Expect erratic moves in the bond market

Liquidity infusions are not what they appear to be, as actual and perceived liquidity can vary greatly.

By Stock Traders Daily Jun 19, 2013 11:25AM

U.S. savings bonds © Corbis , SuperStock Stock Traders Daily has issued a special report on monetary policy, outlining the influence of the recent combined efforts of the U.S. Treasury and the Federal Reserve over both perceived and real domestic liquidity. 


Specifically, we focus on the perceived liquidity on the heels of the popular $85 billion monthly bond buying program the Federal Open Market Committee initiated last year.


Because the velocity of money has not increased proportional to the stimulus programs enacted in recent years, virtually the sole benefit of these programs has been added liquidity to the U.S. economy. However, and often unnoticed by the general public, the efforts of the Federal Reserve are largely offset by the simultaneous bond issuance and other operations of the U.S. Treasury.


In our report, we quantify the net influence of the $85 billion monthly bond buying program adjusted for U.S. Treasury operations and foreign interest to find the real versus perceived liquidity the current monetary policy has infused into the U.S. economy. The conclusion is that the actual infusion of capital is far less than the face value of the program, and the Federal Reserve therefore has very little wiggle room.


Any meaningful adjustment to the $85 billion monthly bond buying program could cause monetary policy to become an immediate drain on domestic liquidity.


Since May 1, 2013 iShares Barclays 20+ Year Treas Bond (TLT) has fallen by more than 9% as investors have expressed concern over the risk of tapering, and that raises many eyebrows. Investors in long-term Treasury bond funds and ETFs could be trapped if interest rates begin to increase aggressively more than they already have.


Given today's uncertainties, Stock Traders Daily recommends that investors avoid positions in ProShares UltraShort 7-10 Year Treasury (PST) and ProShares UltraShort 20+ Year Treasury (TBT), short bond-based ETFs, as well as bond funds and bond ETFs that are net long the bond market. Expect erratic and emotional moves in the bond market and therefore expect risks to bond investors to increase meaningfully, more than they already have.


If the stock market has increased based on perceived versus actual liquidity, we also suggests the equity and housing markets may also come under severe pressure if monetary policy becomes a drain on domestic liquidity levels.

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