It is important that analysts who say that something huge is coming provide coherent evidence for such an event. Let me offer a recent example of an analyst who failed to do this.
In an article by Jim Willie, whose subscription-based newsletter is the improbably titled Golden Jackass, we learn that the Treasury bond market is now a huge carry trade market. A carry trade exists when a lot of investors have borrowed short-term at low interest rates and have lent long-term at high interest rates. If you borrow at 1/10th of 1 percent and lend at 1.6%, you make 16 to one. That’s a very nice rate of return.
Banks can borrow overnight money at 1/10th of 1%. They were able to buy 10-year T-bonds last May at 1.6%. (Today, it’s 2.7%). Jim Willie warns that this is a carry trade market. He does not say that it is a possible carry trade market. He says that it is one. For this, he needs to offer evidence.
Rates on 10-year T-bonds have climbed by about 65% since May: from 1.6% to 2.7%. This is well known. He concludes that this T-bond carry trade is unwinding. The investors are trapped. Rising rates have knocked down the market price of all the low-rate bonds held by banks. The holders must now sell to avoid huge capital losses.
Really? Why? Commercial banks are allowed to maintain their investments on their books at the prices which they paid, not what the bond market says they are worth today. They need not report any losses on their T-bonds until they sell the bonds. My conclusion: bankers will not sell their banks’ bonds. Keeping the bonds in their portfolios lets them conceal their losses. The higher the banks’ real-world losses, the less willing bankers will be to sell.
But if the bond owners will not sell, then this market, while analytically speaking is a carry trade market, and may possibly be one in operation, is not in imminent danger of collapsing. To the extent that banks hold T-bonds, it will not collapse.
Mr. Willie says otherwise. He bases his argument on the ownership of T-bonds by banks: commercial and Federal Reserve.
(For the rest of this article, click the link.)