Waiting for the U.S. Treasury Bubble to Burst

What will dominate when the US Treasury bubble bursts?

The good news:

…When the Treasury bubble does pop, it will likely be a sign that the economy is turning around and that credit is more available again, experts said. People will sell off their Treasury holdings because they think that stocks and corporate bonds will offer better returns….

The Bad News:

... investors could lose money even on super-safe Treasuries. A swift increase in yields would send prices plummeting. For every 1 percentage point increase in yield on a 10-year note, investors would see a corresponding 7 percentage point drop in value…This would leave investors in a tough bind - either hold onto a note with yields that could be far lower than the market rates at the time or sell it at a steep loss.

As The Economist notes

The dilemma is just as acute for government-bond investors. The example of Japan shows that bond yields can stay low for a long time. Ten-year yields of 1-2% could well be possible. But if Japan is not the template, then those yields will look ridiculous; we are heading for a world in which fiscal deficits are exploding and governments seem to be competing to depreciate their currencies. If 2009 does see an equity-market rally, it is likely to be accompanied by a government-bond-market slump.

There are observers who feel this is not a bubble yet and that the Fed will sustain this rally. Bubbles don’t happen when many call it so - the sign would be when a number of new treasury funds are floated.

As the rescue progresses the cost of government borrowing will increase (everyone agrees that such huge amounts cannot be borrowed overnight) and that it may crowd out other borrowers is a real risk. It will also increase the interest cost for businesses which might also find liquidity tight once again. If the government limits the cost of borrowing, then it puts a lid on how much stimulus and other packages can do.

Monitor how this tradeoff progresses.

Disclosure: No positions.

Comments

[morph366:]

If bond prices plummet as suggested when the recovery appears should we expect to see a suspension of the mark to market method of accounting for Treasury holdings?
Also as a point of information can any one throw light on my lack of knowledge on this but - Does the Fed have to mark its own holdings of Treasuries to the market on a daily basis?

Jan 11 06:33 AM

[Dave Wrixon:]

The irony is that those that scrambled into T Bonds for safety are going to get badly burnt. Not only are they going to get clobbered as the yields increase as they must, but also because they are going to be trapped in currency that is rapidly depreciating. Of course this is all going to add up to another colossal destruction of wealth. But never mind Obama is giving everyone 1000 Bucks in credit to tide them over. Actually, it is a lot more than that because to balance the books taxes should theoretically be rising, and it is all going to have to be paid back with interest.

But what else can he do? And even he realizes that measures are going to be needed to stop that infusion bleeding out into the wider global system. I personally think exchange controls can only be just around the corner.

Jan 11 09:12 AM

[S M J:]

"Bubbles don’t happen when many call it so - the sign would be when a number of new treasury funds are floated". Really ? What about self fulfilling prophecies in economics ? It is generally accepted by all economists that when a growing number of people believe in an event, it becomes very likely because everyone contributes to it by acting accordingly. Just a thought !

Jan 11 11:56 AM

[TBill:]

As long as the Fed wants interest rates near zero, treasury investors need not worry... no matter how much paper is brought to market, the Fed will support it.
BUT, eventually the economy recovers, and so do interest rates. I also expect a big bout of inflation at that time. That's the time holding a long term bond paying less than 3% is going to look silly.

Jan 11 01:37 PM

[FreddieBoy:]

US Debt outstanding did NOT go up in the month of December (refer to US treas web site- "Debt to the Penny")
The Federal Reserve is in this market and buying Treasuries to keep rates down. Monetary base has DOUBLED in the last 12 months. They can do this a long time as long as we are in a Recession al-la Japan. Whenever consumer demand does pick up ( 5 years ?) there will be the devil to pay and rates will go UP. But not yet. I wouldn't buy'em but don't bet the ranch that it is a bubble that will pop anytime soon.

Jan 11 04:56 PM