More Bond/Mortgage Pain Ahead

Mortgages cant catch a break as the Negative Convexity Trade is in full effect.

Treasury Auctions for $19 billion in 10 years on Wednesday and $11 billion in 30 years on Thursday not to mention $35 billion in 3 years tomorrow will pressure prices, thus creating more upward mobility in Mortgage Rates.

Lot of Bond Bets are being placed, most of them calling the Treasury/Fed's bluff on the direction of rates.

Yields on long-term US Treasury's have risen by about 167 basis points over the last five months. This translates to a jump of about 81% over the same period.

Long-term bond yields are generally seen as a benchmark for long-term interest rates. This means the bond markets act as a check against government profligacy. If yields go too high, it would seriously complicate further debt financing and choke off any possibility of a near-term recovery.

Yields may not be “too high” now. But the recent 81% jump is a stern warning to government that bond investors are aware of the pressure on US debt.

Right now, Washington, in its infinite wisdom, is borrowing 50 cents for every dollar it spends. And this year alone, Team Obama intends to borrow $1.84 trillion – or about 13% of annual economic output – to fund its spending. The last time the federal government borrowed this much money it was to fund its involvement in the second world war.

According to the Congressional Budget Office, the government will be forced to borrow a further $10 trillion to fund it spending programs over the course of the next decade. At a conservative estimate (assuming wildly optimistic economic growth forecasts), this will push borrowing to 100% of GDP by 2017 – without taking into consideration the country’s massive unfunded obligations to finance Medicare and Social Security.

All this, of course, has to be funded by the issuance of government bonds. And it’s unthinkable that this tidal wave of debt will not push yields up further as investors call into question the US government’s ability to pay this debt pile back without resorting to deliberate inflation.

World War II left countries bankrupt. Now the government is bankrupting the US trying to save it.