The Case for Shorting Long Dated U.S. Treasuries

I believe that long dated US treasuries are one of the worst investment options available right now. Should we short them? Let's examine the evidence:

Exhibit A: US government debt continues to balloon.

I wondered last month why the rest of the world will continue to lend money to the US at 3%+ percent, while our government spends money like drunken sailors. Someone on Seeking Alpha even hilariously asked me what drunken sailors have ever done to me to earn such an insult.

Basic lending 101 dictates that the higher risk of defaulting the prospective debtor appears to have to the creditor, the higher the interest rate the creditor will demand. And right now, our government is behaving like a banana republic government.

Exhibit B: Long term interest rates are below the current rate of inflation.

The 10-Year Treasury is currently yielding 3.936%. Official CPI calculations are running around 5%, and in reality probably higher than that. According to John Williams of Shadow Stats, using the pre-Clinton era method of calculating the CPI, inflation is north of 8%.

What kind of investor commits to a long term investment that is guaranteed to lose money?

Exhibit C: Tom Dyson - The global asset liquidation may soon spill over into Treasuries.

Tom writes in the October 17th edition of Daily Wealth, "My concern is, if this credit crisis gets worse, it's going to trigger even bigger whales to liquidate their Treasury bond holdings... whales like the Chinese, the Japanese, or the oil exporters."

Exhibit D: Jim Rogers is short treasuries.

It's tough to argue with Jim Rogers. Here he is on Bloomberg on September 10, 2008 - he mentions his short US Treasury position at the 9-minute mark.

Exhibit E: Doug Casey also thinks interest rates are going to the moon.

Here's a clip of Doug on Fox Business back on August 14 (mentioning interest rates at the 2-minute mark).

Exhibit F: The US government must print money as fast as it can.

Somebody has to pay for all of these stimulus/bailout/rescue packages - and there are only two ways our government can raise the money needed to cover these:

1. Raise taxes
2. Print money

I think we'll see a bit of both, but raising taxes will be challenging in this bleak economic climate. I believe the printing presses are already humming quite loudly.

Exhibit G: Treasuries have started a downtrend over the past two weeks.

This is especially telling because, based on the action of the equity markets, you would have expected to see investors piling into US Treasuries over the last two weeks. Instead, they behaved quite poorly in the context of the broader economic picture.

It appears that a downtrend in 10-Year Treasuries has begun.

Conclusion:

I believe long-dated US treasuries are ripe to be shorted. I have begun to build up a full short position via the futures markets, and intend to increase this position over time as interest rates rise.

I would recommend readers avoid financial positions that may be vulnerable to rising interest rates.

Ironically, this may in fact be an argument for diving back into the real estate market before it bottoms. A long-term mortgage locked in around 6% will be quite desirable if interest rates spike to their highs from the early 80's.

Aggressive investors can look to profit from rising interest rates by shorting long-dates Treasury or Eurodollar positions via the futures markets. Alternatively, there are several ETFs that inversely track interest rates - DXKSX is the one I own in my Scottrade account, because it provides 2.5x leverage.

Comments

[freefall51:]

Good one.

2008 Oct 22 07:57 AM

[J-Man:]

Would you not also want to buy TBT under this scenario?

2008 Oct 22 08:45 AM

[PhilSeltzer:]

Good but one horrible note on the way out:
"Diving back into real estate" and "avoid financial positions that may be vulnerable to rising interest rates" are completely contradictory. Huge inverse correlation between real estate prices and rising interest rates. But if you want I'll sell ya plenty of mine. ;)

2008 Oct 22 08:53 AM

[soonerxii:]

A lot of people have been calling for this trade. I guess you can short the TLT or buy RRPIX also. When people say long term Treasuries, do they mean 10, 20, or 30? Or all 3?

2008 Oct 22 09:25 AM

[Brett Owens:]

Phil - thx for the note.

Quick clarification, I agree that real estate prices and interest rates are inversely correlated. My intention was to point out the flip side - a 30-year mortgage locked in at a low rate may be a fantastic asset if interest rates do skyrocket.

2008 Oct 22 10:31 AM

[Brett Owens:]

Soonerxii - any one of those 3 will do the trick - they all track pretty closely. In the futures markets I believe they are referring to the 10-year only.

2008 Oct 22 10:32 AM

[gjvoor1:]

Are there any ETF's that short treasuries. Also would you not be better off shorting short term treasuries instead of 10 year plus?

2008 Oct 22 12:29 PM

[Brett Owens:]

I think you're better off shorting 10+ year treasuries, because shorter term rates are often too closely tied with the Fed Funds rate set by the govt.

I anticipate long term interest rates will lead the way up.

DXKSX is the inverse fund I own. Here's a nice SA resource for ETFs related to US govt bonds:
seekingalpha.com/artic...

2008 Oct 22 12:59 PM

[CLH:]

Wrong, wrong, wrong. Interest rates will be low until anyone over 50 is dead and gone. Interest rates stayed down for 40 years after the 1930s. This is the effect of disinflation or debt elimination. People will start to save (yes it makes sense) and stop borrowing.

2008 Oct 22 06:35 PM

[kotika98:]

oh what a bunch of rehashed bull! Treasuries fall 7 points and people start talking about "shorting" them. Where were you before this fall? And anyway we heard all this before last year, when the euro was going to the moon, the inflation was 8%, oil was at $150. Wake up! Things have changed drastically in the past couple of months. With money deposited in the bank, in money markets, in any emerging country bonds, not really safe your only option is to buy treasuries and keep them. Secondly gold, oil, and PPI have all plunged in fact PPI hasnt just slowed down but turned negative and will stay negative for the next a year or two.

2008 Oct 22 09:28 PM

[soonerxii:]

Bill Fleckenstein has predicted pretty much everything that is happening now. He was actually about a year early. Anyways, I recomend him to people who want to drop about 120 a year for a daily roundup.
This is an email he answered on his site about a week ago. He is ramping up his shorts on long term treasuries I believe, but his trades can come and go fast....I'm not trying to pimp Fleck here, but I am posting something from a paid site, so I need to reflect that, (but also, I will pimp Fleck, because has been fricking invaluable this past year).

"Bill,

It's probably a good thing in the very short term that the "flight to safety" has permitted the Treasury (and ultimately the Fed) to fund the bailing out of the world, because the rate of interest on those short-term Treasuries being bought is REALLY low (as low as one tenth of one percent yield). That reduces the interest-rate burden created by the selling of so much government debt into the markets.

However, this surge of bailout debt is another "weapon of mass destruction" that is going to fall on us somewhere down the road. There is absolutely no way that the bailout debt (like all other U.S. debt since WWII) will be payed down. To quote Dick Cheney, describing the political stupidity of the American electorate, "Reagan proved deficits don't matter."

Now, all this short-term bailout debt has to be rolled over each time it falls due. Once the credit panic is over and the "flight to safety" ebbs, the interest rate on Treasuries will snap upward as the debt is rolled over with fewer buyers bidding on it. As a result, the 10 year yield will rise at least to it's fifty-year average of 7% (not even counting possible conventional bombs going off like inflation from so much liquidity injection or the major devaluing of the dollar).

In other words, the panic has created a "bubble" specific to Treasuries as an asset, and when the bubble pops, the cost of the interest payments on the trillions of dollars in new debt will become a fiscal disaster. With some real bad luck, this can be unfolding just about the time the Boomers are depleting the Social Security trust fund reserves and all that off-the-books Social Security liability will start seriously devastating our already-deeply-underwa... annual fiscal budgets.

How high can interest rates go? Can you say 1979?
• Thanks for that-- I agree-- foks who don't understand how rates can rise given the economy should read this twice. "

2008 Oct 23 04:12 PM

[soonerxii:]

I hadn't heard of DXKSX before this article. I'm going to build a position up starting tomorrow.

2008 Oct 23 05:28 PM

[Charlie Bottle:]

What type of upside and carrting costs do you anticiapte for such a trade with futures?

I wrote a similar artcile 4 months ago (seekingalpha.com/artic...) I was clearly too early, and now think that although a valid trade at some point it shoudl still take a few months or even years before it makes sense. Inflation needs to pick up again or China and middle east need to be in real trouble to start dumping dollars (unlikelly in the short term).

2008 Oct 24 02:52 AM

[Kunst:]

CLH, so sad.

2008 Oct 28 01:07 AM

[soonerxii:]

I still trying to wrap my head around this trade, but I've got a core DXKSX position now. So, I would certainly read more articles on this subject.

2008 Nov 10 10:49 AM