Gleacher Head Of Rates Shares A Very Bearish Outlook On Treasurys

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From Russ Certo, head of Rates at Gleacher & Company

Good morning.  Quick update of views:  Having just returned from being out of the office for a week, I have a few observations. 

First, In light of all things Japan and even Libya, sometimes we have to separate the compassionate elements of developments and the ebb and flow of news with the daily reality of investment decisions. As I was leaving for a week away from computer screens, kindly recall the investment thesis that commodity leadership in risk asset arena, infrastructure plays, rebuilding, military deployment, general belief of cooler investment minds prevailing, led us to recommending cautious addition to risk assets and the consequent negative implications for “risk free” or industrialized G3 bund, gilt, Treasury space.  We told you we would let you know how it went.  It went well.  Really well. 

As I arrive back and survey markets and prospective opportunities, I see the U.S. Treasury market down nearly 10 consecutive days in a row.  Although, I believe SUBSTANTIALLY HIGHER  rates are here come in the intermediate future, I feel asymmetry exits in the next 72 trading session hours and into next week.  Let me explain. 

Market price action is often about positions.  Whereas, a week or so ago, it was not “politically” acceptable to explain to your committee or boss to be short during a nuclear meltdown, emotional purchases occurred at high end of range and may have cleaned out shorts.  However, now the technical profile likely has changed meaningfully. 

I also view the technicals as asymmetric in the sense that there is an event to occur, actually two events in the coming days, which COULD prospectively upset prevailing views or positions.  First, payrolls with private payroll consensus expectation of 210,000 gains, also begs of crowded view, particularly in light of 9 trading session in a row of lower prices, a 3% move in price in 10 year notes in a string of consecutive sessions.  I put out a support level on 10 year notes yesterday afternoon that held despite apathetic activity in volume and markets since. 

Further, and hesitate to be so pedestrian, but a winter storm warning is in effect for Thursday night/Friday morning in the NYC metropolitan area.  I don’t know if this is some sort of sick April fools joke, but forecasters are predicting as many as a foot of snow in the Northeast at the end of the week.  I can just see traders struggling to manage risk, cover positions with payroll risk on the books heading into the weekend.

I also will simply observe that commodity market leadership weeks ago was powerful leading indicator and leaded equity bourses HIGHER.  Now, it appears that the leadership is waning.  Copper, for example is down 2% today and most of the complex has been mixed at best in recent sessions. Even oil flattish.  This somewhat counters equity melt up, which was investment thesis a week or so ago.  Don’t’ know what just happened but there has been a multiple percent pullback in gold and silver from this morning as well. 

Please don’t confuse a NEAR TERM thesis with that of intermediate or longer term views.  I would feel more comfortable with better prospective location, lets’ say, after a weaker than EXPECTATIONS payroll report to have better location, let’s say 2% or 3% in price, to re-establish shorts in fixed space.  LOCATION, LOCATION, LOCATION.  And this does not make for an exciting investment thesis going into payrolls but I prefer better entry points for the bears so that pigs don’t get slaughtered on the 10th day of a sell off.

Longer term investment thesis?  I firmly believe higher rates, substantially higher rates, are forthcoming.  For those of you that have followed my work for years, I was a steadfast interest rate bull, for nearly a decade, despite market proclamations of higher interest in past several years.  I have officially turned to a bear and I think for years to come, so, the interim blips are just that, opportunities for better location to lighten up on duration. Remember when your Mr. “doom and gloom” constantly berated you with anecdotal headlines of prospective risk asset and economic deterioration,  risk deleveraging prospects, and imbalances of asset valuations.  Did you ever think I would become the bull in risk and bear in fixed space?

The way I look at it is there is NOW a low priced or inexpensive option.  If the economy gets better on a slew of better earnings and earnings growth and economic recovery, investment cycle, ramping of GDP, inventory building and the like, rates go higher.   Possibly, MORE IMPORTANTLY, if the economy doesn’t continue recovery, the trashed/trashing of balance sheet becomes even more onerous in applicable sovereign debt crises FOR THE UNITED STATES, that’s right, just like Club Med Europe. 

You see, every moment, literally every minute, that passes, the imbalance of U.S. government budget balances has transcended sustainable deficit levels.  Here in the U.S., NON-DISRETIONARY spending represents near 65% of all budgetary earmarks and spending.  These are the fastest growing entitlements and from the highest base levels of Medicare, Medicaid, Social Security and defense spending.   So, the fastest and largest portion of our ledgers are exponentially getting larger by the day which will transform into a credit proposition for the U.S. government and unsustainable interest payment as percentage of GDP. 

Yes, this has been discussed at nausea for years, and decades and is fashionable order of the Tea Party day at moment.  But unsustainable spending really has crescendo(ed) into the point of no return.  We can discuss the numbers. And it is all about the numbers which support these claims.

Here’s the challenge.  I don’t see anyone protecting the value of the 30 year bond, unless recent Fed ruminations of various tightening schemes in the form of asset sales, matched  sales, Treasury sales exist has teeth.  I see 3rd wars, global rebuilding and the largest part of U.S. budget, non-discretionary spending, not being addressed by the latest Congressional budget.  So, the upshot is that if the economy does better, higher interest rates are in order as this rate structure is simply too low.  And if the economy does worse, ledgers are so trashed that the “risk free” rate becomes more of a high grade credit expression or high dividend yielding perpetual asset like equity expression as a better storehouse of wealth.

An entire camp of investment managers, likely leveraged, may subscribe to return of equity earnings growth but possibly more importantly is concerned about attempting to not be devalued by central bank monetary and government fiscal policies.  They are attempting to re-allocated to assets that perform during massive debt restructurings, dilution of paper currency, and prevalent monetization of the debt policies.  This is what befuddles the bearish equity crowd and is what is perhaps missing.  It’s NOT about earnings. It’s about hard assets or perpetual assets embodying a measure of protection from these asinine policies.  Every day that a creditor becomes marginalized has a zero sum transfer to lowest level of capital structure, equities.  They are the new risk free assets not industrialized trashed sovereign rate markets. 

Russ.