Rising Treasury Yields Could Mean It's Time to Short Them 29 comments
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Could it be the early glimmerings of a policy bind? It seems the more the stock market rallies and the economy quickens, the more yields on government bonds climb. Of note, the 30-year U.S. government bond jumped to 4.3% last week. And despite the Federal Reserve allocating $300 billion to buy up the 10-Year Treasury note and hold its yield down, it rose to 3.3% last week (up from 2.2% in November).
That’s not especially good news. Yields on long-term Treasuries affect a wide range of interest rates in the economy, from mortgages to auto loans. When they go up, so does the cost of buying a house or car – not exactly the right medicine for getting out of recession.
But the more the economy picks up, the more the flight to safety unwinds and inflation fears revive. Let’s hope that the economic turnaround doesn’t ramp up too quickly and intensify selling of government bonds on these two fronts.
For the rise could potentially get out of hand considering other upward pressures on yields. One is the tsunami of new government bonds being issued as a result of the U.S. government’s massive spending plans on guns, butter, bailouts, and gargantuan stimulus packages. These plans are epic: they are projected to raise the 2009 fiscal deficit to a 60 year high of 12.5% of GDP.
Yet another source of upward pressure may be the huge domestic stimulus program in China. It’s even more massive than the one in the U.S. and seems likely to lessen the importance of exporting to the U.S. as a means of promoting industrialization in China. That could lower China’s need to hold its exchange rate down against the U.S. dollar, and, in turn, its buying of U.S. dollars and parking them in U.S. government bonds.
If U.S. government bond yields do get too far out in front, they risk choking off the recovery. If this eventuality becomes apparent while the economy is still trying to find its feet, the Fed would likely print even more money and buy up Treasuries in greater quantities to keep yields low. So there could still be an upswing in the economy but it probably will be more violent and short-lived since inflation is likely to begin galloping sooner and compel the Fed to take liquidity out of the system.
So the aftershocks of the financial earthquake of 2008 may be felt for years to come in the form of more extreme fluctuations in economic activity. Maybe it’s back to the 1970s?
Conducting monetary policy will certainly be a challenge to say the least. It would appear we are threading the needle on this one. As I said before, it reminds me of a scene in the computer-animated movie, Polar Express, my 6-year-old used to watch. In it, a train full of children runs off the tracks onto a frozen lake. With the ice breaking up behind it, the engineer guns the swerving locomotive toward the railway tracks on the other side and, just as the water is about to engulf the passenger cars, hits the rails square on and speeds to safety across the Arctic tundra.
Hopefully central bankers of the world will be able to pull off a similar feat. In any event, holding government bond yields down by printing money does not seem to be a sustainable policy. As mentioned previously, it may be a good time to start, or add to, a short position on government bonds – especially if the Fed does step up its monetarizing of Treasuries and succeeds in pushing rates back down for a time.
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This article has 29 comments:
Allow me to bottomline it again for anyone that prefers clarity:
1. Long term interest rates are rising and will continue to trend up whether or not the economy recovers any time soon.
2. Inflation/USD devaluation is increasing and will continue to increase whether or not the economy recovers any time soon.
The government will lack both the political will and the monetary tools to put the inflation genie back into its bottle when the time for decisive action is at hand (10-year above 4% IMNHO).
The question is whether we can and will deploy our personal assets to take advantage of the opportunities, and to hedge the risks, associated with this senario or with the opposite one if that appeals.
When you short a bond you pay the difference in the yield curve. Today that is very steep. Approximately 3% per annum. Given the leverage of 10 - 20 times that the bond contracts provide you end up with a very big negative carry. I hate negative carry trades.
Shorting bonds is a pro traders game.
The street is shorting the bonds in front of the auctions and then covering their shorts with the Treasury new issues. That is is a money machine. However if you do not have the "flow" it is a tough game to play.
Caveat Emptor.
The other real trick will be to prevent widening spreads when no one wants to be a debt holder after the government crams down GM and Chrysler senior obligations.
It's been bad enough to be an equity holder; now this.
total return of about 9.7%, which, in technical terms, fails to suck.
And there have been *plenty* of pundits crying "bubble in treasuries," so anyone who wasn't doing a rip-van-winkle should not be surprised.
So now, we look back at this progression:
5/08 4.71%
6/08 4.52
7/08 4.57
8/08 4.42
9/08 4.31
o/08 4.37
n/08 3.43
d/08 2.67 (ok, are we reeeediculous yet?)
1/09 3.60
2/09 3.70
3/09 3.53
4/09 4.03
now 4.20
Does today's level seem THAT shocking? Hold on to your hats, folks....
BTW, don't go shorting bonds, unless your brother's a repo trader. Maybe explore buying puts on an ETF.
--rq
QUESTION: IT seems to me that the retail investor cannot truly short treasuries. The retail investor can buy certain ETFs which are known as "Treasury Short" ETFs, but these are not true shorts, these are merely futures.
I guess it is the institutions/market makers who are doing the shorting. MY suspicion is they are doing it thru Treasury Delivery Failures. AM I correct??
Is there anyway the average investor can truly short treasuries??
I love how some people on here think that the recession can get worse AND we'll see inflation at the same time. You can't have it both ways. You can have stagflation (ie, stagnant economy and inflation) but if people aren't buying, then prices aren't going up. Increasing the amount of money in the money supply doesn't just magically make prices go up - people have to use that money to buy stuff and create shortages.
On May 12 02:06 PM Sasha B wrote:
> yield is rising ... why short? let's buy them long
On May 12 02:06 PM Sasha B wrote:
> yield is rising ... why short? let's buy them long
I opened an account at Lind Waldock sold the July futures short and made a bundle- not that hard guys.
On May 12 10:09 AM Cetin Hakimoglu wrote:
> This is a good sign though...don't short into shtrength
>
> ----------------------...
> Could it be the early glimmerings of a policy bind? It seems the
> more the stock market rallies and the economy quickens, the more
> yields on government bonds climb. Of note, the 30-year U.S. government
> bond jumped to 4.3% last week. And despite the Federal Reserve allocating
> $300 billion to buy up the 10-Year Treasury note and hold its yield
> down, it rose to 3.3% last week (up from 2.2% in November).
The new 'fails' rule involving Treasuries will cause the bid to go down.
I thought bernake would keep it under 3%. my guess is that he feels a correction will bring it under that again. he can't let dollar fall too fast because chinese will through them away.
I was thinking about whether they could introduce a rule on shorting similar to the one they introduced on bank stocks. Not sure how they would do it, as it would cause the swaps market to implode, so I suspect they will find other ways to keep yields under control. One thing I do know, if the Treasury market goes down, we're all going with it.
On May 12 10:04 AM reluctantQuant wrote:
> If you were long 10yrs starting 5/12/2008, you've pulled a
> total return of about 9.7%, which, in technical terms, fails to suck.
>
>
> And there have been *plenty* of pundits crying "bubble in treasuries,"
> so anyone who wasn't doing a rip-van-winkle should not be surprised.
>
>
> So now, we look back at this progression:
> 5/08 4.71%
> 6/08 4.52
> 7/08 4.57
> 8/08 4.42
> 9/08 4.31
> o/08 4.37
> n/08 3.43
> d/08 2.67 (ok, are we reeeediculous yet?)
> 1/09 3.60
> 2/09 3.70
> 3/09 3.53
> 4/09 4.03
> now 4.20
>
> Does today's level seem THAT shocking? Hold on to your hats, folks....
>
>
> BTW, don't go shorting bonds, unless your brother's a repo trader.
> Maybe explore buying puts on an ETF.
>
> --rq
On May 12 04:11 PM nobby73 wrote:
>Onething I do know, if the Treasury market goes down, we're all
> going with it.
If the dollar is worth less, then it will buy less. Therefore it will take more dollars to buy the same item - that's inflation and it's gonna be just like Jimmy Carter inflation in the early 80's.
On May 12 10:35 AM thiazole wrote:
> reluctantQuant, look at the lifetime chart of 10 year treasury notes
> (^TNX on yahoo finance). The rates ARE historically very low. I wouldn't
> hesitate to buy a short treasury fund right now (and own a fair amount
> right now). Yeah, you missed the bottom, but that isn't a good reason
> to just sit on the sideline.
>
> I love how some people on here think that the recession can get worse
> AND we'll see inflation at the same time. You can't have it both
> ways. You can have stagflation (ie, stagnant economy and inflation)
> but if people aren't buying, then prices aren't going up. Increasing
> the amount of money in the money supply doesn't just magically make
> prices go up - people have to use that money to buy stuff and create
> shortages.
The economy is recovering by the Fed is short for, "Uh oh, i can't keep the target interest rate low anymore. I better make a good excuse fast as to why I'm going to raise interest rates in a down economy, even though in fact I am not raising them. They are raising themselves."
Right now inflation seems inevitable as the dollar becomes worth less. If we wake up tomorrow and the dow has crashed 2500 points we will still be printing dollars to pay the stimulas costs so the dollar keeps getting worth less and then we get stagflation.
On May 12 03:26 PM Sasha B wrote:
> so you are saying that if yield is rising today it will continue
> rising in the future? I thought deflation was a real possibility.
> If deflation happens then yields should go down, but it will not
> matter to me because I bought at higher yield and lower price.
On May 12 10:51 PM thiazole wrote:
> Printing more money doesn't cause inflation - spending the money
> causes inflation. The money supply is vastly larger now than it
> was in the summer of 2008, but gas prices are cheaper right now then
> they were then. Gas and oil didn't automatically go up in price
> just because the money supply expanded. Until people start spending
> that money, nothing will go up in price.
The economy has sunk 6% annualized 2 quarters in a row. we will see some stabilization and some uptick in growth BUT: when the going was good every dollar added in debt created ever less of additional pennies in gdp. now it will barely succeed in halting the decline. business cut spending, fire people, cut capacities, renegotiate contracts with suppliers. that happens across the entire food chain and is a self re-inforcing spiral. we had a 'jobless recovery' from the late 1990s till 2007, meaning few jobs added even though the economy grew handsomely. Now, with the biggest driver of gorwth, the consumer, being dead and busy with balance sheet repair for years to come and local govts forced to fire people and cut spending, I find it hard to see where growth and especially jobs will come from. growth will not be a factor to push treasury yields higher, don't worry. we will see very sluggish 'growth' for a very long time.
next inflation: the bursting credit bubble, the almost-collapse of the banking system and the subsequent global deleveraging have killed tens of trillions in asset value. capacity utilization is low and unemployment rising fast. there is no near-term (2-3 years) catalyst for inflation. nowhere. even rising oil would not be inflationary because cosnumers would be forced to cut down elsewhere when gasoline rises again.
supply/govt debt: that is a real issue and i fully expect that we will see fresh announcements every quarter by the FED to by a couple hundred billion of treasuries and mortgage bonds. before this is all over it will likely be 1-2 trillion that they have to buy - not the paltry 100bn they did so far. one of the reasons is the shrinking trade deficit which means fewer dollars end up abroad that will be recycled into the treasury market. still, for the time being, the fed will buy whatever amount necessary to keep 10 year yields below a certain level (my best guess is below 3.5%)
to sum up, I am pretty sure we will 10 year yields getting first into the low 2% again before they climb above 4%. As the consensus trade right now is to short or to shun long dated treasuries they start to look compelling, especially when one assumes (as I do) that there will be a floor (a fed-put, so to speak) anywhere between 3.5-4%. Of course, with stocks you can make 10% in a week right now, the question is just, for how much longer and at one point it copuld easily be a 30% loss instead of a 10% gain.. Imho the equity market's optimism regarding economic recovery is crazy at this point. I will continue to scale out of equities into any new rally attempt and start to put the money into 10year treasuries where it will sit safely while I wait for the real opportunities in equities to present themselves over the next 12-18 months
Now, I'm not saying your logic is flawed. Based on your limited premise, your logic is fine. What is missing is your premise. "If the US prints money, the value of the dollar will fall". That premise is too limited in scope to address what we are seeing. A better premise is "If the US prints more money relative to its GDP than the rest of the world, then the value of the dollar will fall". Guess what, the whole world has dramatically expanded its money supply, so the dollar has actually strengthened relative to other currencies. So again, until people start spending the money, prices won't go up. If you still don't believe that, then look at Japan. Japan has had huge trade surpluses for a very long time AND they have had interest rates near 0% (ie, aggressive monetary policy) for a very long time so their per capita money supply dwarfs ours, yet they have been struggling with deflation for two decades. Why? Because they are a nation of people who refuses to SPEND. If they don't spend, they won't have shortages and prices will remain deflationary.
On May 13 12:11 AM doubleguns wrote:
> Printing more money dilutes the value of the dollar. now it takes
> 2 dollars to buy from china what one dollar bought yesterday. (inflation
> through debasement of dollar) add in rising unemployment, failing
> economy, and you can get stagflation where no one is buying much
> but prices are going up.
Let's consider oil prices - if there is a recession, people drive less and this creates inventories of oil to rise. It is relatively cheap to produce oil, so prices drop until they are low enough that consumption picks up again.
So what would make oil prices go up? Either the cost of producing oil increases or consumption picks up causing shortages. Many things can cause this costs of producing to increase, but as far as economics go, the only thing is labor costs. Of course, if you are in a recession, labor is hardly in a position to demand higher salaries, so that isn't going to happen. So the only thing left is if consumption picks up, ie SPENDING. It is that simple. It doesn't need to be complicated by dollars in circulation or anything like that. Increasing money supply does nothing unless people use that money to buy stuff.
If you were a business and had too much inventory (ie recession), WHY ON EARTH WOULD YOU RAISE PRICES??? Because the federal government is printing money? Does anyone honestly believe that there are businesses out there that have excess inventories but are raising prices just because the federal government is printing money??? That would be the fast track for going out of business, and guess what happens then? Your inventory gets liquidated and sold even CHEAPER than you would have sold it before the hairbrained idea of raising prices, and therefore the idea of "raising prices in a recession" actually contributes to deflation instead of inflation (just look at the housing market - people who refuse to sell at market get foreclosed and end up selling below market).