Bonds may be in for a shock

[King of New Orleans]

http://biz.yahoo.com/bizwk/040419/b3880105mz020_1.html

A Business Week article about the risky nature of the bond market right now:


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But today's bond market is anything but normal. It functions on a hair-trigger of speculation about just how soon the Federal Reserve will begin raising overnight interest rates. The market sold off sharply, too, the morning of Apr. 14, when the government announced a much bigger than expected 0.5% jump in consumer prices. Anxiety is so intense because the market is more leveraged and more hooked on cheap Fed financing than it has been in at least a decade. Traders fear the end of a profitable ploy known as the "carry trade," in which hedge funds, banks, and Wall Street dealers borrow money at dirt-cheap overnight rates and buy 5- and 10-year notes, which yield two to four times what they are paying for their borrowing.

Indeed, the market's bets are leveraged more than ever. Net borrowings by Treasury securities dealers, including big Wall Street banks, are up to nearly $800 billion, double the level of three years ago. Bond purchases by leveraged hedge funds and other financial institutions based in Caribbean tax havens have doubled, to $100 billion a year. And open interest in Treasury futures contracts, which are leveraged instruments, has also doubled, to 35% of the value of outstanding Treasuries.

The trouble is, the carry trade will turn sour as soon as it's clear that the Fed is about to start raising overnight rates, now at a 46-year low of 1%. Traders know that the time will come, but they're inevitably tempted to wait another day before closing their positions. Says James A. Bianco, president of bond-research firm Bianco Research LLC: "The minute they end the trade, they stop making money. That's what blinds everybody."
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Of course, don't know if this will bite everybody in the hindquarters. Ya never really know until it happens. But it's something to be wary about and another reason to be reluctant to an ARMs right now too.