The Fed's Next Step: Thoughts on Operation Twist 2 and the Fed's Third Mandate (yes, there are really 3)

Now that Chairman Bernanke has inasmuch admitted he has no clue what's going on, but is ready to pull yet another rabbit out of his beard at the next FOMC meeting, it's time to address his monetary manipulation options and just why the most likely one might be illegal. While some might doubt the imminence of the next round of easing, according to the minutes of the last FOMC meeting, released only yesterday, there was a secret meeting by videoconference on August 1 to discuss the debt ceiling and the "possibility" of a ratings downgrade of US debt (which would occur just four days later). The last (and only, according to our search) videoconference was conducted October 15, 2010, just prior to the FOMC meeting that would announce QE2.

Curiously, Bernanke made scant mention of his "tools" Friday at Jackson Hole, perhaps not wanting to tip off the broader bond market on which Treasurys to load-up (though we're sure Larry Meyer is advising his clients). However, his options are basically twofold and come down to targeting either interest rates or the Fed's own balance sheet size.

Really, the Fed has been doing both, as it has continuously targeted the shortest end of the curve in the overnight Federal Funds market at 0-0.25% since late 2008, while its QE1 and QE2 operations aimed at increasing its balance sheet by a total of $2.35 trillion. Arguably, the latter helped facilitate the former. And, in the last FOMC statement, the Fed committed to keeping an exceptionally low Federal Funds rate into mid-2013. This means that even if the market starts demanding higher short term interest rates in the next two years, the Fed has pledged it will step in and flood the markets with liquidity via open market operations (likely temporary repos) to keep rates low. Think about that.

Correct or not, many perceive this massive digital money printing as causing the recent and growing price inflation at the pump and Piggly Wiggly. Recent civil unrest in MENA and (gasp) Londontown are serving as wake up calls. The public, when it perceives itself sufficiently aggrieved, will turn on its government on a shiny, FDR dime. Bernanke knows he needs something different to give himself plausible cover. See here for a variety of possibilities set forth by Goldman.

Today, we'll focus on interest rate targeting further out on the yield curve (so-called Operation Twist 2, or OT2), and why it looks increasingly likely. First hypothesized by David Rosenberg and discussed in detail at ZeroHedge, OT2 would be a quasi repeat of the Kennedy-era Fed operation, whereby it committed to purchasing enough Treasurys at the longer term yields to effectively cap them, in order to strengthen the US Dollar and prevent gold outflows, while simultaneously not putting pressure on short term rates. It was initially judged a moderate success, as indeed the yield curve flattened. While gold convertibility itself is now itself a barbarous relic, the concept of long term interest rate targeting has been revived as an alternative to balance sheet targeting.

The question is what maturity the Fed would target. If, as Rosenberg originally suggested, it is in the longest maturities (10 to 30 years), then we could indeed see higher stock market prices. As TradeWithDave reasoned (prior to Jackson Hole and the last FOMC meeting):

Here’s Dave’s gut instinct. This is a temporary attempt to strengthen the dollar artificially cooling inflation while attempting to coax cash off of corporate balance sheets into mid-term investments by inverting the yield curve and motivating banks to lend to businesses again due to attractive low, long-term rates. What will it actually do? Dave thinks it’s like “cash for clunkers”, but it’s really more just “cash for candy.” It will create the need for increased liquidity and more paper money and it will increase the near-term velocity of cash actually creating a currency shortage.

It will be like a sugar high. Like dropping a Mentos into a bottle of Coke. Wow! Then you’re left with a flat soda and sticky mess. Is anyone foolish enough to sink long-term or even mid-term (say a 7 year term loan for a business) investments when you have such an unstable environment? No. So, what will happen is an increase in liquidations (further drop in real estate prices) in an effort to lock-in short term returns.

In other words, companies will sell the ranch and use the money to chase the higher near-term returns which will allow them to pay stellar dividends which will rocket their stock price all while they destroy their (and our) long-term prospects… but who cares because they’ll make their numbers for the quarter while no one else is, which means they will not only survive, but prosper and further consolidate their leadership positions in the UPS/Fedex, Verizon/AT&T, Apple/Android, Coke/Pepsi duopolistic fantasy of a free market. If the sugar fix was legitimate investment and the dollar was fundamentally strong, then it would destroy the stock prices, spoiling our dinner and the intended wealth effect and we can’t have that now can we.

Since then, we have learned the Fed will target short term rates for two more years (which presumably could include a couple of modest Fed Funds rate hikes up to 0.75%). Accordingly, this might ultimately weigh on the US Dollar. If indeed the Fed ends up targeting longer term yields as well, we might end up with a yield curve that looks something akin to a handlebar mustache. In this scenario, the chase for yield would indeed be in the belly of the curve.

What the Fed might have all along planned is for a two prong interest rate targeting of both ends of the yield curve spectrum, with each leg to be implemented at successive FOMC meetings, sandwiching Jackson Hole for maximal PR value.

Another possibility, raised by Bill Gross of Pimco, is that the Fed will target the 2 to 3 yr maturities. Other than restarting the mortgage option-arm market, we're curious to know what this might accomplish, as the Fed would cede control of the long end. However, we do present it below as a possibility, which is a very rough sketch (we're not bond market wizards):

Why OT2 will not come from QE-Lite

The Fed continues to maintain its balance sheet size by buying Treasury securities as the Agency and Agency MBS securities it also owns mature or are paid off (so-called QE Lite). People pay down mortgages, the servicers pay Fannie and Freddie, who in turn pay the MBS holders, which includes the Fed (holding just under $1 trillion in MBS now). Accordingly, the Fed is still buying Treasurys at about $15 billion per month (down from over $100 billion per month during QE2).

It has been suggested that the Fed could simply target longer maturities with this $15 billion fire power, or actually reshuffle its portfolio to extend its duration. Our view is this puts the Fed in a very precarious position, because once it guides expectations that it will extend duration, the bond market might awaken and demand a full commitment for yield targeting. As many have noted, the Fed cannot target long term rates and its balance sheet size simultaneously. It must be willing to purchase every single bond at a given maturity range.

The legal problem

The oft-cited "dual mandate" of the Federal Reserve for maximum employment and stable prices was enacted in 1977 when Congress modified the Fed's mandate. Curiously, stable prices is always interpreted by the Fed to mean 2% annual inflation dollar devaluation. However, there is actually a third mandate for "moderate long-term interest rates". It's right there in the Federal Reserve Act:

Section 2A. Monetary Policy Objectives

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy's long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

Exactly why the third mandate fell down the memory hole is revealed in the footnote of a speech given by none other than Bernanke himself (emphasis ours):

The Employment Act of 1946 established the objectives of "maximum employment, production, and purchasing power" for all federal agencies, whereas the 1977 amendment to the Federal Reserve Act gave the Federal Reserve the specific mandate of promoting "maximum employment, stable prices, and moderate long-term interest rates." Price stability requires that the central bank not attempt to drive employment above its sustainable level, and so in practice the Federal Reserve has interpreted its mandate to include maximum sustainable employment. The goal of moderate long-term interest rates is frequently dropped from statements of the Federal Reserve's mandate not because the goal is unimportant, but because moderate long-term interest rates are generally the byproduct of price stability.

Yet, what if exceptionally low long-term interest rates are the by-product of intentional distortions created by Federal Reserve interest rate targeting? Wouldn't this be an intentional and explicit violation of the Fed's statutory mandate of "moderate" long term interest rates?

What constitutes "moderate" is not explicitly defined, but long term rates are already at historically low levels, and it would be difficult to characterize any further targeted lowering as "moderate". While the 2-3 year range might be considered "middle term", the Fed's most likely option, the 10-30 year, is definitely long term.

All it would take is one Federal lawsuit and a sympathetic judge to serve a temporary restraining order on Brian Sack at the New York Fed to bring the digital money printing wheels to a grinding halt.

Now think about that.

End of Intermediate Term MIDAS TopFinder in Gold Suggests Moody's Downgrade Now Priced In

Today, we're taking a break from rummaging through the Fed's website to present a bit of voodoo technical analysis, which we usually reserve for our daytrading forum, but will post here, as it might be of some interest to those keeping track of the barbarous relic's recent surge.

For background* on the MIDAS TopFinder(TF)/BottomFinder (BF) tool, see our post at ZeroHedge from October 15, 2010, and the follow up by Andrew Coles here (coincidentally posted on July 5, the low from which the current TF was launched, and when he noted a rally was indeed possible as TF support from the weekly time frame had held).

The termination of the current TopFinder concurrent with the ominous bearish engulfing candlestick today likely signals an end to the current epoch of panic-to-quality induced by the Moody's downgrade of US debt. This would mean long term Treasury yields have likely troughed as well, at least for the short term [and, yes, they indeed plunged much lower than we had anticipated just prior to the Moody's news].

As Paul Levine wrote in 1997:

What I’ve just described here may be confusing to those who are new to using TopFinders, since people are usually expecting one indicator that will clearly identify the top. It’s important to understand what a TopFinder does and does not do. It does identify an accelerated uptrend that is all “of a kind”, with price behaving in the same way all the way to its end. The end of a TopFinder does identify the end of this kind of price behavior and the beginning of a consolidation even if it’s only a brief consolidation. And the end of the TopFinder does identify the place beyond which price behavior will be distinctly different. However, in spite of the catchy phrase “Top Finder”, it does not necessarily “find the top”. After the consolidation, price may resume going up, albeit with a different pattern than before the end.

So, the end of the TopFinder on the daily chart does not preclude yet another disaster from setting the markets ablaze, but it does suggest the Moody's downgrade is now priced in. Indeed, on the weekly time frame (reproduced to conform to Coles' July presentation), we might see a retracement to its rising TF (currently $1686), with a subsequent price rally to new highs above $2000. At 95% completion and incrementing 1% per week, that would coincide with mid-September.

Finally, on the secular/decadal time frame, as Coles wrote in July:

It may not have escaped the noticed of some readers that the secular degree trend (10 to 25 years) in gold from the 2001 bottom also appears to be accelerating. Indeed, as in Chart 7, we have the same setup for a TF (red), since S1 (green) displaced immediately from the trend when it was launched from the March 2001 bottom. This enormous secular-degree TF is 56.9% done, suggesting – on an extrapolation of a price/time reading from the cumulative volume prediction – that we could see another decade of rising gold prices.

Conclusion: sell your bullion? No! But, be wary of leveraged long gold exposure here.

*The recent Bloomberg Press publication by Coles and Hawkins, MIDAS Technical Analysis, has become the definitive reference book on Paul Levine's work, incorporating a number of innovations, including some of our work.

More on how the GAO's phony Fed audit failed to disclose some dirty secrets about BlackRock and JP Morgan

We recently revealed that the Government "Accountability" Office (GAO) audit of the Fed's emergency practices during the financial panic (which caused so much consternation even in watered down form) was a complete whitewash. In its review of the Fed's outsourcing practices, it failed to mention the most damaging and suspicious sole-source (no bid) contract awarded to BlackRock, which was for handling the New York Fed's toxic Bear Stearns portfolio, otherwise known as Maiden Lane. This contract would generate $108,000,000 in fees and was one of the largest awarded during the bailout period, but it might also have saved JP Morgan $1.1 billion in losses from its Bear Stearns acquisition.

A key finding from the GAO report related to the noncompetitive award of contracts to third parties, particularly by the New York Fed:

The Reserve Banks, primarily FRBNY, awarded 103 contracts worth $659.4 million from 2008 through 2010 to help carry out their emergency lending activities. A few contracts accounted for most of the spending on vendor services. The Reserve Banks relied more on vendors more extensively for programs that provided assistance to single institutions than for broad-based programs. Most of the contracts, including 8 of the 10 highest-value contracts, were awarded noncompetitively due to exigent circumstances as permitted under FRBNY’s acquisition policies.

The report also stated there was a total of three sole-source contracts awarded, and the GAO went out of its way to highlight the reason for two of them:

For example, FRBNY noncompetitively selected BlackRock as the investment manager for Maiden Lanes II and III because BlackRock had already evaluated the underlying assets pursuant to an engagement with AIG prior to the extension of credit by FRBNY.

Yet, amazingly (or not so), the GAO failed to disclose that BlackRock had no similar experience with the Bear Stearns portfolio (the original Maiden Lane). According to [now] Vice President Sarah Dahlgren of the New York Fed, there was no "clear reason" for BlackRock to be awarded the management rights on a noncompetitive basis. We know this because of internal emails, which were subpoenaed by Congress pursuant to its investigation of the Fed's bailout of AIG:

To Sarah Dahlgren/NY/FRS@FRS

Re: Sole Source

Spent some time with him [Tom Baxter, Jr., FRBNY GC] tonight. (He doesn't understand ML3, and I can't begin explain it either -- so don't needle him! -- and I am going to have [Paul] Whynott [FRBNY VP] spend some time with him tomorrow, BTW, you might touch base with Joyce [Hansen, FRBNY Deputy GC] about her reaction to Sunday's briefing; I think she had some concerns about how ML3 was presented to Geithner, which she expressed to Paul.) [Geithner] knew that Stephanie [Heller, FRBNY Asst. GC] was handling the Blackrock contract -- he didn't express any concerns -- and I explained that, in contrast to MLI, we had a clear reason to sole source it this time (that they had already modeled, etc.). So, although I have no worries, yes, probably worth reviewing it with him [Geithner] before taking it to Tom."

As to the New York Fed's guidelines on third party contracts, the GAO notes:

FRBNY awarded contracts in accordance with its acquisition policy, which applied to all services associated with the emergency programs and single-institution assistance. FRBNY is a private corporation created by statute and is not subject to the FAR. Instead, FRBNY developed its own acquisition policy, called Operating Bulletin 10.

According to the New York Fed's Operating Bulletin 10, sole-source contracts require approval at the highest levels (emphasis ours):

4.3 Exceptions to Competitive Acquisitions

A. Procedures other than competitive solicitations or small purchase procedures may be used in the following circumstances. The Contract Representative should draft a memorandum with sufficient supporting documentation to justify the use of the exception to acquisition procedures, and obtain the approval of a senior officer (Vice President or higher). The approving senior officer must have the appropriate level of signing authority, pursuant to Operating Bulletin No. 2, for the expected dollar expenditure. A copy of both the approval memorandum and senior officer approval should be placed in the acquisition file of the Contract Representative area and forwarded to the Procurement Division as the central repository for contract information. Contracts in excess of $500,000 that are not competitively bid must be approved by the Bank’s Board of Directors pursuant to Operating Bulletin No. 2.

1. Sole Source. The property or services are available from only one responsible supplier and no other type of property or services will satisfy the Bank’s needs.

Commentary

(1) A sole-source acquisition involves no competition and should be utilized only when justified and necessary to serve Bank needs. A sole-source award should generally be made only where no other source of supply is available.

In short, the approval of the $108 million BlackRock contract had to be approved by both a senior officer at the New York Fed and its Board of Directors due to the size of the contract. And just who comprised the board at the time?

STEPHEN FRIEDMAN, Chair and Federal Reserve Agent

Chairman

Stone Point Capital, LLC, Greenwich, Conn.

DENIS M. HUGHES, Deputy Chair

President

New York State AFL-CIO, New York, N.Y.

JAMES DIMON

Chairman and Chief Executive Officer

JPMorgan Chase & Co., New York, N.Y.

JEFFREY R. IMMELT

Chairman and Chief Executive Officer

General Electric Company, Fairfield, Conn.

CHARLES V. WAIT

President, Chief Executive Officer, and Chairman

The Adirondack Trust Company, Saratoga Springs, N.Y.

RICHARD L. CARRIÓN

Chairman, President, and Chief Executive Officer

Popular, Inc., San Juan, P.R.

INDRA K. NOOYI

Chairman and Chief Executive Officer

PepsiCo, Inc., Purchase, N.Y.

VACANCY 2010 B

LEE C. BOLLINGER

President

Columbia University, New York, N.Y.

Notably, ex-Goldman Sachs Chairman, Stephen Friedman, would later resign in disgrace after it was learned that he was loading up on shares of his former employer (Goldman) as it was receiving overt and covert bailouts from the very same New York Fed through the various emergency lending facilities.

And while the contract amount of $108 million might seem like peanuts in light of the billions being thrown around at the time, BlackRock might have served another function by becoming investment manager for Maiden Lane. As we wrote in June, 2010, BlackRock ended up heavily trading the MBS portion of ML, which had been sold to the public as a vehicle to simply unwind Bear Stearn's toxic assets. So much so, that MBS trading profits papered over the substantial losses in the RMBS and loan sections of the portfolio. While the New York Fed had loaned ML approximately $28.8 billion to purchase the portfolio, JP Morgan ponied up a cool $1.1 billion of its own, and was last in line to be paid if there were losses.

Also, BlackRock was also one of the managers of the NY Fed's separate $1.25 trillion MBS purchase program as part of QE1. Contrary to the lie on the NY Fed's webpage (that the MBS auctions were conducted via competitive bidding), the NY Fed's own purchasing manager, Brian Sack, admitted in a paper that, "the MBS purchases were arranged with primary dealer counterparties directly, [and] there was no auction mechanism to provide a measure of market supply."

Putting it all together, it looks like Jamie Dimon signed off on hiring BlackRock for no justifiable reason to trade the very Maiden Lane portfolio that could have caused his bank, JP Morgan, to lose up to $1.1 billion. And, it was entirely possible that BlackRock saved the portfolio by trading the MBS portion of ML with the New York Fed directly as QE1 was underway.

Unfortunately, the GAO's work product is not subject to public request, but it can be compelled to be released by Congress. The next time Congress decides to subpoena the Fed, or Bloomberg decides to file a FOIA, they might request the acquisition file for the BlackRock Maiden Lane contract containing the officer approval and justification notes, as well as the minutes of the director meeting with Friedman, Dimon, Immelt et al.

If one guy with nothing more than a laptop and an internet connection could find all this, we are left to wonder what other elephants the GAO ignored during its field trip to 33 Liberty Street.

Is the ECB starting to massively print money again?

Earlier today at EPJ Central, Robert Wenzel warned that the Eurozone economy is on the edge of a major downturn (emphasis ours):

A tight money policy by the European Central Bank is causing the eurozone to go into an "unexpected" recession.

In Germany, the second-quarter gross domestic product growth number of a mere 0.1%, was significantly lower than the 0.5% Keynesian economists had been predicting. German GDP expanded 1.3% in the first quarter.

And the Markit/BME purchasing managers’ index for the German manufacturing sector fell 2.6 points in July to 52 points, its lowest level since October 2009.

There was zero growth registered by France in the second quarter and the euro area’s overall GDP rose only 0.2% in the second quarter from the preceding three months, after growing 0.8% in the first quarter, Eurostat said Tuesday. Growth in Spain and Italy was 0.2% and 0.3%, respectively.

A non-money growth policy is the best policy, however, this policy, following a period of money printing results in the downturn of the boom-bust cycle as the economy adjusts to a non-money manipulated economy. Central banks rarely allow this correction to play out and return to money printing. Keep an eye on the ECB if it returns to money printing, we may very well be near the first near-global price inflation, as the U.S. money supply is already in near super-growth mode.

That last paragraph is indeed interesting, as only today, the ECB published its consolidated financial statement of the Eurosystem for the week ending August 12, 2011. The statement reflects the first round of new bond purchases (€22.0 billion) since early January, 2011 via the ECB's Securities Market Programme (SMP) . But it also shows that, contrary to the previous bond purchases, which were sterilized with concurrent liquidity withdrawals, last week there was a massive ramp in liquidity providing activities. Here's the asset side of the balance sheet:

We can see the €22.0 billion in bonds under line 7.1, "Securities held for monetary policy purposes", which is where the 2010 bond purchases were reflected week by week.

Here is the liabilities side:

In the previous bond purchasing period, there would be a concurrent increase in line 2.3, "Fixed-term deposits", which are akin to short term non-negotiable bills the ECB would issue to banks to soak up liquidity [reductions in refinancing operations would account for the balance of sterilization]. Last week's increase in fixed-term deposits? Zero. Instead, there was a €54.6 billion reduction in the regular deposit facility at line 2.2.

Going back to the asset side for a minute, we also see there was a €57.8 billion increase in line 5.2 "Longer-term refinancing operations" (LTROs), which is also liquidity providing. This combined €112.4 billion went into line 2.1 on the liabilities side, "Current accounts (covering the minimum reserve system", which increased €127.0 billion over the week. To be fair, there was a large drop in the prior week in this line of $48.5 billion, and it is historically subject to large fluctuations from time to time. However, Current accounts is now at one of highest amounts on record, as is the weekly change.

One final table, which lists the ECB's open market operations and demonstrates where most of the increase in Item 5.2 LTROs on the asset side of the balance sheet came from:

The highlighted LTRO liquidity providing operation is the fourth longest maturity on record at 203 days, the longest since December, 2009. Apparently, the ECB was spooked enough when it announced the operation on August 4, 2011, that it knew it would need to provide a cool €50 billion to banks for a guaranteed six months.

Going back to the balance sheet, what's interesting about the Current accounts line is it apparently contains both required reserves and any excess reserves. Contrary to the US Federal Reserve, the ECB does not pay interest on excess reserves (it does pay interest on required reserves), so banks typically keep excess reserves very low and put any excess money in the deposit facilities to earn interest.

One possible conclusion is that we are seeing very short term time preference by the Euro banks, where they are voluntarily foregoing all interest on excess reserves in return for immediate access to the zero maturity funds, if need be. It is also remotely possible that these are in fact required reserves, which have been increased due to regulatory change.

One week does not make a trend, but it is undeniable thatthere are some very large chairs being rearranged on the Eurosystem's deck, and the ad hoc day-to-day changes in monetary policy are setting the stage for a potential meltdown either from the previous epoch of liquidity contraction, or a new epoch of monetary inflation.

Big Banks and Brokers to Treasury: Too Much Short Term Debt Means Rollover Risk is Real

From Bloomberg yesterday (bolding and brackets ours):

The committee of bond dealers and investors that advises the U.S. Treasury said the dollar’s status as the world’s reserve currency“appears to be slipping” in quarterly feedback presented to the government.

The Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Pacific Investment Management Co. [not to mention JP Morgan Chase], said the outperformance of haven currencies and those from emerging nations has aided in the debasement of the dollar’s reserve status, according to comments included in discussion charts presented ahead of the quarterly refunding. The Treasury published the documents today.

“The idea of a reserve currency is that it is built on strength, not typically that it is ‘best among poor choices’,” page 35 of the presentation made by one committee member said. “The fact that there are not currently viable alternatives to the U.S. dollar is a hollow victory and perhaps portends a deteriorating fate.”

Indeed, and here is the full slide from page 35 (click for larger image):

The presentation continues with a look at the mix of maturities of OECD nations:

The exposure that the US has on the short end of the curve (less than five years) is a key concern of these well-connected financial insiders. Highlighted is that any comparison with the mid-1940's is not apt because the US had a much greater percentage of its debt in longer maturities at that time.

While GDP is bogus, it's still a closely watched statistic, and the TBAC is noting the alarming trend in debt maturing as a percentage of GDP.

Another chart that projects interest expense differentials. Note the worst case scenario covered is a relatively mild (in our view) 500 bp (5.00%) "shock" increase in rates in five years.

And the somber conclusion that, for once, includes a statement of "it's different this time" with which we agree.

Conclusion

• The benefits of extension do not come for free. Historical analysis suggests that shorter term funding has at many times been both cheaper and the volatility volatility costs costs have have not not been been high high

• Recent cycles of rising rates have not lasted long enough for maturity extension to pay off

• It is possible, however, that “this time is different” because
  
  o Nominal rates are much closer to the zero bound than previous periods
  
  o Deficits are are very very high high historically historically and and rising rising interest interest expense expense less less acceptable acceptable
  
  o Concentrated foreign ownership creates less reliable demand
  
  o The benefits of funding attributable to being the reserve currency may be fading

• While this this presentation presentation has has focused focused exclusively exclusively on average average maturity maturity, a topic topic for future study is the impact of the distribution of maturities on total interest expense

The full presentation in PDF format may be found here.

Are T-Bonds a Sale Here?

On February 9, we timely asked "Is the 3 Decade Bond Bull Market Officially Over, or Will the Central Planners Succeed in Kicking the Can?"

To which we responded, "While we're long term bond bears, the 30 year yield shooting north of 5% is too great a risk for the central planners to not exercise the few powerful cards they still hold."

And posted the following chart:

Though the catalysts would be a MENA meltdown, then Tsunami fallout, followed by a PIGGS rout, indeed, February 9 was the high of the rally in yields. Today the 30 Year hit the downside target, albeit two weeks late according to our crude cycle analysis:

While we might see a capitulation dip to 3.60% or thereabouts in the coming days, we suspect the intermediate term trend will soon turn upwards. The question then becomes when (not whether) the three decade secular bear trend in yields (bull trend in bonds) officially ends with a definitive break of the highlighted downward trend channel. It might be as soon as the end of 2011.