By: Larry MacDonald
The bubble economy has spawned another bubble. This time it’s government bonds. The flight to safety during 2008 has pushed yields to lows never seen before in Federal Reserve records (compiled since 1962). For example, the yield on the one-month bill stands near 0.04%, two-year note near 0.75%, and ten-year note near 2.21%.
Yet, the federal government has taken on spending commitments that entail gargantuan budget deficits for some time and a tsunami in bond issuance. Current spending commitments include trillions of dollars for existing commitments such as Social Security, Medicare, etc. and the Iraq war — as well as trillions more for bailing out the financial system, propping up ailing industrial sectors, and massive fiscal stimulus package promised by the Obama administration.
At the same time, the Federal Reserve is creating credit at rates never seen before. As Northern Trust economist Paul Kasriel noted, the year-over-year increase (to November of 2008) in bank reserves is about ten times the previous high, which occurred in 1934. Deflationary forces are ascendant right now but one wonders for how much longer given the massive stimulus unleashed.
Shorting government bonds would thus appear to be a no brainer as risk appetite responds to signs of an upturn in economic growth and inflation worries arise anew. But what might not be so obvious is the timing of the trade.
Lags in the impact of stimulus measures could mean deflationary news will linger for awhile yet. More importantly, the Federal Reserve has stated it is committed to buying Treasuries to keep interest rates low until the crisis and economy stabilizes. China too will likely be a buyer of U.S. Treasuries as part of its strategy of suppressing the yuan to enhance the competitiveness of its exports.
So watching from the sidelines may be the strategy for now. Ways to short the bond bubble include going long on the ProShares Ultra-Short 20+ Treasury and ProShares Ultra-Short 7-10 Year Treasury Fund ETFs (but understand the constant leverage trap first) and short selling the iShares Lehman 20+ Year Treasure Bond ETF
4 Responses to “ Bond bubble ”
I went long HTD (horizons beta pro US 30 year bond bear plus) when yield hit 2.6% last week. Yield closed at 2.8% on Friday.
http://finance.yahoo.com/bonds
What I am not sure about and am trying to calculate is the expected price of HTD if yield goes down to say, 2%. If yield does go to 2%, I’ll buy more. I’m looking for yield to return to 4.5% sometime in 2010, giving my an expected return of about
50% from my recent entry point.
My only question is this:
If 30 year bond yield drops to 2% (can’t see it go below that as that would mean that shorter term treasury like 5 and 10 year would yield about 1%), wouldn’t the whole world be shorting treasury? Afterall, the most it can go down to is 0%.
On the other hand, with the trillions the US is printing, making the US dollar less valuable combined with inflation to come, I won’t be surprised see 30 year bond at 6% to 8% in the next 5 years.
Seems to be that shorting this bond is the best idea of 2009.
John
By John Gan on Jan 3, 2009
Forgot to mentioned that although both the HTD and the TBT are short US long bonds (the former 30 years, the latter 20 years), the HTD is hedged in Canadian dollars, so no exposure to the US dollar. It’s tough enough trying to bet on interest rates, never mind having to be right on both interest rates and the currency as well.
John
By John Gan on Jan 3, 2009
John
Good point re the HTD.
LM
By Larry MacDonald on Jan 4, 2009