This is the biggest three day drop in the yield in the 3-month Treasury bill yield ever. In 1998 there was a flight to quality into three month Treasury bills that caused a big spike down in rates, but this move in the past few days has made that one look like nothing. The only time the yield dropped more Monday in one day is on the day of the 1987 stock market crash. The sharp drop in three month Treasury bill yields suggests that the Federal Reserve’s discount rate cut on Friday has not stabilized the creditmarkets, especially since one month yields hit a 3 year low.
Investors are flocking to the safety of short term US government debt as liquidity continues to dry up in money market funds and commercial paper. The fear of further credit problems has made principal protection everyone’s top focus especially for banks and money market funds that need to find a new place to invest after liquidity dried up in the commercial paper market.
Let me put it to you this way. There is a liquidity problem in the banking system. There are banks that are dying in mortgage backed securities in need of water - further lending from other banks. The Fed has injected billions of dollars into the banking system over the past few weeks and lowered the discount rate on Friday and it has had zero effect. Instead of making new loans with the money banks are hoarding it and using it to buy the safest thing possible - short-term Treasury bills. They are thereby causing the price of bonds to rise and their yield's to collapse.
The bond market is also factoring in rapid and huge cuts in interest rates over the next six months.
You have to ask yourself what is going to happen between now and the end of the year to cause the Federal Reserve to lower interest rates by over 2%?
Today the Senate Banking Committee is going to meet with Fed Chairman Ben Bernanke in closed doors to discuss the swings in the stock market. They are scared. These yields have fallen so much that you think they would be due for a bounce. If they don't bounce they could knock the stock market down with them, but hopefully they bounce from here. What I'm interested in is what happens over the next few weeks. Are people going to be more bullish in the Investor's Intelligence figures, because they think the Fed has saved them? Will Treasury bill yield's stay depressed and forecast a looming recession and rapid and Fed cuts?
One of my themes is that we are seeing things in the stock market happen internally that we have never seen before. Yesterday was another one of these things. And that scares me. At the moment I do not want to own anything until this crisis clears.
21 August 2007
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