A lot has been made of the massive move into Treasuries in recent weeks despite the fact that they are paying next to nothing. As of writing, the 10 year Treasury is yielding just 2.56%; this is down almost 40 bps from last month.
But could there be a good reason money is flowing to Treasuries and out of equities or is this just another bubble in the making that will end badly? The answer probably lies somewhere in between.
First, let's take a look at what the critics are saying. Toby Connor of the Gold Scents blog makes the point that the bond cycle could have already burst. He shows several charts reflecting a parabolic move in 30 year Treasuries outside of the channel trend that he believes could be a top in Treasuries. He also makes the case that when the government interferes in a market, you can almost always make money with impunity by taking the other side of the trade.
We believe Toby may be right that the long-term trend in bonds will be up. After all, how much lower can bond yields go? Zero is just 2.56% down for the ten year Treasury, while yield could move up to infinity. Purely from a risk/return perspective this investment makes no sense.
But maybe there is more to this trade than meets the eye. First, we learned in 2009 that fighting a strong trend is a huge mistake. As you can see from the weekly chart of the ten year Treasury ETF below, this is a strong trend. You can tell this from the fact that price is moving up in the outer band of the grey bollinger bands and has yet to correct outside this upper band. Also, on balance volume clearly shows there is a lot more buying volume than selling volume.
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Now you can make the case that RSI is overbought at 80.62, but it remained overbought for 6 months in 2007-2008 during the beginning of the final crisis. This speaks to a strong trend that was fueled by the symmetrical triangle consolidation that lasted from early 2009 through May 2010.
We believe Treasuries are just reflecting current economic conditions and warning of tougher times ahead. First, we know the government has pledged to take maturing mortgage security proceeds and use them to purchase long dated Treasuries. Like it or not (not) this will create competition for Treasuries and hold down yields.
Unemployment continues to hold steady and we believe does not adequately reflect the true number of under-employed or job seekers who have just plain given up looking for jobs. Now that the excess spending from those who chose to spend vs. pay their mortgage is starting to subside and those individuals are actually realizing foreclosure or a short sale, retail sales are reflecting how weak the consumer really is today. Where will inflation come from with global overcapacity and rising unemployment? The answer is from nowhere unless there are interruption in certain raw materials as we have seen recently in grains. So Treasuries just reflect supply and demand and a deflationary environment.
Finally, Treasuries reflect fear. The populace as a whole is fearful for their jobs, their way of life and there is great uncertainty with regard to what solutions Washington is proposing to remedy this problem. In fact, most would argue Washington is the problem. It is certainly not corporate earnings.
So bubble, maybe. However, we believe at the moment there are a number of good reasons to be in Treasuries and they are just reflecting where we are in this current economic environment.