A New Conundrum in Treasuries?

Mark Hulbert on MarketWatch is reporting a new conundrum in US treasuries.

I have another conundrum to add to the one that Federal Reserve Chairman Alan Greenspan complained about six months ago.

Greenspan, of course, was referring to the puzzling behavior of long-term interest rates. Even though the Fed has been steadily raising short-term rates, long-term rates have been falling -- unexpectedly flattening the yield curve.

The additional conundrum I have in mind has materialized more recently. The bond market has fallen markedly over the past month even while bond investors appear to have become less concerned about inflation.

It's usually the other way around, of course. Bonds more typically rally in the face of a lessening of inflationary fears, on the theory that the Fed will thereby feel less pressure to raise interest rates.

Marvin Appel, editor of the Systems & Forecasts newsletter, pointed out this unusual behavior in his telephone hotline Monday night: "Long term bond yields continue to climb, supposedly reflecting fears that Federal Reserve Chairman Alan Greenspan will testify later this week as to ongoing strength in the economy."

Personally I think there are three logical explanations for this behavior and there is no "new conundrum".

1) In the wake of capitulation by Bill Gross and Stephen Roach (the newest treasury bulls), some sort of snapback should be expected. I went neutral on treasuries shortly after Gross's capitulation.

2) Perhaps the treasury market is looking forward to the next FED pause. I think at least a short term selloff is likely when the FED pauses and then again when the FED first cuts. Mish did you say cut? Yes I said cut.

3) Corporate bond investors have gotten insanely greedy lately. Investors are chasing any little bit of extra yield they can find. As a topping process in this greed, there is an increased risk preference for junk bonds vs. treasuries. Even the riskiest of junk has been receiving very healthy bids. Eventually this insanity in junk will unwind and there will be a mad rush (a re-pricing if you prefer that term) back into treasuries and away from risk.

There you have it: Three logical explanations for the newest treasury conundrum. I think it is some combination of the three. Simply put, there is no conundrum.

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