A Lose-Lose Situation for Long-Term U.S. Treasuries

In March, I wrote about the win-win situation for commodities. In the article, I argued that commodities were going to rise whether the economy turns up or down. This time, I am writing about an opposite asset class – long-term U.S. Treasuries. No matter what the economy does, I believe that long-term Treasuries are in a lose-lose situation.

As the latest Barron’s points out, the 30-year Treasury has fallen 20% year-to-date. Despite this sharp fall, however, the long-dated Treasury is still yielding 4.1%, or about 50% below its average yield between 1977 and the present. Therefore, if the economy shows the slightest sign of recovery, long-term yields are almost guaranteed to rise from the recent lows toward more normal levels. When yields rise, Treasuries fall! No rocket science there!

But then again, with so many structural problems in the world’s economy, who really believes that the economy will heal any time soon? So suppose we stay in this trough for a while longer, and suppose the Keynesians continue to rule the world, a likely scenario, the government will spend, spend, and spend even more to get things going again. With dwindling tax revenues, the government will then have to issue more Treasuries to finance new spending. The liability side of the government’s balance sheet will then bloat; and debt ratios will deteriorate. Naturally credit ratings, and hence prices, of U.S. Treasuries will plummet!

Is that how it will end? Not necessarily. There is an alternative, but similarly tragic, ending. The Fed may emerge to make a desperate rescue attempt. But we already know this rescue will be in vain, because we have already seen this movie before. Back in March, the Fed announced that it was going to buy $300 billion worth of long-dated Treasuries. Treasuries jumped for a day or two after the announcement, but then they have resumed falling since. And even if the Fed succeeds at propping up Treasuries, it will only be because Gutenberg had invented the printing press. And if Gutenberg had not invented this magical contraption, Bernanke would have. In the end, Treasuries will be repaid, but with paper that, may not exactly be worthless, but will definitely be worth less. Treasuries buyers, choose your poison!

Disclosure: No positions in TBT, PST, TLT, TLH.

Comments

[popey:]

Those deflationists who try to compare Japan with the USA are wrong in my view. Japan is a capital flow creditor and the US is the world's largest alcoholic (debtor). The systemic structural weakness of the USA is profound. That is why you are completely right. Sure, there will be some rallies in Treasuries over the next 2 years, but they will pale into insignificance when the treasury bear market crushes the govt debt junkies and finishes the obscene debt binge that we have all witnessed over this decade.

May 18 07:47 PM

[Stephen Yu:]

I agree with your analysis. When a creditor country such as Japan runs into economic trouble, the result is deflation. But for a debtor country, the result is inflation. This era is comparable to the 30's. The U.S. was a credit nation during the Great Depression, and there was deflation. But during the same time, post-WWII Weimar Germany was a debtor nation, and it had hyperinflation. I don't know if we'll see hyperinflation here soon, but I do not think we will experience pervasive deflation in the near future.


On May 18 07:47 PM popey wrote:

> Those deflationists who try to compare Japan with the USA are wrong
> in my view. Japan is a capital flow creditor and the US is the world's
> largest alcoholic (debtor). The systemic structural weakness of the
> USA is profound. That is why you are completely right. Sure, there
> will be some rallies in Treasuries over the next 2 years, but they
> will pale into insignificance when the treasury bear market crushes
> the govt debt junkies and finishes the obscene debt binge that we
> have all witnessed over this decade.

May 19 01:49 AM

[User 55145:]

Advice, please:

I have 20% of my net worth in series "EE" & "I-Bond" U.S Trsys. I have held them, tax deferred, for several

years. The EEs' yield varies with the current market; the I-Bonds have been held > 5 yrs.

I'm 60 yrs old and was planning on keeping these bonds for retirement. Should I sell, and take the tax-hit?

Thanks!

May 19 08:40 AM

[Stephen Yu:]

Hi, everyone's needs are different. Since I do not have a good picture of your financial situation, I will do my best to provide some general advice, but please take it with discretion because it may not be appropriate in your situation.

Series I bonds are inflation-protection to some extent so they are not as vulnerable as regular Treasuries, which provide no inflation protection. Also, based on current prices, Series I bonds prices are attractive relative to other Treasuries. So I would recommend holding them.

Series EE bonds are tied to 5-year Treasuries. The Treasuries that I have a serious problem with are the long-dated ones, such as those with 20-year or longer maturity. So the shorter dated 5-years Treasuries are not so vulnerable. However, if I were looking for a bond investment for a 5-year time horizon, I would consider either the PIMCO Total Return Bond Fund or the Loomis Sayles Bond Fund (LSBRX). Both funds are run by fantastic managers. The PIMCO fund is more steady, but it may lose out to inflation over the time frame. The Loomis fund takes on more credit risks, but it should be reward with higher return, which helps hedge against inflation.

I hope this helps, and remember, my advice may not be appropriate for your situation. Good luck.


On May 19 08:40 AM User 55145 wrote:

> Advice, please:
>
> I have 20% of my net worth in series "EE" & "I-Bond" U.S Trsys.
> I have held them, tax deferred, for several
>
> years. The EEs' yield varies with the current market; the I-Bonds
> have been held > 5 yrs.
>
> I'm 60 yrs old and was planning on keeping these bonds for retirement.
> Should I sell, and take the tax-hit?
>
> Thanks!

May 19 02:00 PM