Fun with Government Bonds

T-Bills are hitting Great Depression type levels as the flight to safety and economic conditions have driven yields into the ground, therefore sending T-Bill prices through the roof.

As recently as last week, when the S&P was hitting multi-year lows, the near month T-Bill rates were basically at zero. That doesn't even make any sense and can only be explained by a panic flight to quality to get out of investments and into the closest thing to cash as possible.

What's the best way to take advantage of this fear and panic, which has created an opportunity not seen in the Treasury markets since the Great Depression?

Ultra Short 20 yr. T-Bills via TBT

You can see the gap down as the market plummeted last week and the flight to quality in the government bond markets has driven yields to unsustainable lows.

Here are three reasons why I think now is a great time to begin a position in TBT.

1. The backing by the Federal government of our banking system, and most recently Citi (C), shows that they will do whatever it takes to keep our banking system alive. This will help to create more stability in the market place, thereby stemming the panic flight to T-Bills.
2. The US is taking on a huge amount of debt and it looks like we are not done printing money just yet. It has become necessary to spend our way out of this crisis. A 700 billion dollar bailout, 150 billion to AIG, 150 billion split up between some banks, 300 billion backing of C with another 20 billion dollar infusion just Tueday, hundreds of billions more to Fannie (FNM) and Freddie (FRE) and, most recently, another 800 billion going towards buying bad asset backed debt. It is now looking like 4 trillion dollars may end up being a conservative number in regards to the total bill coming, and many people whom I talk to think we have already spent at least that. Some estimates I have heard are closer to 6 trillion. There is little doubt among economists that this will eventually lead to inflation, which will cause yields go up and the T-Bill prices to come down.
3. Not only do you have inflation to worry about, but also because of the huge new debt level of this country, we will likely see foreign governments lower their debt ratings on the US and therefore require a higher yield in compensation. I believe that now more than ever we will need to be able to sell our debt around the world to help us pay for what has happened and so yields should also rise as the countries credit rating has deteriorated.

You can see the Treasuries rates for the 3 month to the 30 year bonds here.

Now one point that must be considered is the current Fed strategy to help the economy through a strategy known as Quantitative Easing. This is part of the reason that yields are currently at these levels. Here is a paper by Bernanke in 2004 entitled "Conducting Monetary Policy at Very Low Short-Term Interest Rates". In it. he talks about the Fed using Quantitative Easing to expand the Fed's balance sheet by buying government debt at very low interest rates to try to stimulate the economy. This is now playing out in the current situation.

This situation may cause yields to stay lower than they would have otherwise in the near term. Another panic in the markets could also cause a short term spike down in near and longer term yields; but looking down the road, if the government is going to need more money, yields will have to go up and T-Bill prices down. The alternative is the downward deflation spiral of death plunges the country into a terrible prolonged recession.

Things will no doubt be tough in the short and intermediate term but it looks to me we are more then determined to print our way out of deflation, disregarding long term impacts on inflation.

You can view the Daily Treasury Yield Curve Rates here.

Disclosure: Author holds long positions in TBT and TLT

Comments

[Mr. Cynical:]

He's right but this trade is way too early. The quantitative easing by the Fed will flatten the yield curve and keep long term rates low for some time.

In fact, they will push rates lower so that everybody can re-fi at 5% or less.

This is like, what, the zillionth long double-short treasuries article on Seeking Alpha in the last 2 weeks? Sheesh. Leave this one to the monkeys and go call Obama and tell him to start the great derivative unwind on 1/20.

2008 Nov 28 01:12 PM

[SW Richmond:]

Yes, this is an oft-discussed topic. Let's examine one more important aspect.

Capital, that is real capital, as clearly distinguished from newly-printed faux-capital, seeks productive employment in exchange for return. Under normal historic circumstances, capital would flee to economies with safe currencies that are not being actively debased by their hosts.

The current circumstances are different: cooperative global debasement, a new modern phenomena, leaves capital no safe currency to which to flee. I view this as covert capital controls, revealing cooperative global banking as a capital trap. This is a more serious an issue than it might seem. Once successful, and coupled with the coming global regulation regime, a new inescapable system will exist where capital can be forced to flow where bankers and governments want it. Complete control of money is the end of financial freedom. The phrase "investment opportunities abroad" will be become meaningless. If you want to "save" or "invest", you will have to do so in a controlled system. It is reminiscent of the American one-party political system.

While I do own some TBT, I am rethinking it; if this global regime succeeds, and if all currencies are equally debased, then rates could in theory never rise.

2008 Nov 28 04:13 PM

[Vigilance:]

Sure, buy T bills and take out a mortgage on our already bankrupt country.
Here's a novel idea: Why don't we insist that the federal government start abiding by the Constitution? We've had nearly a hundred years of managed economy under the Fed...How about giving the free market a chance? That which is inefficient and unprofitable SHOULD fail. By the way, the Constitution granted congress the power to coin (not print) money and it did not grant them the power to delegate that power to a private cartel

2008 Dec 01 12:55 AM

[Vigilance:]

Sure, buy T bills and take out a mortgage on our already bankrupt country.
Here's a novel idea: Why don't we insist that the federal government start abiding by the Constitution? We've had nearly a hundred years of managed economy under the Fed...How about giving the free market a chance? That which is inefficient and unprofitable SHOULD fail. By the way, the Constitution granted congress the power to coin (not print) money and it did not grant them the power to delegate that power to a private cartel

2008 Dec 01 12:55 AM

[Crank Monkey:]

Central bankers own everything, including the the government. It would require a second American revolution to loosen their grip.

2008 Dec 01 01:39 PM