in recession and Asia slowing rapidly, is enormous.

Moreover, that 1 month LIBOR is .31% while 1-month Treasuries sit at 0% is not crazy either, except perhaps in reverse (the spread is not high enough). Distrust between banks is high and rising and for good reason. Even on this nearly 3% up day in the markets, Bank of America is trading down nearly 3% and at one point touched as low as $6.01, down about 6.5%.

The risk trade is off and it may be off for longer than most think. For reasons, please see Another "Lost Decade" Coming Up; Boomer Retirement Headwinds; P/E Expansion and Contraction Demographic Model; Negative Returns for a Decade Revisited

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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