Shorting The Bond Bubble? Hold On

The bubble economy has spawned another bubble. This time it’s government bonds. The flight to safety during 2008 has pushed yields to lows never seen before in Federal Reserve records (compiled since 1962). For example, the yield on the one-month bill stands near 0.04%, two-year note near 0.75%, and ten-year note near 2.21%.

Yet, the federal government has taken on spending commitments that entail gargantuan budget deficits for some time and a tsunami in bond issuance. Current spending commitments include trillions of dollars for existing commitments such as Social Security, Medicare, etc. and the Iraq war — as well as trillions more for bailing out the financial system, propping up ailing industrial sectors, and massive fiscal stimulus package promised by the Obama administration.

At the same time, the Federal Reserve is creating credit at rates never seen before. As Northern Trust economist Paul Kasriel noted, the year-over-year increase (to November of 2008) in bank reserves is about ten times the previous high, which occurred in 1934. Deflationary forces are ascendant right now but one wonders for how much longer given the massive stimulus unleashed.

Shorting government bonds would thus appear to be a no brainer as risk appetite responds to signs of an upturn in economic growth and inflation worries arise anew. But what might not be so obvious is the timing of the trade.

Lags in the impact of stimulus measures could mean deflationary news will linger for awhile yet. More importantly, the Federal Reserve has stated it is committed to buying Treasuries to keep interest rates low until the crisis and economy stabilizes. China too will likely be a buyer of U.S. Treasuries as part of its strategy of suppressing the yuan to enhance the competitiveness of its exports.

So watching from the sidelines may be the strategy for now. Ways to short the bond bubble include going long on the ProShares Ultra-Short 20+ Treasury (TBT) and ProShares Ultra-Short 7-10 Year Treasury Fund (PST) ETFs (but understand the constant leverage trap first) and short selling the iShares Lehman 20+ Year Treasure Bond ETF (TLT).

Comments

[AustinESW:]

What about shorting EDV?

Jan 04 10:56 AM

[Ray Winter:]

Governments have no compunction but to lie in order to achieve their own ends. So why anybody would buy Government bonds with such a low interest coupon and with such a mssive exposure to hyper-inflation eating into the value of the investment is beyond me.

Far better to follow Mr. Buffet's advice and invest in good quality, dividend paying, undervalued stocks. At least the investor has an opportunity to maintain the currency's value.

Jan 04 12:42 PM

[LA:]

Larry made a good point. We are in a largely government-manipulated market. The government itself is on one hand issuing new debt to attract the liquidity it needs to finance the various packages, and on the other is buying back its own debt to keep interest rates artificially low. It's like borrowing cash with a credit card to deal with its monthly minimum payment. In my opinion it is not a question of if the bubble will pop, but - Larry says - when.
As per AustinESW's comment about EDV, be wary of that EFT's very short history (it was launched only 1 year ago) and very poor liquidity.

Jan 04 01:12 PM

[Rob Viglione:]

Futures options present another good short vehicle. I recently loaded up on 30-Year Treasury futures put options.

This article makes a great point in that government manipulation of the market may delay the day of reckoning, but timing this sort of thing is difficult.

Jan 04 02:18 PM

[TBill:]

Treasury issues debt, Fed buys it. Net, same as the government printing money and spending it. I think there is enough history of governments doing that around the world to know what happens next.

Jan 04 02:39 PM

[flow5:]

Excess reserves during the Great Depression were real. Now additions to excess reserves act as open market sales. Your not comparing the same thing. And that seems real stupid.

As to government borrowing, the massive demand for loan funds by the Federal Government will effectively abort any recovery. I.e., the government will then be competing with the private sector.

Jan 04 03:30 PM

[flow5:]

Monetary lags are always exactly the same length. Paul Krasiel doesn't know that.

Jan 04 03:32 PM

[Kunst:]

Right. But the increased money supply should push up inflation, and that in turn will tend to push rates up. I don't think the Fed can buy enough treasuries to really control interest rates. There is the danger that our big foreign creditors will increase their diversification out of the dollar into gold, other currencies, and commodities (it's a great time to stockpile oil), which would lower demand for treasuries and push rates upward. Ultimately, I think we will see a significant (say 50%) devaluation of the dollar, which would also address the trade deficit that is one root of the overall problem.


On Jan 04 02:39 PM TBill wrote:

> Treasury issues debt, Fed buys it. Net, same as the government printing
> money and spending it. I think there is enough history of governments
> doing that around the world to know what happens next.

Jan 04 04:00 PM

[Alex Filonov:]

Inflation is what we need right now, but I'm not sure that's what we get. Yes, current zero rate, huge stimulus environment might create inflation. Actually, it's a goal of both. The problem is, we are in deflation now. If you think that inflation is impossible with fiat money, look at Japan. And if we get one year of deflation, it's Great Depression 2.0.

I hope for inflation. But I never trade on hope. I'm long TBT now, my thesis is that part of December Treasury bubble was window dressing. Planning to sell position this month.

Jan 04 05:13 PM

[Augustus:]

Short both TLT and TBT.

Jan 04 08:05 PM

[vaughn:]

The government's solution to solve current financial and economic crisis is creating more debt, both a coming circa $1 trillion fiscal and a done circa $2 trillion so far Fed Reserve alphabetical facility program.

Japan tried that, but did not succeed. Some pundits argue that Japan did it late or not did it large enough. This time it will be different here in the USA. Well, that might be the case given that Japan did not need foreign finance given its high saving rate while the USA heavily depends on foreigh investments with pitiful savings rate.

If using more debt can cure the problem created by debt, then it seems we don't need ecomomists, politicians, etc., Obama's $1 trillion stimulus package must fail, by defition, because it is financed by debt.

The current economic crisis can only be solved through painful recession or even depression. There is no other way out, just like when nature calls one has to go, eventually. All debts must be repaid with interest or an outright default.

Jan 04 08:56 PM

[jepittman:]

Although I am long a very small tbt position (at a rather painful loss) I think the author's advice of waiting a while may be good advice. The Fed is likely to be a buyer of treasuries soon because a stiff correction may negatively impact mortgage rates. This debt monetization will support treasury prices until the economic recovery arrives and the Fed ceases or substantially slows its purchases.

I believe a better bet than shorting treasuries is buying the S&P 500 double ETF, symbol SSO. Treasuries and stocks have been inversely correlated recently and a falling treasury market should result in a rising stock market as money seeks higher returns.

Jan 04 10:03 PM

[Naive:]

Shorting Lehman 20+ Year Treasure Bond ETF (TLT) is very costly. It pays a monthly dividend (over 4% at the moment) that you will be responsible for as a borrower.

Jan 05 08:33 AM

[Timmothy Posey:]

Just short using TBT, or futures put options.


On Jan 05 08:33 AM Naive wrote:

> Shorting Lehman 20+ Year Treasure Bond ETF (TLT) is very costly.
> It pays a monthly dividend (over 4% at the moment) that you will
> be responsible for as a borrower.

Jan 05 02:51 PM

[jt:]

Why do people insist on saying we're in a deflationary mode??? Go look up the definition. Inflation and deflation have to do with MONETARY POLICIES regarding the increasing or decreasing of money supply above or below the growth (to paraphrase) of the country's economy. Yes, we have gone thru a time of "deleveraging"...ie, selling off just about any and all assets /equities for whatever to get cash, and we are in the middle of a credit crunch b/c those who spawned this mess bet 30:1 against the house (reality) and lost and are holding that money for now to perhaps pay off the thugs that they're afraid will come and break their kneecaps (like they did to Lehman Bros and BearSterns). But the money supply is being increased at rates beyond all historical bounds...and the money isn't being burned...it's still out there. Increasing prices is just a common symptom of inflation, but it is NOT there when there is a credit contraction at the same time.

It's like filling up a dammed up lake that sits high above a large city (the US...maybe "the world"...at least the Western World...but some parts of the Eastern World and maybe all of it are also in the flood plain) that depends on the liquid(ity) contained behind the dam wall staying there. Normally the water is held at about 100' depth...but b/c of heavy rains (more like b/c of the heavy-handed reign of the banksters and their fraudulent, criminal, Ponzi schemes), the water level is now at 200' with no end in sight. Somewhere above 250' flooding will begin...and any persistence at that level will start to break down the dam wall itself, and all that supposedly "black-holed" electronic funny money that noone thot they'd see again will come rushing right down MainStreet....

Jim Willie just put out a very good article about all this that can be read at this link (put the pieces together as this site tends to chew of full links:

news. goldseek. com/GoldenJackass/ 1230912000.php

Jan 06 01:01 AM

[Naive:]

To: Jt
Money supply includes many "layers" of debt. This debt has begun shrinking (alot of it disappearing permanently) due to major defaulting and shrinking asset values (including capital markets). In fact Capital markets are supposed to be accessible to businesses to access capital by using their stock as currency. This is now impossible. This has created a massive vacum in the "money supply" that is unable to be replaced fast enough!!
This is why the economy will continue to regress even as the global participants continue to inject seemingly unlimitted amounts into the
system. Additionally, a very very disturbing phenomenon is begining to happen. Govt's are getting the money by borrowing from future generations of the world. Do they have a choice?
It will be a while for this to straighten out. Two scenarios: 1) Grow slowly with reasonable and cautious leverging (increasing the money supply) the right way, this will be painful and very very very slow with potentially violent consequences globally, or 2) Recover in shorter term (stay alive) by opening the flood gates to lending again(faster replacement of money supply) and pay for it later when we are stronger and wiser???
Who Knows?

Jan 06 06:24 PM

[MGA_1:]

Inflation / Deflation ??

Anybody have an accurate to predict this or even define what it means? The best I've found for tracking inflation/deflation is correspodence to the price of gold which means we had deflation in the second half of '08 - inflation from about '01 to '08. I don't exactly trust the government CPI numbers.

Jan 13 02:49 PM