Guzzo the Contrarian

With all of the economic data due this week that could affect the direction of stock market, we tend to forget about issues involving the bond market.

Tuesday marks the debut return of the One-Year T-Bills (pdf). The degree of success the Fed has in selling these new issues will determine the fate of all the markets. According to a Bloomberg.com article today:

For the first time since 2001, the government will sell 52-week debt tomorrow, expanding its source of funding as the budget deficit approaches a record. The Fed is selling Treasury bills at the fastest pace since it was founded in 1913 to support bank-lending programs meant to boost confidence in financial markets. The Fed owns $34.3 billion of the securities, down from $267 billion, or 27 percent of the market, in December.

But, as I mentioned in my previous post, where’s the incentive to buy these treasuries?

According to the same Bloomberg.com article:

David Glocke, who manages $33.1 billion of short-term securities at Vanguard Group Inc. in Valley Forge, Pennsylvania, doesn’t plan to buy one-year bills for his money-market funds because he expects the Fed to stop lowering borrowing costs after seven cuts since September.

“It’s not a good fit in an environment where interest rates may rise,” he said. Plus, “the fact that the Fed’s been selling a lot of bills would imply maybe that there’s less overall liquidity in the market because the Fed’s reduced positions.”

The Fed is somehow going to have to make the 52-week T-Bills appealing to investors in order to generate interest (pun intended).

If the Fed adjusts the yield to make purchasing the new T-Bills more attractive, it could throw the rest of the bond market into a state of flux. Who would want to purchase longer-term bonds when less-risky, shorter-term treasuries are paying higher yields?

You can bet I’ll be watching this auction closely.