Bonds demand high may be due to an unofficial deal between FED and loyal banks

 

A seeming paradox appeared on markets. The USA government bonds rose, instead of falling, after the FOMC minutes were published. FED is the main "investor" in US debt, so if we assume FED will decrease its activity, therefore the bonds have to lose value and the yields must go up. Out of FED the global investors are not very confident in US debt. Strategic investors like China, Oil-countries and Russia are selling their US bonds. So if FED will not start the QE3, who will buy bonds in future so the prices to go up?
The answer of this question is in the mechanism of printing money. Direct money print is buying bonds by the central bank (quantitative easing). But there is also another way. This is the purchase of bonds by loyal to government banks, that pay them with loans taken from the central bank. This system was soon used in EU where the ECB flooded the market with almost 1 trillion euros and it happened via lending 3-year loans to banks. After that most of this money went to government debt market.
The same is in USA. FED is keeping record low interest rates. So it is profitable for banks to borrow from FED, paying 0,25% interest and then investing in Obama bonds with 2% interest. They are making an immediate profit of more than 1,5%.
Overflowing the portfolios with so much government bonds is risky for banks. This is a very fragile system, that is difficult to balance. In fact, it can bankrupt the banks, just like it happened with subprime mortgages . They were also considered a non-risky AAA asset, some of them - even guaranteed by the government. But at the end of the game - everything crashed.
So it is not very clever to invest much money in government that borrows 40% of the money it spends. But it is enough clever if you have an additional information that others do not have. So it is highly probable that the loyal US banks have unofficial guarantee by FED that there will be no crash on bond markets. If FED had promised to intervene on markets at any cost if needed, then there is no risk with these bonds. But it is absolutely clear that most of investors (generally non-US ones) have no such information. Otherwise they would also buy bonds. Borrowing from FED and investing in Obama is a perpetuum-mobile - a money machine, easy money and easy source of high bank bonuses. But only for ones that know the yields will not go up due to overdebting the government.
There is also one more option. It is possible the QE3 has started unofficially. Banks can buy bonds if they have a preliminary information that QE3 will start anyway, and then FED will buy the bonds form them. This is so called "bridging". Banks are giving money now, but FED will give them its newly printed money in few months. A bridge operation. Very profitable for the one who knows the future in exchange for his loyalty.
So seemingly it is a paradox. But in fact it is nothing unexpected when we calculate some predictable and highly probable additional factors.

Dobri

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