T-Bills: Bubble, Bubble, Toil and Trouble

The graph below shows that rates on T-bills and notes are at record lows across the yield curve. The graph covers the entire period that data is available for from the Federal Reserve of St. Louis. It shows the history for 1-month, 1-year, 5-year and 10-year notes.

Investors are entirely concerned right now with the return OF their money, not the return ON their money. If you plan on holding a T-note to maturity, you can be assured that you will get your money back. You have absolutely no assurance of what the buying power of that money will be, however.

If you have to sell before maturity, you can lose on your T-note bets. Back in the 1970's, T-notes were routinely referred to as "certificates of confiscation." It is probably safe to assume that those holding the 1-month, and perhaps even the 1-year bills, do actually plan to hold them to maturity. However, for many holding longer term T-notes and bonds, this is not the case.

Right now, the U.S. is going through its first real bout of deflation since the 1930's. Thus, on the surface the low rates for the short end of the curve seem plausible. However, at rates this low, there is no real difference between holding a T-bill and simply stuffing a wad of dead presidents into a safe deposit box. Physically it might be tough to simply put all the billions that Paulson & Co. have showered on the banks into the vault, but economically the banks are doing the same thing by hoarding cash in the form of short-term T-bills.

Holders of longer term T-notes and bonds are playing a far more dangerous game. It strikes me as highly unlikely that the U.S. will experience deflation for 10 years. While historically it has happened, most notably in the late 19th century, we were under a gold standard then, not under paper money.

To buy a 10-year T-note today, one has to assume that over the next 10 years inflation will average less than 2.18% -- and average less than 2.66% for the next 30 years in the case of the 30-year bond. That does not even consider the effect of taxes.

Meanwhile, last week the Fed made clear that it will do everything in its power to prevent deflation. The amount of money the Fed can create is infinite, so one has to believe that in the end it will be successful in putting an end to deflation. It might take a few quarters to do so, but in the end the Fed will be successful.

Given that monetary policy always works with lags, and the data that the Fed is working from is far from complete and accurate, the danger that the Fed will overshoot is huge. There is at least a 1/3 probability that by 2011 inflation will surpass its late 1970's peaks. Just take a good look at what sort of yields T-notes had back then.

It is true that right now, owning T-notes is just about the only thing that is working. However, do you really want to be holding a 30-year bond (27 year bond by 2011) with a yield at cost of 2.66% when comparable bonds are yielding over 15%.

Life insurance companies are traditionally some of the biggest holders of long-term treasuries. I would avoid names like Hartford (HIG), Met Life (MET) and Conseco (CNO).

Comments

[flyingdogal...:]

i mean 20 yr = TBT


On Dec 23 04:45 PM flyingdogaleman wrote:

> TBT is the double short 10 yr ETF i'm legging into

2008 Dec 23 04:47 PM

[IbetU:]

TBT, but don't tell anyone else!


On Dec 23 04:18 PM Chris B wrote:

> Does anyone know of an ETF that is shorting long-duration treasuries?
> Seems like a no-brainer to me, they can't get much more expensive
> than they are now or we're talking negative yield.
>

2008 Dec 23 04:49 PM

[Illusional ...:]

Agreed. There is no safety against disaster, only less damage. And thanks User 325005

On Dec 23 04:18 PM Chris B wrote:

> Does anyone know of an ETF that is shorting long-duration treasuries?
> Seems like a no-brainer to me, they can't get much more expensive
> than they are now or we're talking negative yield.
>

2008 Dec 23 05:05 PM

[Chris B:]

Thanks DVW!



On Dec 23 04:38 PM DVW wrote:

> ETFs that short these thing -- TBT is 2x short 20yr treasuries, PST
> is 2x short 10yr treasuries... then there's also the futures, which
> are shortable.

2008 Dec 23 05:11 PM

[Ricard:]

I would just like to say...this article and the subsequent comments are worth their weight in treasury shorts. I'm in.

2008 Dec 23 05:37 PM

[thegreatyakk:]

Thanks for the comment, DVW.

As I understand it, the buying stampede is occurring mainly in short-term Treasuries. That being said, it seems reasonable to purchase an ETF such as PST. But on the other hand, the value of long-term bonds are the most susceptible to interest rate fluctuations. So, which ETF would be best suited to profiting from a potential (or should I say inevitable) collapse in the Treasuries market, PST or TBT?

2008 Dec 23 05:45 PM

[Ricard:]

The long term yield has also collapsed. You can buy FDIC insured CDs at just about any term that yield more than the 2.5% the long bond is yielding. You can make whatever argument you want about this situation, but in the end, there's a complete lack of pricing in an inflationary environment in the 20+ year treasury markets as well.

On Dec 23 05:45 PM thegreatyakk wrote:

> Thanks for the comment, DVW.
>
> As I understand it, the buying stampede is occurring mainly in short-term
> Treasuries. That being said, it seems reasonable to purchase an ETF
> such as PST. But on the other hand, the value of long-term bonds
> are the most susceptible to interest rate fluctuations. So, which
> ETF would be best suited to profiting from a potential (or should
> I say inevitable) collapse in the Treasuries market, PST or TBT?

2008 Dec 23 06:11 PM

[Teutonic Kn...:]

Great comments from the many of the heavy hitters. Question: Common sense says that going short is a bit more riskier than going long, because humans always hope for the best (just look at the birth rate).

So instead of buying TBT, would holding onto TIP or TIP ETF be a better, or safer deal here?

2008 Dec 23 07:15 PM

[Moon Kil Woong:]

I suppose the safest way quasi-short bonds is by not owning them. If you park your money in bonds I suggest short term bonds just in case. I would agree that the extra 1 or 2% for longer term maturities are not really worth the risk.

If you are a big bank, I'm sure they are making up the difference charging huge spreads on the few loans they do actually make. Which is part of the problem.

Also may I point out that the Fed is begging for $ by paying interest on bank deposits (encouraging them to take money out of the system and put it in the valut where no one can reach it) to fuel it's debt buying binge and balance sheet inflation. This is itself deflationary. So in actuality they are deflating at the same time they are inflating.

If you are a fund manager, if you haven't been making money on volatility plays you are probably under water. The tough part in 2009 will be that just about everyone is now making them and the premiums are getting bubbly (fit's nicely with the theme of the article lol).

2008 Dec 23 09:28 PM

[hoover:]

You say, "The amount of money the Fed can create is infinite," and that would seem to indicate that the Fed CAN create as much inflation as it wants. But, with so many economic theories that blew up this year, perhaps this one also won't work as planned either. This is a global economy. People have more information than ever about paper money vs. real money. Everyone knows the story of German hyper-inflation in the late twenties. When everyone knows how the government con games are arranged, they cease to work. Somehow I get the feeling that tangible stuff (property that is owned outright, precious metals and possibly some gems, non- deteriorating commodities, etc.) will always be worth a reasonable amount of value in a marketplace for tangible stuff, whether its bartering, trading, or payment in some form of acceptable money. All paper things called assets (stocks of most corporations, debt paper, paper money, paper promises to pay, paper gold -- like "vault" held gold -- chuckle, chuckle -- things based on promises to pay) may be in jeapordy in the future. Just some thoughts for a cold rainy day here in St. Louis.

2008 Dec 23 10:28 PM

[Mark Anthony:]

I have a very simple theory which is perfectly logical, for those people looking for a safe place for their money:

Safe Havens of Any Kind Must Necessarily be Small and Can Only Accomodate Very Few People. If it is big enough to allow every one in, then it is NOT a Safe Haven, but a Death Trap!

Treasury bond is such a Death Trap as it basically can accomodate every one in it. Anything that provides accomodation to every one, is NOT Safe at all.

Read the reasoning behind it:
seekingalpha.com/artic...

2008 Dec 23 10:51 PM

[Ross Snyder:]

Where do you get the 1/3 probability of an inflation blow-up in less than two years?

2008 Dec 23 11:29 PM

[Ricard:]

Seems there are some very heavy "Buyer Beware" stickers floating around regarding the ultrashorts, although the treasury incarnations are too new to have much of a reputation.

Anyone have an idea what kind of performance to expect from TBT and PST? I see that the prospectus has 74% of its assets in shorts, and the rest in 1-3 month derivatives...are we to assume that if the market stands still for 3 months, we lose 25% of principle? What if the market goes down (yields go down even further)? Conversely, what kind of upside potential are we talking about? I'd say that 2x the opposite of the long is not enough reward for the downside risk...anyone else have any thoughts on this? Or, if possible, can anyone recommend something that has less risk?

2008 Dec 24 12:43 AM

[Jackson Cash:]

Dream on.

First of all, the death toll (as I like to measure any popular orchestration of government intervention) is only 1.

Well, folks, let's just go out on a limb and say that we have another rocket downward of -30% worldwide in equity indexes short term (under a year).

Let's see the death toll by "then", knowing full well that no one whatsoever has any clue of the true value of Wall Street at the present.

If you think you have a clue, you are buffaloed.

Don't say I didn't warn you.

2008 Dec 24 01:59 AM

[Anthony Alfidi:]

Return of principal is destroyed when measured in long term inflation-adjusted dollars. That is the inevitable outcome of quantitative easing.

2008 Dec 24 02:18 AM

[Aly-Khan Sa...:]

I beg to differ. Many years ago, when I ran an Interest rate trading desk in london, one of my Traders lent a Japanese Bond [on repo] on the basis that rates could not go negative. They did in the very short end of the curve because it was against the Law to FAIL TO DELIVER. The FED has already put everyone on notice that there are ready to reduce penalties for a failure to deliver and this will launch the curve through 0%.

Secondly, i think Japan is the precursor. We are in an unprecedented situation. We are moving from a situation where credit was the oxygen and now there isn't any. This is not a small thing. Its a tectonic shift. We are in a process of asphyxiation. The FED will certainly loosen the taps but unless Bernanke is set to put his Helicopter thesis into action, I think the bias [many of us are too young to recall a bear market depression] is towards an elongated L and not a V. We live in an instant gratification world but this time its going to take a lot to resuscitate the patient.

finally, i think you entirely underestimate, the ability of bernanke et al to discipline the curve and keep it bid buy deploying outsize buying at various points in the curve, as and when desired. We have a Bernanke PUT on the bond market as oppose to the Greenspan PUT on the equity markets.

I reckon the 30 year will trade a 2% yield and I am selling PUTS [and have been doing for some time].

Look at japan post bubble.

The world has changed.

Aly-Khan satchu
rich.co.ke

happy Christmas.

If you have the inclination, you might go here
www.rich.co.ke/rctools...

and play with the calendar to see comments from the beginning of the year.

2008 Dec 24 02:45 AM

[Mark A. Sad...:]

I agree with the previous comment. Those who believe that it is easy to get out of the liquidity trap just have not done their homework.

2008 Dec 24 04:17 AM

[Ricard:]

Thanks for the insightful opinion. I'm thinking that the helicopter will come (dunno when), and any nominal losses will be masked by a large bout of inflation. So, we may not see the S&P go to 500, 600, or 700, but it will sure feel like it did. At least that is what I am planning to brace for. Your comment is yet one more reason in the pile I have acquired that says that TBT and PST are absolutely the wrong vehicles to carry out this plan.

On Dec 24 02:45 AM Aly-khan Satchu wrote:

> I beg to differ. Many years ago, when I ran an Interest rate trading
> desk in london, one of my Traders lent a Japanese Bond [on repo]
> on the basis that rates could not go negative. They did in the very
> short end of the curve because it was against the Law to FAIL TO
> DELIVER. The FED has already put everyone on notice that there are
> ready to reduce penalties for a failure to deliver and this will
> launch the curve through 0%.
>
> Secondly, i think Japan is the precursor. We are in an unprecedented
> situation. We are moving from a situation where credit was the oxygen
> and now there isn't any. This is not a small thing. Its a tectonic
> shift. We are in a process of asphyxiation. The FED will certainly
> loosen the taps but unless Bernanke is set to put his Helicopter
> thesis into action, I think the bias [many of us are too young to
> recall a bear market depression] is towards an elongated L and not
> a V. We live in an instant gratification world but this time its
> going to take a lot to resuscitate the patient.
>
> finally, i think you entirely underestimate, the ability of bernanke
> et al to discipline the curve and keep it bid buy deploying outsize
> buying at various points in the curve, as and when desired. We have
> a Bernanke PUT on the bond market as oppose to the Greenspan PUT
> on the equity markets.
>
> I reckon the 30 year will trade a 2% yield and I am selling PUTS
> [and have been doing for some time].
>
> Look at japan post bubble.
>
> The world has changed.
>
> Aly-Khan satchu
> rich.co.ke
>
> happy Christmas.
>
> If you have the inclination, you might go here
> www.rich.co.ke/rctools...
>
> and play with the calendar to see comments from the beginning of
> the year.

2008 Dec 24 12:55 PM

[GloomBoom.com:]

Whoever owns the long bond is going to get screwed. It makes no sense to invest in them now. But where to put all that money?

2008 Dec 24 11:27 PM

[There_vdp:]

TBT


On Dec 23 04:18 PM Chris B wrote:

> Does anyone know of an ETF that is shorting long-duration treasuries?
> Seems like a no-brainer to me, they can't get much more expensive
> than they are now or we're talking negative yield.
>

2008 Dec 25 11:32 PM