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Guggenheim's Minerd: "Don't Fight The Treasury Bond Rally"

Tyler Durden's picture


Authored by Scott Minerd via Guggenheim Investments,

Don’t Fight the U.S. Treasury Bond Rally - U.S. Interest Rates Could Head Significantly Lower.

The consensus among market watchers last September was that, with U.S. interest rates so low and the U.S. Federal Reserve (the Fed) about to withdraw stimulus, interest rates would trend higher. I took a different view, writing in a commentary that “10-year rates may be heading back to 2.25 percent or lower.”

When 10-year Treasury yields ended 2013 at 3.02 percent, some may have thought I had taken the wrong end of the bet. But in early August, 10-year Treasury yields went as low as 2.35 percent and I believe the path of least resistance on interest rates is still lower.

A number of factors have helped push Treasury yields lower. With yields on German 10-year Bunds dipping under 1 percent for the first time and Japanese government bonds yielding around 50 basis points, Treasuries look comparatively attractive. Add to that the perception that both the yen and euro are a one-way bet toward depreciation and it is reasonable to expect that international capital will continue flowing toward the U.S., pressuring Treasury yields down as quantitative easing draws to an end.

Tensions from Ukraine to Iraq have added to a flight-to-quality trade, boosting demand for U.S. Treasuries. With the size of incremental U.S. government borrowing also expected to decline because of shrinking federal budget deficits, Treasury yields could move lower.

Reduce Rate Risk

My original forecast of 2.0 to 2.25 percent still seems reasonable. Nevertheless, markets do not move in straight lines, so yields could retrace to 2.5 percent in the near term. Ultimately, as rates head back toward 2 percent portfolio managers should use the rally to reduce interest rate risk.

As anyone experienced in investing in the U.S. mortgage market knows there is a phenomenon that traders call the “refi bid.” When interest rates fall, a larger percentage of mortgages become economically attractive to refinance at a lower interest rate.

Whenever a threshold is breached where a large amount of mortgages make attractive refinancing candidates, prepayments spike up dramatically and portfolios that own mortgages have a sudden surge in cash. This causes portfolio duration to shorten and leads to a need to buy longer duration assets in order to maintain the target portfolio duration. This demand surge can result in a sudden and dramatic decline in rates.

Currently, I estimate that the next “refi level” will hit when the 10-year Treasury yield drops to about 2.25 percent.

An unusual feature of this potential wave of mortgage refinancing is that the vast majority of U.S. mortgages are on the cusp of being candidates for refinancing, given the relative stability of mortgage rates over the past year or so.

Additionally, there is one dominant holder of these mortgage securities that has vowed to reinvest in new mortgages as prepayments come in—the Fed.

Traditionally, in a refinancing rally, spreads on mortgage-backed securities (MBS) widen due to increased prepayment risk and expected increases in supply. Spreads will not widen on this occasion to the same extent as during previous refi rallies for a number of technical reasons.

Among those reasons is that the Fed, the biggest mortgage investor on the block, has made clear it will reinvest principal repayments dollar for dollar. Normally, the widening in mortgage spreads mutes the impact of the rate decline on mortgage rates, slowing the pace of refinancing.

This time, advertised mortgage rates are likely to fall more rapidly than in prior refi experiences.

Selling Opportunity

Given the likely rapidity of the interest rate decline, the potential for shortening in the duration of fixed-income investment portfolios could further intensify the current rally and lead to a more extreme decline in rates than would normally be anticipated.

Declining mortgage rates will also give a lift to housing affordability, which could help clear unsold inventories of homes and support new construction activity. This would further support the U.S. economy.

Ultimately, this expected run-up in bond prices and the associated decline in interest rates should prove unsustainable once the refinancing bid is past. For the near term, risks favor lower interest rates - perhaps sharply lower. In the medium term, as the economy strengthens further, this rally will reverse itself and will have proven to be a selling opportunity.

It is premature to sell now, but as 10-year U.S. Treasury yields approach 2 percent it should provide an opportunity for rebalancing portfolios. In other words, don’t chase the rally, but don’t fight it either. The opportunity to sell bonds is coming - but not just yet.

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Mon, 08/25/2014 - 12:51 | 5140988 kliguy38
kliguy38's picture

time to get short

Mon, 08/25/2014 - 13:00 | 5141020 OC Sure
OC Sure's picture

"The hasty stroke goes oft astray."

-J.R.R. Tolkien

Mon, 08/25/2014 - 13:07 | 5141045 knukles
knukles's picture

He golf, too?

Mon, 08/25/2014 - 13:50 | 5141212 Comte d'herblay
Comte d'herblay's picture

Butt it sure helps speed up the game for the rest of us. 


Mon, 08/25/2014 - 14:24 | 5141341 Thanatos
Tue, 08/26/2014 - 05:01 | 5143919 Comte d'herblay
Comte d'herblay's picture

You are the only person I have ever seen who even knows of Harry White.  Read about him a decade ago.

And yes, we have been being screwed by these elitist, intellectual abusers of power for centuries.

There was another member of the Roosevelt admenstruation whose name escaped me, who was the brains behind yet another conspiracy. All but forgotten by the fiction writers of our history.


Mon, 08/25/2014 - 14:53 | 5141418 Thanatos
Thanatos's picture

I'm thinking those "Crazy" John Birch Society FOLKS were right about more than was polite to admit at the time.


If this:


is near true, all those Crazy Bircher's were spot on and this country is going to implode just like the USSR did (ala Orlav's Meme).

If THAT is true... Whew! I feel a lot LOT fucking better.


Mon, 08/25/2014 - 12:55 | 5140999 LawsofPhysics
LawsofPhysics's picture

Shit, rates on all government paper is going to zero (along with the purchasing power).

Mon, 08/25/2014 - 12:57 | 5141005 knukles
knukles's picture

Gettin' any pushback from non-imvestment types, Scotty?
They never learn.

Mon, 08/25/2014 - 12:58 | 5141013 Dr. Engali
Dr. Engali's picture

I'll wait until I see a 1% ten year before I sell.

Mon, 08/25/2014 - 13:07 | 5141042 knukles
knukles's picture

Hah ha ha ha ha ha
And they keep tellin' us we're nuts, Doc.
(That's a whole nother topic....)



Mon, 08/25/2014 - 13:07 | 5141044 Grande Tetons
Grande Tetons's picture

Are you sure you want to miss the ride between 1% and .00000001%? 

Mon, 08/25/2014 - 13:12 | 5141056 lasvegaspersona
lasvegaspersona's picture

yep...lots of doubling between 1% and zero. Bonds could go to in-fini-te-eeee

Mon, 08/25/2014 - 13:35 | 5141153 blackbeardz
blackbeardz's picture

"To infinity... and beyond!" or  “Jupiter and beyond the infinite” from  2001: A SPACE ODYSSEY

in pennyland .0001 is 1 away from it.  No limit down here.

Mon, 08/25/2014 - 13:00 | 5141022 Colonel Klink
Colonel Klink's picture

Ahhh, the tribe of Guggenheim giving us advice.  Um, wouldn't believe a word they say.

Mon, 08/25/2014 - 13:55 | 5141241 disabledvet
disabledvet's picture

They're good. Not just an "anybody" manages that account.

Mon, 08/25/2014 - 13:01 | 5141023 Cognitive Dissonance
Cognitive Dissonance's picture

Still plenty of room left in the back of the US Treasury bus.

<All board the USS Titanic.>

Mon, 08/25/2014 - 13:00 | 5141024 Consuelo
Consuelo's picture

"In the medium term, as the economy strengthens further, this rally will reverse itself and will have proven to be a selling opportunity."

 I really wish we could come to a standardized definition of what 'economic strength' really means...

Mon, 08/25/2014 - 13:20 | 5141093 Salsipuedes
Salsipuedes's picture

Krugman will find the definition soon, written on a snowball in Hell.

Mon, 08/25/2014 - 13:51 | 5141223 seek
seek's picture

'economic strength' = new war. It's been true for the past 20+ years now.

Mon, 08/25/2014 - 13:00 | 5141025 I Write Code
I Write Code's picture

Go not to the elves for advice, for they will say both yes and no.

Mon, 08/25/2014 - 17:43 | 5142202 JamesBond
JamesBond's picture

I didn't know Middle Earth had pump monkies where, evidently, Scott would feel right at home.




Mon, 08/25/2014 - 13:05 | 5141034 himaroid
himaroid's picture

Yield jumps -temporarily - only if germans let draghi qe.

Mon, 08/25/2014 - 13:08 | 5141047 lasvegaspersona
lasvegaspersona's picture

'It has already been written in the stars' (but we don't get to see Fed minutes for 5 years or more).

At this point speculation is just silly. Since there is no longer a market to determine what the 'market' say rates should be it is entirely up to the Fed to work it's magick™ and set them where they need them to be.

With QE ending some other manipulation must be performed because the monetary system is dead and only sitting the corpse upright and making it appear to move will convince the rabble (that's us btw) that it still exists on this plane of reality.

Mon, 08/25/2014 - 13:13 | 5141061 himaroid
himaroid's picture

Buy the dividend every damn month. Then profit from the hedge unwind.

Mon, 08/25/2014 - 13:25 | 5141115 NOTaREALmerican
NOTaREALmerican's picture

"Then profit from the hedge unwind."   Good non-financial book title.   Or poem.

Mon, 08/25/2014 - 13:29 | 5141130 ThroxxOfVron
ThroxxOfVron's picture

Crowded trade.  Lotsa fun 'til it isn't...

Mon, 08/25/2014 - 13:46 | 5141203 Seasmoke
Seasmoke's picture

Decade At Bernie's.

Mon, 08/25/2014 - 13:52 | 5141232 disabledvet
disabledvet's picture

Good thing Warren Buffet is still willing to spend over a billion a year in advertising for his Geico affiliate!

Stocks are still a wonder to me but I don't have that kind of risk tolerance. Again...that is still...even at under two percent...huge carry.

I remain bullish on Treasuries just from a rebalancing perspective. That is still not bullish on the economy or the recovery thesis which I do not like to be. We're still just adding more debt and since that will inevitably lead to higher taxes a tremendous risk for liquidity "squeezes" and defaults.

Can't speak to gold because it's long term price action has way over shot relative to silver. Silver however is still trading about where it did in 1976.

Mon, 08/25/2014 - 14:10 | 5141304 knukles
knukles's picture

That's because of all the electric cars (They tell is in CA)

Mon, 08/25/2014 - 14:43 | 5141384 nobodysfool
nobodysfool's picture

On CNBC: Jim Krammit, er Kramer said the 10yr could go to 2.125%. Time to sell everything and buy Tsys? But, but, the economy! It's growing, steady improvements, how could that happen, How can rates go lower? Obama said He saved 3mm jobs!? Aaaarggghh ! I'm so confused! 

Mon, 08/25/2014 - 16:09 | 5141803 knukles
knukles's picture

Talkin' 'bout CNBS, where's Buttaroma when we need her?
Not that I've watched more than 5 minutes on a quarterly basis for 3 or more years....
And then I cringe through the nefarious pain by telling myself I'm only doing this to double-check the PTB's party line....
Especially that Simon guy.  Like Piers Morgan but really closet struggling to come out.
Or maybe he got an A+ in Cross-dressing and Buggery 101 at Eaton?

Mon, 08/25/2014 - 16:22 | 5141863 farmboy
farmboy's picture

Haha, Guggenheim is a bear I go for a yield below 1% for 10Y

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