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The Treasury Bond Market is Blind to Risk
After promising to deliver you a nicely marbled, medium rare, prime rib, I am the first to admit when I actual come up with a piece of tasteless, salt water injected Costco turkey. I am talking about my suggestion that Treasury bond prices would fall this year, and that the best way to play it would be through the leveraged short ETF (TBT).
Nimble traders were able to wrest three round trips out of a $46-$51 range in Q1 before a flight to quality broke it down to $36 during the April-May sell off. But if you didn’t keep stop losses in place, which I always highly recommend, you got hammered.
After listening to The Ascent of Money author and Harvard business school professor, Niall Ferguson this morning, I am more convinced than ever that this trade will have its day in the sun. The next financial crisis will be a chain reaction that has already started in small, peripheral European countries, will spread to large European countries, and then eventually hit Japan and the US. From a fiscal point of view, the US is no better off today than Greece or Spain.
The next crisis has already started at the state level, where there is little choice but to dramatically cut spending and increase taxes. Debt service will soar from the current 11% of the federal budget to a gob smacking 28% as early as 2014. When this happens, the Treasury bond market will become extremely sensitive to even the smallest changes in interest rates. A reassessment of American credit worthiness could tip us into crisis very quickly, possibly as soon as two years.
Washington is doing nothing to avert the impending crisis, and with ten year yields now at a paltry 2.94%, the bond markets are clearly blind to these risks. Prices will eventually head downtown on an express train. I’m not wrong on this one, just early.
To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at www.madhedgefundtrader.com . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.
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The effects of recession will only amplify the issuance of debt.
In talking with people I am always amazed at how debt instruments are viewed in terms of risk.
The reasons for confidence are almost a form of mental illness when I ask about long term risks. The belief system is very strange, almost like a religion. But through history holders of debt get crushed when exposed to sovereign default. More importantly, is the risk of loss in instruments which are easily devalued through QE.
What if the bond interest return is swamped by devaluation (QE)? What do you do? Sell it? To whom?
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Given the President's budget who would buy any long term US debt? We may be the best looking horse in the glue factory, but who says you should be buying horses?
Take $50 dollars out of you pocket and give it to uncle sam for close to nothing in return, when this same $50 could have purchased an asset or commodity. That you have control over, that can maintain real worth. At this time, who in their right mind would buy any US sovereign debt?
The maintenace of real worth through a fiat currency instrument, in the presence of uncontrolled QE, is fundementally flawed. It is a lie.
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This brings me to the obvious.
People who understand bond investing know the Treasury Bond Market is not blind to risk. The answer; something else is at work here which is influencing this market. And that big pink elephant is the FED. Specifically, the FRBNY. Make no mistake, Ben B. is just a debt pimp, in a three piece suit. I have said this before; he should be called Huggy Ben.
Mark Beck
This Treasury market is kind of like a huge coiled spring---in your shorts.
Off topic, but what the heck is up with the VIX today?
Here on gold- bug central you wanna hype / not- hype treasuries?
No man, gold man, go!
Who knows what the future will bring? The Eurozone austerity hype (reality) is gaining traction so the euro is rising vs. the dollar. How long with that last? A liquidity squeeze in Europe means what, exactly? This is the key to the entire lending/bond question!
If the policy changes for whatever reason or the euro cracks up by default of its clients then the outcomes will be determined very rapidly. The ECB might decide to loosen and the euro would plummet. Yields would rise and the capital flight to the US would lower yields here. At the same time, uncertainties in other areas (China) also effects yields here. For better or worse the US is a safe haven.
Watch the dollar/oil trade which is making the buck a defacto hard currency backed by crude oil; dollars priced in crude have real value. The mechanism is the 'trade back' where dollars are preferred and dollar- denominated assets are dumped to obtain the cash currency. This isn't something the US government has a handle on. Much of the treasury float - and currency float - is overseas.
When that starts happening in earnest the treasury trade will be a dead duck. 8% 10yr, anyone? Did someone mention, 'money- printing'. See 'liquidity trap' also ... keep in mind ... that appearance of liquidity when it is in desperate supply might be the catalyst for money panics. These are two governors on printing.
Watch that oil price, below $70 is a real alarm bell. People need gas, to hell with debt.
Look, as I understand it, banks with access to the Fed discount window can pledge treasuries there and take out cash at 0 percent interest. Then they can do whatever they want with this cash, while their pledged treasuries earn interest.
As far as I can tell, they can then take these funds and buy more treasuries, then pledge them for more discount window loans, thus earning more interest. It sounds like infinite leverage at 0 percent interest to me. The only limit is how much the government is willing to borrow from these banks.
Why in the heck would treasuries ever go down when they're in an infinite loop like that?
http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/785759...
Andrew Roberts, credit chief at RBS, is advising clients to read the Bernanke text very closely because the Fed is soon going to have to the pull the lever on "monster" quantitative easing (QE)".
"We cannot stress enough how strongly we believe that a cliff-edge may be around the corner, for the global banking system (particularly in Europe) and for the global economy. Think the unthinkable," he said in a note to investors.
Roberts said the Fed will shift tack, resorting to the 1940s strategy of capping bond yields around 2pc by force majeure said this is the option "which I personally prefer".
"I’m not wrong on this one, just early."
Early in trading = Wrong
+1000
Trading advice from Niall Ferguson? How about Nassim "every man, woman and child should be short Treasuries" Taleb? These guys sell books and make speeches for a living -- they know shit about trading. Wanna double down with these clowns, be my guest.
Pimco is doing great right now...I expect continued upside as Europe melts down and Eastern Europe falls even faster. Japan will do nothing and China will swing wildly, but stay even. Bernanke has pledged to keep us at zero to infinity or collapse whichever comes first. This is at least ONE thing I believe coming out of the FED. As the S&P rolls over, where is all that money going to go? U.S. Bonds and Gold most likely with emphasis on bonds for now, gold later. Once the S&P revisits it's '09 low or plunges even further, PIMCO will have probably outlived its usefulness at that point. Gold and Energy stocks will likely have good entry points well above S&P 500 or so.
This trade will obviously be golden one day. However, with the govt doing everything it can to manipulate all markets (and especially bond markets) picking that day is impossible.
Wait to get in on this until it is obvious that the bond market realizes the US debt will never be repaid. Better late than early but remember, even then, your biggest risk is political, not market. Them making shorting treasury bonds illegal is as likely as making money on this trade.
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The next crisis has already started at the state level, where there is little choice but to dramatically cut spending and increase taxes. Debt service will soar from the current 11% of the federal budget to a gob smacking 28% as early as 2014. When this happens, the Treasury bond market will become extremely sensitive to even the smallest changes in interest rates. A reassessment of American credit worthiness could tip us into crisis very quickly, possibly as soon as two years.
Washington is doing nothing to avert the impending crisis, and with ten year yields now at a paltry 2.94%, the bond markets are clearly blind to these risks. Prices will eventually head downtown on an express train. I’m not wrong on this one, just early.
...
lets say you're right.. 10year % is up.. debt serice is over roof.. multiplying defaults, housing is dead.. etc etc
next 2 choices: either gov prints money AKA hyperinflation, or goverment will print
TO BUY BONDS... so why would gov ever let %rates to rise..???
it will never happen... stock market can go up or crahs to hell.. real money AKA
bond market is watched.. :)
alex
UHHH, it's going to be quite a while.
Actually, I'm more frightened of the curve
inverting again right now. Flatlining
Buy the time this trade works out, you should be broke.
Buy the time this trade works out, you should be broke.
i agree, and i think the latest fx moves should have everyone who piled into us treasuries shitting themselves...
Sure, riiiiight. Every time those coupons hit my account, I just smile as I think about the chumps who piled into the most crowded, sure-thing trade of the year: "Short Treasuries -- look at that supply -- how can we lose?" LOL.
I hate bonds at current yields. Those that buy and hold at these levels will lose money. But I do not recommend a short in bonds. It is too expensive to carry the leveraged position. Short bonds has caused more losses than long stocks. Beware this trade. It is not a buy and hold. It is a traders play. Your timing has to be excellent. Who has excellent timing? no one. Not even MHFT.
Agree Bruce - it is a short term trade only. The math on the 2X leverage takes TBT to zero in the long term.
But he's suggesting buying the ETF, right?
TBT at 36 - seems like a prudent person might buy just a little bit for a core position. Rates will eventually have to move higher.
(Full disclosure, I bought some at 36 the other day).
Another way to play with less downside is to buy $70 january 2012 puts on the TLT. They're at $2 per share ($200 for a standard option) right now. Lay down $2k today, and you're going to make 1k for every dollar the TLT drops under $68.
Imagine the move down TLT will make if yields on the 30-year double by 2012 . . . If you're a true treasury bear, that's a damned high ROI. Plus, you break free of that nasty long-term decay in the TBT, which kills all but the very best market timers.