LTCM All Over Again? Gamblers In Greek/Spanish/Italian Debt Buying Back Short Hedges In UST

Frederick J. Sheehan

The Producer Price Index for April was released May 14, 2014. The one-month change was +0.6%, after it rose 0.5% in March (revised to that figure in the April report). Foods rose 2.7% (+1.1% in March). In “All the Junk Food You Love is Pricier This Year,” Max Nisen writes on Quartz: “Chipotle’s [Grill – CMG: NYSE] food prices were up 34.5% last quarter in total, with big increases in [beef, cheese, avocado, and pork].”

Chipotle’s CFO John Hurtung laments: “While we want to remain accessible to our customers, we’re at a point where we need to pass along these rapidly rising costs.” Chipotle’s stock price was $505 at the close on May 14, 2014, up from $49 at the great liftoff on March 9, 2009

 Nisen went on to report McDonald’s “has already boosted prices. McDonald’s CFO Peter Bensen suspects: “[Y]ou do see franchisees generally around the industry, not just McDonald’s, anticipating some of these higher input costs.”

Nisen also went on to discuss higher prices at Taco Bell, Pizza Hut, KFC (Kentucky Fried Chicken to those over 50: it was the Chipotle Grill or Facebook of the Go-Go Years) and Pepsi. Pepsi CEO Indra Noori discussed the situation as unintelligibly as possible: “The strength of our brands is clear in our ability to achieve consistent net price realization.” Whatever that means, family incomes are falling.

It seems doubtful Pepsi’ stock price will benefit, but analysts, accountants and public-relation experts are very well paid.

At the same time, U.S. Treasury yields are falling. From over 2.7% in late April, the 10-year Treasury closed at 2.53% on May 14, 2014. The Wall Street Journalcommenced its front page dissection on May 15, 2014:
“Global bond rates dropped to their lowest levels of the year Wednesday, as central bankers signaled their determination to jolt the world’s largest economies out of their malaise. Investors piled into U.S., German, and British government bonds-used to price everything from mortgages to car loans-driving down their yields. The yield on the 10-year U.S. Treasury dropped to as low as 2.523%, its lowest level in more than six months. In Germany, 10-year bund yields fell to their lowest point in a year. The Journal‘s headline was “Nervous Investors Pile Into Bonds.”
Note the “central bankers” comment. Only 9% of Americans knew who the Federal Reserve chairman was in 1979. These temporary celebrities’ [redundant – ed.] determination for the masses to believe “inflation is too low” knows no limits. They are determined to prevent “deflation.” Whether they believe that or not, all of the tendencies: among central bankers, the media, and Wall Street, will foster this myth. Martin Wolf wrote another irresponsible mandate in the Financial Times on May 14, 2014 with the headline: “Time for Draghi to Open the Sluice.” The top of the front page of the same edition drew readers to the column: “Time for Draghi to Pull Out Another Bazooka,” Martin Wolf, page 9.”
It is said, and with truth, that “stocks always get it last.” Meaning, watch the bond markets for signs of change. That phrase circulated before bond markets were policy tools of central planners.
At least part of the reason – I think most of the reason – the 10-year bond yield has fallen is due to short covering. One of the most widespread tactics in recent months has been to hold long positions in riskier bonds while adding protection by shorting Treasuries.
Treasuries are hard to come by. The Federal Reserve’s various QE (i.e. money printing: in which the money is credited to banks in exchange for the banks’ U.S. Treasury and MBS holdings) programs have made certain maturities hard to come by. For instance, in 2011, the Federal Reserve held 24% of the 10-30 year U.S. Treasuries. On December 31, 2013 it held 46%.
A bond manager who is watching and worried that other bond managers may cover their short positions (they have to buy the Treasuries they had previously sold), contributes to the downward momentum in yields by reducing exposure to a Treasury rally (by buying). Falling yields signal the opposite change to the actual and immediate problem of price inflation everywhere.
If the downward momentum in short-covering really takes wind, the 10-year could fall below 2.0%, for a long enough time to buy or refinance a mortgage before the great inflation grows obvious.
Frederick J. Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession  (McGraw-Hill, 2009) and “The Coming Collapse of the Municipal Bond Market” (Aucontrarian.com, 2009)