The Bond Market's Hidden Agenda

Without discounting the significance of the fund-flow data, the more crucial questions are: Why are those bond-fund flows continuing? And why are institutions -- aka "the smart money" -- aggressively buying Treasuries, as are retail investors, rather than trying to sell bonds to the "dumb money" crowd?

One answer is that Treasuries are being bought by those who believe the central bank soon will be doing the same thing in response to the threat of deflation. Admittedly, that is a troubling answer for stock and bondholders alike, as it suggests the Fed is meddling in financial markets rather than letting nature take its course. The history of currency interventions suggests such efforts at manipulation ultimately are doomed.

Where We Be

Increasingly, fixed-income participants believe a big buyer, namely the Fed, has emerged to help overcome potential negatives such as the dollar's decline (which resumed vs. the euro Thursday after the European Central Bank left rates unchanged), the onrushing supply of government paper, and the waning inflow of foreign capital for the three months ended February.

Concerns expressed Tuesday by the Federal Open Market Committee about an "unwelcome substantial fall in inflation" -- and more explicit language about "disinflation in core prices" in minutes of the FOMC's March 18 meeting -- have encouraged market participants to believe that the central bank will go to extraordinary measures to fight deflationary pressures.

If the Fed really is pulling out all the stops, odds are the bank ultimately will trigger some inflation, which would be bad for Treasuries. But rather than worrying about such an outcome, fixed-income investors are "acting as though the Fed will end rate cuts and instead start purchasing long-dated Treasuries," as Anthony Crescenzi, chief bond strategist at Miller Tabak, commented on RealMoney.com.

Last month, Kenneth Fisher, CEO of Woodside, Calif.-based Fisher Investments, mentioned here the possibility of the Fed buying long-dated maturities in order to inject liquidity into capital markets.

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