Re: longbond follow up hummel/henwood

[Doug Henwood <dhenwood@xxxxxxxxx>]

William F. Hummel wrote:

>Bond traders at the screens of terminals in the bond trading
>rooms of security dealers are focused on small changes in price
>that might work for an hour, a day, but seldom much longer.  They
>employ a large amount of capital and are mainly looking to make
>quick, but not necessarily large, profits per round trip.  They
>work primarily with breaking news, and gain their advantage by
>being first to act on such news.  Breaking news could relate to
>number of things -- an assassination, a natural disaster, a
>president's illness, or a speech by Greenspan.

A speech by Greenspan, like his dramatic testimony yesterday, can change
the whole interest rate outlook, if it's a hint of a major change in Fed
policy. So "breaking news" can often be quite significant, and shouldn't be
dismissed as noise.

>The hyperactivity of long bonds applies to long maturities where
>the volatility is greatest.  Traders can't make much profit where
>volatility is low, i.e. at the shorter maturities, including long
>bonds nearing maturity.

Average daily volume in U.S. Treasury bills was $42 billion in May 1997,
when there were $704 billion of them in the hands of the public. That looks
pretty damn active to me. Average daily turnover in bonds and notes was
$165 billion, when there were $2,698 billion outstanding. Both numbers
suggest that 3 weeks trading equals the entire stock of outstanding federal
debt (which I think is how the BIS estimated average holding periods).

[table and prose cut]

>The category "Other investors" was not defined, but it would seem
>to include pension funds, mutual funds (aside from MMMFs) and
>bond dealers.  It is likely then that considerably less than 20%
>of the privately held Treasury debt issues is involved in short
>term trading.  This is consistent with my contention that the
>average 30 day holding period of Treasury bonds must be highly
>skewed by the enormous traffic in bonds due to bond traders.  The
>30 day figure, if not properly interpreted, gives a highly
>distorted picture of what is happening.

Here are two quarters worth of figures on net purchases and sales of U.S.
Treasury securities, from the latest flow of funds data (seasonally
adjusted annual rate). The "long-term" investors seem to move in & out of
Treasuries as fluidly as anyone. The "rest of world" sector includes
offshore hedge funds.

NET PURCHASES/SALES OF U.S. TREASURY SECURITIES
(seasonnaly adjusted annual rate)
                                       97Q1      97Q2     shift
commercial banks                       37.5     -39.1     -76.6
life insurance companies                0.0     -19.3     -19.3
other insurance                         0.9     -24.3     -25.2
private pension funds                  11.0      12.7       1.7
state & local gov't ret funds          17.4     -10.0     -27.4
households                           -192.0    -196.9      -4.9
rest of world                         284.4     150.2    -134.2
Federal Reserve                        38.3      49.2      10.9

I'm not sure how we got to this point, or what we were trying to prove, but
it seems clear to me that the central bank determines short-term rates, but
that everything beyond that is set by the frenetic pace of the government
bond market.

Doug

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Doug Henwood
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