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Are Treasuries FINALLY the Short of the Decade?

by John Rubino on March 14, 2012 · 21 comments

For years now, US government bonds have looked like terrible investments, what with those trillion-dollar deficits and multiple wars and all. But Treasuries just kept rising, earning their owners nice returns and making their critics seem like financial illiterates who didn’t know a AAAA credit when they saw one.

Check out the chart for TBT, a 2X negative long-term Treasury ETF (in other words, a fund that bets against Treasury bonds). In case the price numbers are hard to read, this fund peaked at 70 in 2008 and has since fallen steadily if irregularly to less than 20. Far from being the short of the decade, Treasuries, especially if you were using leverage to bet against them, have been a sound-money investor’s nightmare.

But two things are true of bubbles always and everywhere: They tend to go on longer than a reasonable analyst believes possible. And they burst when fundamentals finally win out. Treasuries will go the way of all bubbles someday and, just maybe, today is that day.

The eurozone can has been kicked way down the road and the US economy seems to be improving, which lessens the urge to hide in safe havens. Risk on, in other words. And today Treasuries got absolutely smacked, with TBT jumping by 5%, a huge move for any bond fund. Here’s a take on the market action from Forbes:

Treasury Market Exuberance Leads To Violent Sell-Off
A violent Treasury sell-off began after Tuesday’s FOMC statement, as bond markets reacted to an improved economic environment, a more optimistic Fed, and the reduced possibility of QE3 in the immediate term, at least for now. While Treasuries appear to be more “fairly” priced, according to Nomura, the possibility of a flare up in Europe, along with a worsening of the domestic outlook, could see fearful investors jumping right back into Treasuries.

Yields on 10-year Treasuries finally broke free from a tight trading range and jumped to 2.27% by 2:50 PM in New York on Wednesday, hitting their highest levels since October.

The trigger was Tuesday’s FOMC statement, where the Fed acknowledged an improvement in labor markets, the continuing economic recovery, and the temporary uptick in inflation (on the back of rising oil prices). Shortly after the Fed statement, JPMorgan said in a press release it had passed the stress tests with flying colors, prompting the bank run by Jamie Dimon to announce a dividend hike and a big buy-back.

Jamie Dimon’s ratification that the economy is indeed better was the final straw, exacerbating the sell-off, according to Barclays. As market players factored in the diminished possibility of a third round of quantitative easing, along with the increased possibility of a rate hike coming earlier than expected, Treasuries plummeted. Gold fell in tandem while the U.S. dollar rallied.

“A new dynamic has been set in motion [as] complacency was widespread,” explained Nomura’s fixed-income strategist, George Goncalves. USAA’s Didi Weinblatt, VP of mutual funds and a fixed-income expert, added that “rates were artificially low,” helping make the move that much more violent. “Everybody that was riding with the Fed got out at the same time,” she added.

Weinblatt warned that markets remain schizophrenic, oscillating between risk-on and risk-off on any headline. Fundamentally, she believes, rates should be a lot higher, but “the Fed is still doing the Twist, Bernanke has QE3 in the backburner, and Europe could still flare up,” once again sending investors scrambling for the safety of Treasuries.

Nomura’s strategists believe Treasuries are now closer to “fair value,” and have a medium-term target of 2.4% for 10-years. While most bond sell-offs start this way, and yields “had no business staying under 2%,” a worsening of the domestic or global environment could dramatically change things in a very short time frame, as Tuesday’s price action illustrates.

Is this the turn for Treasuries? Well, they’re certainly not “fairly valued” on fundamentals. The long bonds of any country with government debt and total debt exceeding, respectively, 100% and 350% of GDP are an automatic short, just on simple math. But the US, as the printer of the world’s reserve currency, is a special case in terms of timing. When trouble strikes elsewhere, people still come here to hide. So even in the face of ridiculous, Greek-like numbers, the dollar continues to function as money and Treasuries continue to find a bid.

There will come a time when shorting Treasuries is the trade that makes fortunes and reputations just as surely as did shorting mortgaged-backed bonds in 2007. But as with any other bubble, it’s best to wait until the market shows clear signs of cracking before jumping in with both feet. Time will tell whether today’s action is that kind of sign, but when such a sign does come, it will look a lot like this.

  • Bob

    I’ve lost my shirt on that damn trade. One of these days it will pay off…it has to right?! so much for fighting the Fed.

    • http://ronpaul2012 Pup

      Ditto. Gave up and sold at what will probably end up being the bottom…

    • Tom

      Me too, down 52% on TBT. I doesn’t pay to be too smart if the market is dumb. If you are right way too soon, that’s the same as being wrong.

    • chris

      people need to invest on facts and figures with knowable outcome. to do anything less is speculating – i.e. gambling.

      u dont know WHEN tresuries will fall its not a predictable event therefore to trade on that assumption would be stupid.

  • W G Thompson

    If the TBT rallys and the VXX follows
    along, you might have your signal.
    But I’m waiting for the buck to lose
    its reserve currency status. Then
    hard assets will cease to the risky,
    obscure plays they are now.

  • Bruce C.

    This subject is so vast and interconnected that it can be analyzed from many different perspectives. Consider, for example, the long-term historical perspective. By “long-term” I mean going back at least 100 years, certainly (and importantly) before WW2. At least two academic studies that I know of come to the same conclusion but in very different ways. One is the recent book by Reinhart and Rogoff “This Time is Different:…” and another by Lacy Hunt. R&R studied economies from all over the world over the last 800 years and Lucy went back to about 1800 in America. I’ll spare you the details but both studies concluded that long-term interest rates are bound to go down even lower (far lower “than any reasonable analyst believes possible”, to echo JR’s line.) They both admit that it’s counter-intuitive given all the “fundamentals”, but that is precisely what both of them have personally invested in, if you can believe their own words. There will be volatility, but the downward trend in long term rates will remain for years to come.

    How is that possible, you ask? Because the alternative is worse and there will/are many market forces that will conspire, though not always the same ones and at the same time, that will react negatively to higher rates.

    For example, it has been said (criticized) that the “printing” of money – the devaluation of fiat money – is the only politically acceptable way of dealing with massive sovereign debt because it lowers its real cost. However, to the extent that it does so, and there are myriad mechanisms for that to happen, interest rates will rise. Unfortunately, higher interest rates are not good for any aspect of the domestic or global economy at this time. Not everyone is shorting Treasuries. The whole Euro zone fiasco is all about high interest rates. The US government doesn’t want rising rates either. That’s not good for its own fiscal health (increases borrowing costs and thus its deficit) and borrowing costs for consumers will rise too which will depress housing prices and affordability even more, along with making everything else more expensive. All of this is actually moot, however, because recent data shows that debt deflation is winning the war again despite election year propaganda: money supply globally has flattened (despite all the “printing”) and money velocity has just dropped below the level not seen since 1959, which is below the long-term rate of 1.675. So, the central banks have created a no win situation for themselves. If they print more (QE 3) then the end game quickens, and if they don’t then a deflationary depression resumes. The bottom line is that Treasury bonds will remain the(?) “safe haven” as the masses realize that the global financial system is in quick sand.

    Now, consider a different perspective. I don’t think many would disagree that every optimistic scenario out there (Like the US Presidency will be more important than ever over the next 20 years as America finally accepts its role as a true empire. Wait…here’s another: Everything negative you’ve heard about the financial system, monetary and fiscal policy is wrong, and the world is about to start a new era that will make the 20th century look like the stone age.) depends upon economic growth, especially in the US. Well, it’s not possible for the US to lead the world in economic growth if the USD is one of the relatively weaker currencies, not even over the medium term. The recent drop in Treasuries due to investors herding into “risk assets” is an anomaly (to say the least) given the simultaneous increase in both the trade deficit and current account deficit. I would suggest those sellers of Treasuries are Chinese and Arabians getting OUT of the dollar while Treasuries are still inflated and accepting the consensus that the Fed will NOT embark on more QE. If the Fed wants to keep rates low until 2014 (blah, blah) then it will have to buy those Treasuries from the party poopers. That won’t be called QE (even though it is) because that is how the Fed has always controlled rates. So, if you don’t want to fight the Fed then don’t bank on them letting interest rates rise. Financial repression and the creation of a liquidity trap is the game, and historically it can be expected last many years.

  • Tony D

    There are so many little signals that “this time is it” that it easy to start jumping at shadows. It is very likely that the real trigger to crisis will only be recognized by someone who has “cried wolf” before but people won’t be listening. It is likely that the trigger moment(s) will only really be clear in hindsight. Readers of this blog all know what islikely to happen. Picking the trigger moment before everyone else will be the skillful part that creates wealth.

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  • William

    I think that the yileds for the $TNX could go down to say 1.0%, 0.5% or perhaps even 0.2% in a sharp spike downwards. And that would be THE signal to buy TBT.

    • William

      But then one has to watch the charts very carefully.

      “”The bull market in government bonds has been epic. And epic bull markets don’t end with a whimper, they end with a big bang and everyone is sucked in and yields will reach outrageously low levels.”” Source: Hugh Hendry.

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  • sgt_doom

    Yup! And I believe that’s why the primo banksters created ELX Futures….

  • Jason Emery

    My guess is that the economic strength we are seeing is just a short term Obama prop, and will vanish shortly after the November election. To this point, the 10-year Treasury yield is still below the October 2011 high. Considering how far the official unemployment rate has dropped since then, that is mighty bullish for treasuries.

    I just don’t think there are any significant wage pressures in our economy. Apple stock is outperforming the market due to innovation, but also due to the hiring of $1/hr Chinese people. Wages have no where to go but down in this nation.

  • Mike Agne

    I don’t understand it, every time the bond yield moves up sharply, we continue to get headlines like this one or that old theory of GDP to debt and implied ratings upon government debt. Every time the bandwagons begin to mobilize I have to rationalize once again the sheer fact that interest rates are no longer a viable indicator of any type of risk. Back in the day before the shadow banking, before there were currency swaps, interest rate swaps and CDS, interest rates and rating agencies actually mattered. However after 1971 this no longer became the case. All you have to do is look at Japan and you will see how long interest rates can stay at zero, how long the ponzi scheme of government buying its own debt and the sheer fact that at $15.6Trn and growing, how the government FED banking cartel will not ever let bond rates go above 5% again. Doesn’t anyone listen to what Bernanke says? low rates thru 2014, guess what for all those that said we are not like Japan, 2008 to 2014 is 6 years of zero rates, but I am quite confident when 2014 rolls around this game will continue, so as I say every time someone comes out and says something as idiotic as the short of the decade, I will gladly take the other side of all bond short bets and park your collateral into gold. Secondly ETF’s like TBT are nothing more than losers and will always have a tendency to go lower much faster than they can go higher, in fact you are clearly better off selling futures. This is a great buying opportunity in the bonds as the 10yr rate will be at 1.75 by year end, wait till the war begins and you will see how fast short bond positions duck and cover.

  • Mary Saunders

    Here’s the deal with government bonds: they are as un-transparent as anything on the planet.

    GS knows how to mine the “muppets” by front-running to take profits from everybody except their privately owned officials, elected and not-elected.

    That means to me that I have to stay away from betting anything on them, anything at all, one way or the other. They make commissions on me coming anad going, considering I am not a congressperson and cannot front-run too.

    My instinct has been to bet on things I like, e.g., the moon metal and some of the rare-and-preciouses.

    If you have silver mines with a real product and paying dividends too, why mess with the Picasso’s of paper when I am not in their inner circle.

    While some property values have gone down, the carrying costs of owning property have rocketed. This is a tricky situation for someone not wired into what the naked wizards are up to.

    Naked wizards need to be detected by U.S. students, at the speed of the Chinese ones who laughed at Geithner.

    When that happens, the underground resourceful nature of U.S. people will be peeking heads above the zero line, and the U.S. will start a real recovery, as opposed to artists drawing lines on fanciful graphs.

  • Dave Ziffer

    Will someone please explain to me why anyone, anywhere would buy a bond that offers an effectively negative interest rate? With short-term T-bills at or near 0% and an inflation rate estimated (depending upon whom you listen to) at anywhere from 2% to say 10%, who in his right mind buys T-bills? Yes I know the Fed “buys” many of them but it doesn’t “buy” all of them. If a bond paying an effectively negative interest rate is regarded worldwide as “quality” and “safe”, then is that not indicative of a global economy in gradual collapse?

    • Bruce C.

      In brief, here are but four answers to your question: 1. Any one who wants the maximum “risk-adjusted” return on his money; 2. Pension funds and various other accounts that have mandates to hold a certain portion of investable funds in US government bonds; 3. Developing countries that export a lot to the US and need to invest those dollars somehow; and 4. The OPEC countries because of the “petrodollar” system.

      In the first case, only certain government-backed money market accounts are considered (by ratings agencies) as “safe” as US Treasury bonds and they pay about 2% less in interest than 10y Treasury bonds. Most people aren’t as cynical, nor as knowledgeable, about state of the things as many of the visitors to sites like this one, so they think everything will ultimately be okay because the powers-that-be will keep things together. It’s like the I-T old adage, “Know one has ever been fired by going with IBM.”

      In the second case, let’s hope that the financial repression scheme in place doesn’t expand to private individual retirement accounts so people like you and me are forced to become buyers of US Treasuries too.

      In the third case, countries like China and Japan that already own a lot of Treasuries (when it did make more sense to buy them) feel the need to keep buying more so things don’t collapse.

      In the fourth case, according to the petrodollar agreement, a certain portion of US dollars earned from the sale of oil by the OPEC countries must be used to by US Treasury bonds.

      (In review: the “Petrodollar system” was established in the mid ’70’s to create a dependency for USDs since they were beginning to lose value because of excessive US deficit spending to fund the Vietnam War and Johnson’s “Great Society”. Since the official price of gold was pegged at $35 per ounce other countries began exercising their right to exchange USDs for gold because the global market price for gold had reached about $60 per ounce during the late 60’s. That is why Nixon “closed the gold window” in August of ’71 to stop the outflow of US gold from Fort Knox (which he called “speculation”). It is estimated that the US lost about two-thirds of its gold during that time due to dollar-gold exchanges with other countries.

      The petrodollar agreement was with Saudia Arabia primarily, but by extension all of the OPEC countries, and it was for oil to be sold for US Treasury bonds in exchange for sales of US armaments to those countries and a US commitment to provide protection for them from Israel. This agreement created an artificial demand for USDs because every country then needed to obtain USDs to buy oil, and the USDs received by the OPEC countries were then exchanged for US Treasuries to fund additional US deficit spending. )

  • http://www.acceptancetake.com Andrew Fruth

    One problem with the thesis that long term bonds are going to collapse is that the Fed may simply buy 100% of them in the near future. If they do not, then even if inflation skyrockets, the yields on those Treasuries will not go up because there would be no private investors demanding an inflation premium.

    Rather than shorting long term bonds, I’d prefer just shorting the dollar / buying silver and gold related assets.

  • http://www.AllenCurrie.ca JustamereBear

    To play the treasury market at this time is to bet against time. There are so many possible outcomes, and no one can possibly tell what desperate men will do to save their treasuries. Treasuries are the short of the century, but when? I think shorting the dollar is a bit safer, but given the status of the Euro and the Yen, not much more certain. I have been doing well betting against all fiat via PMs unleveraged. That is my story and I’m sticking with it.


  • chris

    i highly doubt its time to short treasuries.

    things dont change that fast. the aden sisters mistakenly thought last year was a good time to short treasuries…then they rallied.

    just because something is over valued doesnt mean it will collapse.

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