In Barron's cover story this weekend, author Andrew Bary says the bubble in U.S. Treasury bonds and notes has burst. Treasury yields are up more than 1.2 percentage points since the end of 2008, driving prices lower by 20%. Bary says yields, now 4.1%, could hit 5% by year-end.
To its credit, Barron's called a top in Treasurys at year-end, and it wasn't alone. In his annual letter to shareholders, Warren Buffett said that when the financial history of this era is written, the Treasury-bond bubble of late 2008 may be regarded as "equally extraordinary" to the dot-com bubble of the late 90s and the housing bubble earlier this decade.
Even with prices down 20%, Bary says Treasurys still look unappealing:
- Yields are low by historical standards - as this chart demonstrates, the recent pullback has only brought yields back in line with 2003, which was itself a multi-decade low.
- The government is issuing huge amounts of debt to fund record budget deficits - the Obama administration recently boosted its deficit projection for 2009 to $1.84T from $1.75T, and 2010 to $1.26T $1.17T; compared with a $458B gap last year. Total sales of government securities could hit $2.1T this year from $880B in 2008, and net sales could almost quintuple to $1.55T from $332B. A recent 30-year bond sale was poorly received. And global government issuance is way up, further inflating supply. The Fed is sopping up some of the deluge by buying back its own debt, but the program will end eventually, and if rates rise the Fed could be hit with losses of $140B or more.
- The massive federal stimulus program ultimately may lead to much higher inflation - analysts believe inflation will remain contained in the short-term, but as health returns to the economy and inflation hits a conservative 2%, yields could go to 5.5% as investors seek an inflation-adjusted return of 3.5%.
But while the bear market in government Treasurys may continue, Bary says the bull market in corporate debt that started in March could go on. Junk bonds still look attractive at 15%, down from highs of 19.5%. High-grade corporates at 8%, a comfortable 4% above Treasurys, also look good. Muni bonds aren't as cheap as they were at the end of 2008, but they still offer reasonable returns of 4.5% to 5%. And if President Obama succeeds in lifting the top marginal income-tax rate to 39.6% from the current 35%, tax-exempt munis would benefit.
One way to short Treasurys is using ProShares UltraShort Lehman 20+ Year Treasury ETF (TBT), which should rise at twice the daily decline in the prices of long-term Treasurys. Treasury inflation-protected securities, or TIPS, which yield 1.62% (on the 10-year), and can be accessed through iShares Lehman TIPS Bond Fund (TIP), aren't the bargain they were at year-end, but they do offer protection from inflation.
Here's some more commentary you may find useful:
- In an article today, Jeff Nielson contends muni yields will drop as the government steps in to help out municipalities and states teetering on bankruptcy by pressuring ratings agencies to bolster their scores.
- Tom Lydon's comprehensive summary of fixed-income ETFs this weekend is a good starting-point for investors looking to go long, or short.
- For those looking for a deeper understanding of the bond market and its day-to-day movements, John Jansen's highly-followed bi-daily summaries can't be beat.