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Minyan Mailbag: Inverted Yield Curve

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Central banks seem to be going out on the curve more as they see the economy slowing...

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Hi Professor Sedacca,

I'm missing the mountains already, but oh well, there's always next year! Getting down to business--

Do you know who's buying at the different parts of the yield curve? I know that inversion can be caused by supply/demand pressures, but I assume that foreign central banks don't buy evenly across all maturities. So how much of the long end is expectations, and how much is demand?

~Minyan Candice


Candice,

Well, it is all demand and supply for each trade. Ultimate supply comes from the needs of the Treasury. Central banks seem to be going out on the curve more as they see the economy slowing here, but have remained in the 48-52% range of total outstanding for quite a while.

As for commercials, or 'smart money,' I have noticed a now sizeable short in 10's, like 200,000 contracts and a reduction in their 30 year position as well - both not the greatest signs in the world, despite coming into a seasonally strong time of year. In addition, world markets, as I mentioned, have become HUGE buyers of corporate debt in the US, which is the main reason I think that spreads have stayed so tight. Keep in mind, these markets don't have the greatest of records in our markets for timing.

Prof. Sedacca,

You're right, I should've clarified between domestic and foreign demand. James Bianco did a study on the implications of foreign buying confirming what you said--the domestic bet (smart money) is more often right, while foreign buying is contrarian. So the fact that we're getting net buys of $440 billion in US corporate bonds (almost twice their net purchase of Treasuries!) means...ha.

~Minyan Candice

MC,

None of it is good. What are they really when you think about it? Potential supply? So I don't see how it can be a positive in any way. For us to even NEED the demand is sickening and they remind me of the true elephant in the room if our currency were to get hammered, something I think the Bush Administration will not allow. Those who are supporting our country are not stupid. At some point, however, I think they become a source of supply. It is why I did the short end trade, even though today I wished I owned long stuff! But it reminds me of commercials being mega short SPU's in 1999-2000 but in reverse.

No positions in stocks mentioned.

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