Friday, March 11, 2011

Asia Impact as D-Day approaches for the US treasuries market

Bill Gross, the US "bond king", has jumped out of the US Treasuries market.

As head of Pacific Investment Management, he announced the other day that he has dumped all of his US Treasury holdings due to the uncertain prospects of the Federal Reserve's second round of quantitative easing (QE2), which will end on June 30 this year. Gross is the single largest bond fund manager, who oversees some US$1.2 trillion of assets in the fixed income securities.

For Gross to be dumping all of his US Treasury holdings means that he is worried about the US debt implosion. In fact, Gross has been warning for quite some time that the bond market has reached the largest bubble in the history of the world. If investors, including sovereign holders of US Treasuries, head for the exit, US Treasuries will collapse, resulting in a skyrocketing interest rate rise and inflation going through the roof.

"The Treasury market typifies perhaps the most overvalued area of the bond market," Gross says.

The bond market has been kept alive by the Fed's monetisation of the government's debt. Gross writes: "If someone has been buying $1.5 trillion worth of Treasuries and now doesn't buy $1.5 trillion worth of Treasuries, it'll affect yields on the upside."

According to ZeroHedge (see, Gross's flagship Total Return Fund, in the month of January, reduced its bond holdings to zero and held cash instead. "After sporting $28.6 billion in 'government related' securities, TRF dropped to $0.0, while its cash holdings surged from $11.9 billion to a whopping $54.5 billion (based on total TRF holdings of $236.9 billion as of February 28). This is the most cash the flagship fund has ever held, and the lowest amount in Treasury holdings since January 2009, before it was made clear that the Fed was going to adjust QE1 to include Treasuries in addition to Mortgage Backed Securities."

Following the collapse of Wall Street in 2008, the US Federal Reserve started to bail out the financial system by injecting fresh liquidity through the first round of quantitative easing. QE1 was designed to freeze the bad assets of the big banks so that they did not have to market to market the plunging value of their largely mortgage-related assets. So far QE1 has helped stabilise the US and global financial systems. There has been talk of an exit strategy, but with the US's fragile economic recovery and high unemployment, the Fed has decided to continue its money printing programme via QE2.

Under this programme, it will buy up US Treasuries to hold down the interest rate, hoping that banks will lend to the economy to prop up employment. But QE2 is a monetisation of the Federal government's debt in disguise. The Fed, through QE2, has bought about 70 per cent of US Treasuries. Both QE1 and QE2 are worth about US$1.5 trillion. But there have been reports that the Fed has also printed at least $16 trillion US dollars out of its balance sheet.

QE2 has led to a surge in oil and other commodity prices around the world. The turmoil in North Africa and the Middle East can be traced back to QE2, which has flooded the world with liquidity and caused a flight to commodity assets. Food prices have sharply increased as a result. Many now fear a spectre of hyper-inflation if the Fed continues its money printing programme.

Gross says June 30 could be "D-Day" for the Treasuries market. "Bond yields and stock prices are resting on an artificial foundation of QE2 credit that may or may not lead to a successful private market handoff and stability in currency and financial markets," he writes.

"It becomes a question of musical chairs to a certain extent: who gets out first and who's the last one looking for a chair on June 30," he says.

Which brings us to an important question: Will the Bank of Thailand continue to hold on to US Treasuries in the portfolio of its international reserves and risk suffering a rout; or will it diversify to holdings of other assets?

Probably it is a good time for the Thai central bank and other sovereign nations to start direct talks with China over the possibility of getting more yuan in their portfolios. The Nation, Bangkok

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