Bubbly Treasuries Will Disappoint

Treasuries have reached bubbly levels, both in terms of low yield and the rate of change of price.

Interest rates will rise when the economy recovers, or when bond buyers demand more long-term interest to absorb trillions of new issues to fund recovery programs. Rising interest rates mean Treasury prices will fall.

Consider these charts plotting the interest rate on 10-year and 30-year Treasuries versus the price of 10-year and 30-year Treasuries. Price and yield are near perfect mirror images.

The 19-year history of the monthly yields shows a steady decline, followed by a precipitous drop in Q4 2008. There is little room for further decline, and reasons to believe that rates must rise. Long-term investors, for example, cannot be expected to be content to earn 2+% forever.

Long-term history of rates shows there is much more room for rates to rise than to fall. We don’t know when rates will rise or by how much.

The Ten-Year T-Bond

The 10-year average interest rate for the 10-year bond is 4.68%, while the current rate is 2.18%.

click images to enlarge

10-Yr T-Bond Yield versus 10-Yr T-Bond Price

Yields are shown as a solid black line. Prices are shown as a dashed red line. The 10-year simple moving average yield is shown as a dashed blue line. The current 10-year average yield is indicated as a green horizontal line. The price range for Treasuries when yields were in the vicinity of the 10-year average yield is bounded by a green oval.

The Thirty-Year T-Bond

The 10-year average rate for the 30-year bond is 5.27%, while the current rate is 2.55%.

30-Yr T-Bond Yield versus 30-Yr T-Bond Price

The charts visually suggest a coming significant fall in the prices of 10-year and of 30-year Treasuries in a mean reversion as general business conditions improve.

Treasury Futures

Futures charts for the 10-year and 30-year bonds tell the same story. The relative strength index (RSI) shows an overbought condition for the 30-year bond and a recently overbought condition for the 10-year bond.

10-Yr T-Bond March ‘09 Futures (with RSI study)

30-Yr T-Bond March ‘09 Futures (with RSI study)

Recommendation:

For investors who invest only “long”, closing long positions in long-dated Treasuries, or being alert to a trend reversal necessitating the closing of those positions is recommended.

For investors who also invest “short”, being alert to a trend reversal creating a shorting opportunity is recommended. The current trend is strongly upward, but could reverse dramatically if a Treasury auction brings higher rates. The decline in prices could be as sudden and precipitous as the rise, as the recent gap down in the 10-year futures contract hints.

In either case, whether holding long or short positions, we recommend using persistent trailing stops to minimize the loss potential, while letting profits run.

Investment or Trading Vehicles:

Stock investors can use exchange traded funds. Futures contracts are available to those with accounts at futures dealers. There are also Put and Call options traded on some of the Treasury ETFs through stock brokers. On the long side only, there are low cost mutual funds available.

• Treasuries from 7-10 years are held by the ETF symbol IEF
• Treasuries of 20+ years maturity are held by the ETF symbol TLT
• Treasuries from 5-10 years are held by the MF symbol VFITX
• Treasuries from 15-30 years are held by the MF symbol VUSTX.

IEF has a 3-month average daily volume of 525,000 shares, and TLT has a 3-month average daily volume 2,924,000 shares.

Both may be shorted, but the inventory for shorting TLT is limited, making that impractical to impossible, depending on the broker used.

There are two double-short Treasury ETFs that can be held long to create the economic opportunity of shorting while limiting maximum risk to no more than the invested amount (compared to direct shorting, which in theory could put more than the invested amount at risk).

• PST for Treasuries with maturities of 7-10 years
• TBT for Treasuries with maturities of 20+ years.

PST has a 3-month average daily volume of 133,000 shares, and TBT has a 3-month average daily volume of 3,258,000 shares.

Puts and Calls also have the advantage of limiting loss potential to the amount invested, but they are more volatile than the underlying security, and have an expiring time value, as do futures contracts.

Comments

[morph366:]

If you use a monthly RSI and go back 20 years yields on 10 year Treasury notes, then we are more overbought (adjusting for the inverse relationship between yield and price) than we have ever been. The current reading is around 24 and on previous occasions selling the 10 year when yields reached down to the 30 level that Wilder propsed made sense. Now we are in uncharted territory. This could either mean that Wilder's notion that 30 is a key level is wrong or that we are in uncharted territory where the old TA rules have to be suspended or that we are on the verge of a big sell off in Treasuries
Given that yields are at historically low and unprecedented levels I favor the view that we cannot call for a bubble yet and safe haven plays may persist for some time.
For more on this you may want to review this discussion.

tradewithform.blogspot.../

2008 Dec 25 08:20 AM

[silverwood:]

The safehaven play into Treasuries is demonstrating a true example of a parabolic move. Parabolic moves are unsustainable, so the observation now is a correction is not if, but when, so I agree with the above poster on the timing question. So maybe a cost averaging technique into TBT and PST is now a prudent stratergy.

2008 Dec 25 09:12 AM

[OldLimey:]

Whist I agree with the thrust of the article and the comments, is there not a possibility that the Fed can put a bid under the long end of the curve for quite an extended period if it goes ahead full bore with QE? The bubble must surely burst eventually - I just wonder whether 'eventually' is as proximate as the charts suggest that it should be.

2008 Dec 25 10:35 AM

[otbricki:]

The Fed stated "low interest rates for some time".

2008 Dec 25 11:48 AM

[PeakOiler:]

Perhaps the new year will bring the correction, as those fund managers who have window-dressed their portfolios prior to year-end, undwind the trade to take advantage of better opportunies for big make-it-all-back gains elsewhere.

2008 Dec 25 11:56 AM

[Ricard:]

If the author can comment on PST and TBT and whether or not they are viable long-term strategy vehicles, that would be much appreciated. From the research I've done, seems the options that these funds hold subject the investor to the very risk you warn against in discussing futures. The price chart for TBT seems to substantiate that the investor will take outsized losses versus limited gains (2x the long position) due to options expirations (25% of these funds speculate on 1-3 month derivative contracts).

2008 Dec 25 12:49 PM

[Alex Filonov:]

Not sure it's a bubble. I think (and wrote an article about it) that part of this is windows dressing by funds to the year end. But for most part it's a financial panic. Yes, I bought TBT to (hopefully) make money on window dressing, but I'm selling this position in January no matter what.

I can reconsider my position if I see at least some inflation in data. Current price of Treasuries is close to what was during the Great Depression, which was the last deflationary environment until now.

2008 Dec 25 01:36 PM

[Teutonic Kn...:]

From my simplistic view, I would tend to concur with Alex Filonov that buying into TBT at this moment may be premature. The onslaught of avalanche of worse and worst news is yet to come.

2008 Dec 25 01:52 PM

[Illusional ...:]

I have read a few articles and would agree on both that it is definitely overbought and that it is still early to call it the tip of the bubble. Like many said above, it will end sooner or later.

Assuming it is the last safe haven in US, I assume that it will still be the least risky among most other vehicles for some time to come. I think averaging in is not a bad idea though I think anyone who wants to start getting into PST and TBT will have to wait for quite some time before this fruit matures. IMO, any government policy change will tilt the jug sideways and the unwinding may start anytime. I think the chances of that happening is pretty significant though, so both are definitely in my KIV list.

2008 Dec 25 02:20 PM

[Errol:]

I agree with all of the other reasons that Treasuries are in a bubble but would wait for a technical sign to show that the bubble has burst mainly because I don;t think we have seen the worst news in which a "mania" type phase occurs. Although I do think that once the bubble bursts the flood gate will open, I don't want to short treasuries before a technical indication as many people lost their shirts trying to predict the top or short the tech bubble and oil bubble.

2008 Dec 25 02:27 PM

[Rokjok777:]

"Markets can stay irrational longer than you can stay solvent". That quote from Keynes keeps echoing in my head when I think about TBT...

check out the level of Treasuries from 1965 onward

2008 Dec 25 04:04 PM

[Kevin Walmsley:]

Beware when investors who didn't see the dot-com or the real estate bubbles now pretend they've spotted one in government bonds.

Consider the possibility that we're in a bona fide deflationary environment. In such a case, getting a 0% yield might be a risk-free 4%, given falling real prices across the economy. What's more, foreign investors whose currencies ARE experiencing inflation can still make money in treasuries, buying and selling at par.

Suppose you knew that next year, several hundred billion more dollars were moved out of equities, and into governments, as millions of American 401k and mutual fund buyers merely look at the trailing 12-month returns in their issue of Money magazine. As mutual fund managers, you still have to buy treasuries, irrespective of the price. That can send yields lower still. Japan coasted along for years with an effective negative yield on their paper; who's to say we won't do the same? Just because it seems an irrational trade to buy treasuries here doesn't mean you'll see an exodus into stocks anytime soon.

A lot of sophisticated investors are buying treasuries, with the unsophisticated investors soon to follow. Short govies only at your extreme peril.

2008 Dec 25 07:13 PM

[QVM Group:]

We have published a follow-up article on our blog to respond to the sense of concern that some have expressed in the comments here.

That follow-up is located at:
www.qvmgroup.com/inves...

Richard Shaw

2008 Dec 25 09:10 PM

[Moon Kil Woong:]

Rokjok777 is right. It is similar to all those sane people who didn't buy a house in 2001. It could be years until a correction occurs, in the meantime things look really bad. And as other posters commented, there is nothing to prevent central bankers from trying to spoil the show on short positions.

The argument has always been, I know treasuries are not a good deal right now but then where can I safely park all these fricken zeroes...?

Oh it's nice to have banker's quandaries. Especially when the zeroes are given to you under TARP. Maybe they should rename it PARK because the money certainly isn't moving into the greater economy.

Perhaps this is because the Fed recently helped bankers with this quandary and allowed them to park all their money with them for interest. Talk about an incentive to cause de-leveraging. And of course, the Congress said, great idea. I know your actions always help the public. Go ahead and do anything you want. Now the fed is asking if they can be allowed to issue their own debt?

If the fed can issue their own debt and issue money based on debt doesn't that make the Treasury pretty useless? Also can't they do whatever they want without federal mandate giving them complete control over the money supply and making Congress and budgets irrelevant. Does Congress even care anymore? And everyone wonders why the US economic structure is eroding. Geee...

I digress but with good reason.

2008 Dec 25 09:29 PM

[Mark Anthony:]

Time to get out of US T bonds, and get into shipping stocks and commodity producing companies:

tinyurl.com/7lg4gx

You must read this to understand that Safe Havens MUST be small and CAN NOT accomodate every one, therefore by definition US Bonds could not be a safe haven at all:

seekingalpha.com/artic...

2008 Dec 26 12:52 AM

[xingao:]

The solution financial crisis is very simple

First: The enhancement cash flows speed.The financial crisis is the blood

vessel jamming, must make a connection the blood vessel, lets the blood flow

to restores to the peace condition, thus lets the body restore to the optimum

condition.Fund many places flow to the fund deficient place, has is

fastidious, first usually has the blood place, for instance the five internal

organs six internal organs, have the sufficient blood originally, because of

the financial crisis, lacks the blood temporarily, this part is first

satisfied, then flows to usually the blood not to be many again, but needs

the blood very much the place.

Second: Forces the method through the government, delimits the commodity

price, begins using the government guided price, may the suitable use planned

economy pattern, have the limit production everyday use commodity, prevented

the commodity surges upward falls suddenly, guarantee economical ecology

chain integrity and stability.

Third: Discussed with China that, facilitates the Chinese automobile customs

duty decline.At the same time, the US three big car company's automobile must

reduce prices the sale.

Fourth: The government may build on a large scale, lets more people have the

matter to be possible to do, the government acts a contractor's role,

continues each kind of project, then distribution subcontract.

2008 Dec 26 03:48 AM

[sheridan:]

The Bond market isn't going to sell off unless Bernanke decides to change his mind on buying unlimited quantities to assist in quantitative easing.
This market has a standing bid under it and he could hold it here or higher for a long time to come- look what happened in Japan- they held 10 year under 1%.

2008 Dec 26 05:35 PM