The One Line Bernanke Is Praying Doesn’t Break

The QE party is ending. And the hangover that follows is going to be brutal.

Since 2007 the Central Bankers of the world have operated under the belief that they can hold the financial system together by engaging in round after round of Quantitative Easing (QE) without losing control of the bond markets/ interest rates.

They believed this because:

1) We haven’t had a bear market in bonds in 30+ years

2) They believe that they (Central Banks) will never lose credibility with the markets.

This entire theory crashed into the wall in April 2013 when the Bank of Japan announced its “shock and awe” QE program.

The yield on the ten-year Japanese Government bond has since violated its trendline and is now retesting former resistance. This is a classic breakout that typically precedes sharp moves higher. In the case of Japanese Government bonds, this would mean the bonds losing value.

Why does this matter?

This matters because bond markets have a nasty tendency to spin out of control very quickly once things begin to unravel. A great example of this is Italy, which was considered a rock solid pillar of the EU for the better part of the last 15 years…and then it lost all credibility in a matter of weeks and began to collapse.

As you can see, Italy’s ten-year bond yield broke its trendline in the autumn of 2011 when the EU crisis first began to spread outside of Greece. It hovered around 5% for a few months and then skyrocketed above 6%. Later it spiked again above 7%.

Both of these spikes occurred in just a few weeks’ time. What was thought to be “rock solid” for over a decade became bankrupt in a matter of months.

On that note, Ben Bernanke is praying to the market gods that the 10 Treasury doesn’t take out the line below:

“So what?” many will think. What’s one trendline for bonds?

As the long-term chart shows. This isn’t just any trendline. This is THE trendline. Take it out and the 10 year will likely be yielding 5-6% in no time. Which, by the way, is where it was for most of the ‘90s and very early ‘00s.

The only difference is that a drop like this would literally render the Fed bankrupt. The Fed currently owns 30% of all the 10 year Treasuries in existence. If yields were to return to 5-6% on the 10 year Treasury then the Fed would have literally lost several hundred billion dollars on its Treasury holdings.

Sure, the Fed could print money to deal with this. But if Treasuries begin to collapse while the Fed is already buying them, and it can only buy more by money printing, then it’s GAME-SET-MATCH for Bernanke’s QE, the Fed, and the US economy.