Is the Bond Market’s Arab Spring Upon Us?

Ugly action in bonds over the past few days.

In last month’s post,  Is the Fed ready for the bond market’s Arab Spring?, we suspected the Fed needed more ammo to continue their repression of long-term rates.   Yesterday Mr. Bernanke offered no hint of further bond purchases post Operation Twist.

The market saw its chance to rise up against the Great Financial Repression and managed to  take 10-year Treasury yields up 25 basis points over the past two days.    So far,  so good, however, as bonds are currently reacting to a stronger economy and a Fed that may be handcuffed by rising oil prices,  a better economy, the recession of European sovereign risk, and domestic politics.

Nevertheless,  spiking bond yields have to be closely monitored in a country where sovereign debt exceeds or is around 100 percent of GDP because of the potential for an adverse budgetary feedback loop.   Another brick for the equity bull market’s wall of worry.

Here’s what we wrote back in February,

..the Fed holds over 40 percent of the Treasuries outstanding in several of the years in which they mature.  In many of the specific maturities, the Fed owns up 60-70 percent of the total outstanding issue.

The Fed had to “relax” its self imposed 35 percent limit on SOMA holdings of individual issues and included recently issued securities in order to execute its maturity extension program announced last September. It’s going be interesting to see how longer-term interest rates behave as the economy regains some of its mojo and money comes out of the Treasury safe haven.

The Fed has yet to fight the markets in its repression of long rates as Operation Twist has been riding the tail winds of positive market psychology and strong demand for safe havens due to Europe’s sovereign debt and banking crisis…

We’re the first to admit nobody knows the future, most of all us,  but we smell a potential fight or flight in the bond market, comrades.  An Arab Spring in the bond pit, if you will.    With oil prices north of $100 and rising rents, which is the largest component of the CPI, it is our sense the Fed better be able “to float like a butterfly and sting like a bee.”

The bond market landed a couple of huge body blows in the past two trading sessions.   Let’s now see how the Fed counterpunches.

More talk of sterilized’ bond buying?  Wouldn’t doubt it.

But how about letting markets find their equilibrium levels?

That could be dangerous, however,  with China and Japan’s current account surplus now shrinking or turning negative thus bringing an end — temporarily, or not — to the recycling of surplus dollars back into the Treasury market.    It is going to be interesting,  folks.