Why Bond Bears Should Wait

Includes: TBT, TLT
by: Hamlet Capital

December has been a good month for being short U.S. Treasuries. True to form, whenever bonds take extended losses, talk of the end of the bond bull invariably emerges. But the buyer of last resort might say otherwise.

Guardians of the bond bull, the Federal Open Market Committee (FOMC), decided earlier in December to add $45 billion in monthly unsterilized Treasury purchases to the $40 billion program to buy mortgage-backed securities. Chairman Ben Bernanke revealed that the Fed will continue the purchases until unemployment falls to 6.5%, which the Fed estimates will be in 30 months.

The composition of the U.S. legislative bodies lends favor to continued easing. It is politically expedient to be seen as "doing something" about the economy, namely to urge the central banks to increase their balance sheets. When Senator Chuck Schumer implored Bernanke, "Get to work, Mr. Chairman," it was a clear signal of legislative sentiment. It is no surprise to see those responsible for doubling U.S. public debt over the last six years to press for continued easing.

More importantly, Treasury yields can't rise without bankrupting the government. The U.S. continues to rollover a large number of bills and bonds. When the interest on those Treasuries soar, higher interest payments would be required, increasing the budget deficit. In order to finance the increased budget deficits, the U.S. would then issue more T-Bills further driving up the rates in a negative feedback loop. The U.S. requires near zero interest rates to finance federal expenses. This is why the Fed will continue to be the buyer of last resort.

Then there is the status of the USD as the world reserve currency. As was witnessed earlier this year, the continuing eurozone crisis will force bids on Treasuries if the euro slides. Despite its problems, the USD is still considered a safe haven. Foreign bank insolvency, trans-national conflict and even natural disasters can push yields lower. As long as the USD is considered "safe," then it's unlikely that yields will rise dramatically until real progress can be seen on the macro stage.

In this context, short and long strategies can be executed with ProShares UltraShort 20+ Year Treasury (NYSEARCA:TBT) and iShares Barclays 20+ Year Treasury Bond (NYSEARCA:TLT). The Fed has essentially range-bound these funds, making entry points easier to discern. Both are liquid and optionable with reasonable spreads. January 124 calls and puts on TLT have highest open interest, respectively.

While prices will fluctuate in the short term, it is premature to call the end of the bond bull. Political sentiment, the fiscal reality of the U.S., and the status of the USD in a troubled world all suggest that interest rates will remain low.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.