Sep

15

 The first time that the discount rate or funds rate is increased, the expected number of subsequent increases is about 12 and during about 2 1/2 years. Thus, one would expect a tremendous decline in the short term bond prices when it occurs. You see bond investors are very wise and rational. And as soon as the first increase occurs, no matter how many "once is enough" demurrals ensue in expiation, they factor in the the subsequent 12 increases. The effect usually spills over to the long end for 1 or two weeks, until the realization that it's deflationary steeps in. One would expect it also to be one of those blue days when both stock and bonds decline wildly, as for once the canard that bad output numbers are good for bonds and bad for stocks is gainsaid.

Such increases in the old days were invariably preceded by declines in the stock market as they were announced during the day, but now the announcements are calibrated so as to make sure that those buying the bonds auctions would not have their sensibilities discommoded by such news after they have committed.

The process of borrowing at the 1/4 % fed funds rate, and buying the long bond at 3.8 % must be likened to the selling of premium. It has to be a very profitable strategy most of the time until the day of disaster comes that wipes one out. When will it occur? When the the idea that selling premium in such fields as fixed income is a losing game is right for the wrong reasons. The premiums that the sellers receive are often very high in relation to the expectation. It's just that the other side that does the buying often is better capitalized, bigger, and thus on the rules committee and the margin committee, and a market maker. on the rare occasions that the piper must be paid, they squeeze the sellers into the point of oblivion. But that doesn't mean that the average buyer of premium is not going to suffer a loss. The participants in the squeeze are limited to the top feeders. One says this in relation to the likely outcome when the long bond buyers get squeezed and does not apply this to anything else for obvious reasons.


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