The Treasury market is posting mixed results today in very quiet trading. Traders focused on comments from St. Louis Fed President Bullard, which the headline writer suggested that the FOMC would not tighten until 2012. That is an open question and is subject to varying interpretation.
In my opinion the Treasury curve will undergo a series of bullish flattenings. I would take the substance of the Bernanke address of earlier this week as the foundation for a belief that the funds rate will stay at or near zero through next year.
That belief will force investors out the yield curve in search of performance.
Here is an example or examples of why I believe that happens. At the current time the Treasury 3 1/2s 12/15/2009 are offered at a yield on Negative 24 basis points. The bid side I understand is a little above zero. As far out the short curve as the 2s of February 2010 which are offered at NEGATIVE 2 basis points, there is no yield.
In the T-bill market the December 17 bill will trade at about 3 basis points. (A bit of inside baseball here: Bills are far more liquid than the nearby short coupons so they trade cheaper.) Bills all the way out to August 26 2010 trade no better than 20 basis points.
In my opinion that pricing structure will force buyers to move out the curve as the mountain of cash seeks better returns. I think that the 2 year note will eventually trade around 60 basis points as folks for whom the 2 year note is a long duration instrument seek better returns.
For that reason I would not short the 2 year note.