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Betting on Big Rise in Yields?
Submitted by Leo Kolivakis, publisher of Pension Pulse.
Henny Sender of the FT reports that top hedge funds bet on big rise in yields:
The
recent rise in long-term US interest rates comes as good news for
several leading hedge fund managers, including John Paulson, who have
positioned their trading books to benefit from higher yields on US
Treasury securities.
Mr Paulson, who
made big gains earlier this decade by betting against the subprime
mortgage market and whose firm, Paulson & Co, manages $33bn, has
said he believes that government stimulus efforts would inevitably lead
to higher inflation and a corresponding rise in rates.
“It will
be difficult for the government to withdraw the economic stimulus,” Mr
Paulson said in a speech. “An increase in the monetary base leads to an
increase in the money supply, which leads to inflation.”
Bond
prices fall as yields rise, and Mr Paulson told the Financial Times
last week that he has been hoping to benefit in the Treasury market by
buying options that would become profitable if rates headed higher.
TPG-Axon’s Dinakar Singh has been making similar options trades,
according to a person familiar with the matter.
Julian Robertson,
the hedge fund manager, has pursued a related strategy, hoping to
benefit from a bigger difference between short-term and long-term
interest rates, known as a steeper yield curve, a person familiar with
his trades said.
The yield on the 10-year Treasury, which hit a
crisis low of 2.055 per cent last year, has moved from 3.2 per cent
last month to 3.75 per cent on Tuesday.
Hedge fund managers,
however, have been hesitant to engage in short sales of Treasury bonds
to profit from the rising yields – and falling prices – because of the
Federal Reserve’s heavy involvement in the market. This has led some to
buy options – dubbed “high strike receivers” – that would enable them
to profit from sharply higher Treasury yields, hedge fund managers say.
These trades, which are relatively cheap to execute because they are so
out of the money, are based on the thesis that yields could hit 7 or 8
per cent.
“If they are right, and the world ends, they will make
a fortune,” said one fund manager who is sceptical of the idea. “If
they are wrong, they haven’t lost much.”
Some traders are
cautious because many peers lost large sums betting that rates would
rise in Japan in the 1990s – as yields fell to less than half a
percentage point. The trade was termed the “black widow” because it left so many victims.
“Nobody
understood the extent of deflation and economic weakness in Japan,”
said Dino Kos of Portales Partners, a research consultancy, who was
then a Fed official. “More money was lost on that trade than on any
other single trade. Everyone piled in when rates were at 3 per cent and
then at 2.5 per cent and then at 2 per cent.”
So
is it time to place big bets on rising yields? I could easily see a
backup in yields in the near term as economic reports surprise to the
upside, but I don't believe that bonds have entered a long-term secular
bear market. I think the hedgies are right, best to play interest rate
directional calls though options.
Also, given the increase in
liability-driven investing by pension funds worried about their funding
status, there is an upper cap on bond yields. I don't know what the
exact magic number is, but at a certain level (say 7%), you'll have
pensions scambling to lock in rates. Bond bears tend to ignore this
when predicting doom and gloom on bonds. All they do is focus on the
"pending collapse" of the US dollar, which won't happen.
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Bruce,
I agree with you, if the ten year reaches 8% too quickly, we will blow up. The Fed knows this and so do top hedge funds. I see a cyclical backup in yields to over 4%, but then global investors will be bidding them down again. We'll see how this develops in 2010.
The public has been buying Treasuries but is grossly underinvested in them.
Once owned, they will hold till maturity if possible. Everyone knows that deficits are inflationary, except for the following: printing "money" is inflationary; issuing formal debt is, once issued, deflationary.
The long term charts still show an ongoing bull market in Treasury prices. This can persist even when real yields turn negative. So there just might be more life in the bond bull a la a true bubble, which theoretically could be just as big as the 1999 NAZ bubble.
Relative to overpriced equities and commodities this
vicious selloff in bonds and spike in yields is a gift
to (you know who) the banksters. They're not going
to loan, they're going to borrow short and stick all
their "forbearance" gains at the long end of the yield curve. Heck, 4% risk-free yields in a 1% or 2% GDP world.
Not too shabby as we will all find out.
We need more details Leo. I would like to know how long those options are and actually how much was paid for them. They sound like a bad bet to me.
US rates are going to rise. Some months are going to be ugly, like the last month was. But we can't have the 10 year going up 50bp in a month on a regular basis. Three more months like that and you get mortgage rates at 7% and then the lights start going out again.
I doubt that the ten year can get to 8%. We will blow up well before we get there.
Leo
Your conclusion that the dollar cannot "collapse" is based on hope, something that has historically been shown to be often forlorn.
You state in your last-sentence, linked article that the euro "is already expensive and is the currency of an economy with banking and structural problems that are even more serious than those of the US."
Thus, you conclude, the dollar cannot collapse. This is pure hope. If the Eurozone gets its house in order before the US, the dollar is cooked. It will in fact be replaced by the Euro.
Just a few musings here.
Let's all imagine the interest rate swaps. No one talks about them. They are twice the size of the CDS and even more nasty, imagine hundreds of trillions. JPM is supposed to have over 100 trillion dollars worth alone.
From what I have read, rates on the 30 year over 5%, or under 116.00 on the chart is a lit fuze. Well today we are 115.32 on the chart. Oops!!!!!!
If JPM loses just 1% that is a trillion dollars. That alone will render the system nul and void. So I am told by those who are more knowledgeable than I.
Merry Christmas from my financial crash bunker. Will Santa find me here? No presents again?
Iunno if y'all have had to find yield in the equity markets, but i'm tellin you, a 10 yr over 4% is a worthwhile yield. We're not done with deflation yet imo.
Rising interest rates is monetary deflation. Rising rates will cause the asset price deflation that you are talking about.
long tbt to 60+
call me in feb.
Is TBT the best way to play this? What are other ways? Can an individual slouch like me play call options betting on rising yields with something other than an inverse leverage fund that seems to deteriorate on volatility?
Leo, look at the chart.
10 year from 2.038% to 5.1% is a seismic shift in
anyone's T book. Maybe PIMCO knew something
when they sold?
http://stockcharts.com/charts/gallery.html?$TNX
The usual bond buyers are starting to boycott the Treasury market. This is driving yields higher. Don't need sellers, just no buyers. US Govt is desparate for dinero. They will offer higher, unless, of course, they can create a stock market scare, thus forcing the herd back into the bond corral.
"Bond bears tend to ignore this when predicting doom and gloom on bonds. All they do is focus on the "pending collapse" of the US dollar, which won't happen."
Eventually the dollar will lose a lot of its value. It will happen; it's just near impossible to time it. Even the article you quote conceeds that the Chinese currency will strengthen greatly by 2020. Our major trading partners are diversifying into other currencies and into physical assets (gold, land, etc.). How is this a long term positive for the dollar?
All the major paper currencies have serious problems - I agree. But, if the Fed gets busy monetizing a fair amount of treasuries this year, there will be depreciation - even on a relative basis. Where else will the Treasury get its money for 2010 except for QE v.2.0?
Gwynplaine,
If you are looking for when an inflation effect works its way through after debt de-leverage has stabilized, in reference the dollar index, that is a little tricky to time.
If you are looking for when the currency is debased this is a little easier. The assumption made is that the FED will never be able to properly tighten on the money supply. The FED may increase the Fed Funds rate, but reducing the money supply is not likely.
So what is the dollar worth, I guess lately, relative to gold, it has dropped 10% min. From the front end then, understanding that the effect is not linear, from here on out every $1.0T in QE, through what ever method, the USD, relative to gold at $1100.00 per troy ounce, will lose 10% to 15% in remaining value. The effect is not linear so after every $1T you would see an increase in % value lost. So on the 2nd Trillion the loss in value could be an additional 12% to 17%, something like that.
Now this is the classic problem of how to value fiat currency relative to something else, but gold is perhaps the only reliable commodity of somewhat stable worth. The point is that the remaining value in the currency can be debased to near 0 relative to gold (or something else of stable value), per a rate which is a function of QE (dollar debasement). There will be a convergence in this relationship. Like I said, it will not be linear, but perhaps 2nd order.
Mark Beck
Eventually we're all dead too, but Big4
are buying dollars here...
They can't raise rates. There is no tipping point. You have to understand just a 25 basis point tip will tank the market big time. There is no recovery, numbers are just bouncing off the bottom before starting down again. benny is boxed in, cooked, done!
The housing market will totally collapse beyond what we have seen if rates are raised. Not gonna happen. Love my gold!
We are screwed.
Happy Holidays and Merry Christmas.
Love this site.
They can't raise rates ? what if Japan decides to do a serious treasury dump ?(like they said they would do)
What if treasury holders sell into strength which starts a run on them ?
I am into gold too but I figured I should maybe get into a non leveraged treasury short ETF like TBF.
Why would 7% interest be some kind of "magic number"? In the 70s and 80s, yields were far higher. I don't see what would stop us from getting back up there.
Inflation isn't the problem people see. No, it's the big one. Lack of demand for the relentless supply. While this has been a problem off and on for 230 years it sure looks like maybe the days of the US Treasury being to borrow however much it wants at the worlds lowest rates are over.
If they can then nothing has changed. If and when they can't everything has changed. This is the big enchalada.
Rising rates is what will cause the double dip, it has to. We have had no ressesion yet, ressecions are triggered by credit contraction. 0% interest rates are not credit contraction.
Does anyone know what the tipping point is where the fed can no longer keep rates down and when the market forces will be too powerful ?
50bps on 10y UST... thats when tipping point comes... summer 2003 japan!
Rates rise because of credit quality fear.
oh yes... except they have magic machine, as result they can't default... anyone bid for US$ CDS on UST? i am 0/1 any size
"Hedge fund managers, however, have been hesitant to engage in short sales of Treasury bonds to profit from the rising yields – and falling prices – because of the Federal Reserve’s heavy involvement in the market. This has led some to buy options – dubbed “high strike receivers”
Hard learned lessons from the debacle of C prffered exchange and the subsequent short squeez and the ralley?.Well,at least now it is becoming increasingly difficult for GS to make money through the entrapment process,and with stocks appreciating so much,the margin is increasingly tight.Cap and trade was not successful,and the oil swaps with China is also an old story. So the question becomes what is their next year plan for bangbuster revenue?. And who will be the new sucker?.Anybody here who can think of something,will be able to make a fortune piggybacking on the big six(do you guys remeber the big eight,and know how many are they now?)
The bond bears are right unless we are heading into a severe 2d dip, in which case all bets are off. These are historically low yields on paper of increasingly dubious quality.
Ho Ho Ho , Goldman
http://www.nytimes.com/2009/12/24/business/24trading.html?_r=1&hp
http://community.nytimes.com/comments/www.nytimes.com/2009/12/24/business/24trading.html
"In 2006, I worked briefly for JPMorganChase as a low-level banker, a position for which I had to, and did, get my securities licenses.Within weeks of beginning work, it became clear to me that there was something profoundly wrong with the system. Bankers were literally sent to boiler room call centers, where we were compelled to call "clients" with the most credit card debt and encourage them to take out home equity loans ( which for most meant putting their only real asset on the line ) to pay off the credit card debt, while paying only the interest on the new loan. When I resisted making those calls, pointing out that the debtors were only incurring additional debt and never really paying off the principal, I was roundly derided and treated like a pariah. When I brought abuses to the attention of upper management, such as getting people to apply for loans over the phone without sharing the required disclosure information, I was told "we'll look into it." No one did; the practices continued.
I left Chase, after six-months, of my own accord. I just couldn't drink the Kool Aid, or continue to be part of a process that was so blatantly cynical and unethical. And trust me, everyone involved knew it was fundamentally flawed, and ultimately just wrong. How interesting that we have such a large contingent of people in this country who consider themselves morally superior simply because they practice religion. With our current tropism toward corporate rule( the political definition of which, by the way, is facism ) we need a serious ethical paradigm shift." http://stockcharts.com/h-sc/ui?s=GS&p=D&yr=0&mn=10&dy=0&id=p19940414718
I don't see your connection with the practice of any religion and the fleecing of clients by getting them to take on more debt. Hasn't anyone educated you to the fact that the 'dark ages' religious man St Thomas Acquainus thought the charging of interest on loans was immoral? Hew was a religious man and today's so-called modern man promotes the idea that St Thomas was from the dark ages. I think it highly simplistic to associate a very private and honorable thing like practicing any religion to the out right thievery that is occuring in today's modern society. God Bless
I hear you. And have never thought to highly of the boiler room call centers. But the borrower bares at least 50% of the blame. Money was not foisted on them........
Good for you. A man of conviction. Let me reduce it even further. We are a nation of me. The corporate statists recognize this and pander to it and most people eat it up. As for religion, most people behave the same way. Most Christians I know use the Bible like a Ouiji board, preferring a few passages that support what they already believe and ignoring the rest. It's 100% consistent, and that's why we are gonna get what we deserve as a nation.
That said, you can find the paradigm shift in the Bible. Perhaps too in the Koran and Book of Mormon. I don't know as I haven't read them, but I've read the Bible from cover to cover. IT doesn't say what most Christians think it says. If they knew what it really demanded of them, they'd quit their churches. Most are content to cherry pick though. It makes them feel so self righteous.
We need people of conviction, willing to live real beliefs instead of wearing them on their sleeve like just another brand name. When Jesus told Christians that they were gonna have to pick up their cross and follow them every day, He meant it. Most just want him to hug them and give them a new car. They don't want a cross they have to carry. Problem is, most won't figure it out until they get bitch-slapped, big time.
Good post - few think about big picture. But for most traders, long term is tomorrow afternoon. Agree that most "Christians" do not have a clue about Christianity. And sadly if they did, they would not like it....
"Goldman Saw It Coming"...LOL, understatement of the century! In the summer of 2006, I asked them good folks at GS how we can massively short the ABX. They asked me "why would you want to do that?" Interestingly, they were long initially and then reversed course quickly. Always wondered if my insight had something to do with their decision (kidding....I think).
"If they are right, and the world ends, they will make a fortune, said one fund manager"
I thought about doing this trade, but if treasury rates explodes (i.e. end of the world), wouldn't the USD go down along with it? And if that happens, it wouldn't matter if you made a boat load of money because then it'd be funny money anyway.
Can someone comment on my line of reasoning? Am I missing something here?
Yes, you're missing the basic point that high rates encourage foreign investors to buy more US bonds. Since Tyler posted that the Treasury will issue massive amounts of debt in 2010, that would be a good thing from Treasury's point of view. But not so good for Prez Bambam - a higher dollar would choke off US exports and extend unemployment.
MORONS.. 1. its NOT "high strike receiver" - its high strike payer (i.e. right to pay, payer swaption. 2. NOBODY made money selling bonds (too many factors, supporting low yields and I am lazy to talk about it, but read Bull Gross) 3. at 30y UST at 8% i put all my money in 30y UST and move to Kansas...
A renter is paying off the tail end of your mortgage on your future home there now.
What's in Kansas?
Books
What is Dodge City, Books.
http://www.youtube.com/watch?v=iEzNxtzoTD4&feature=related
Kansas City, crazy little...
http://www.youtube.com/watch?v=RoeoLDDq6Cg&feature=related
Please don't move to Kansas. Kansas is a nice state with good people. They don't trust Wall Streeters, and they have pitchforks. Just saying.
http://www.nytimes.com/2009/12/22/business/energy-environment/22solar.html http://www.pasadenaweekly.com/cms/story/detail/breaking_the_smog_bank/7239/
Arnie is fixing to get terminated! Sholtz ratted him out and probably Algore and Pachauri too. Green energy's house of cards is coming down. Don't say nobody waned you!