In a letter to Congress last week, Treasury Secretary Tim Geithner warned members of Congress that the $14.3 trillion debt ceiling could be reached as early as the end of March. He warned of disastrous consequences if they failed to raise it. Most notably, in this environment where the U.S. must issue gobs and gobs of debt, foreign faith in our bonds could be in peril, according to the Treasury. Republicans are using the coming vote as leverage to extract deep spending cuts.
Considering that Republicans swept into power this past fall because of the economy and runaway spending, they see it as their mandate to stop President Obama’s agenda. Rightly or wrongly, they feel it’s their electoral obligation to yell “stop” to the conductor of the spending train. A recent CBS poll indicated 77% of Americans want spending cuts, while only 9% prefer more taxes. That may harden Republican resolve. The problem with the poll results is that fewer than 40% of respondents could name a specific program to cut.
All of this means that the rhetoric will only rise over the next month in preparation for this vote because both sides will feel they are right. Plus, I doubt the freshmen in Congress are in any mood to compromise. Ultimately, I think the issue will be resolved, but only after much rancor.
Enough politics, how can we make some money on this? I have two relatively straight-forward ways to play the debate: long TBT, or short TLT.
- ProShares UltraShort 20+ Year Treasury (TBT): This ETF seeks daily results that correspond to twice the inverse of Barclay’s 20+ Year U.S. Treasury Bond Index.
- iShares Barclays 20+ Year Treasury Bond (TLT): This ETF seeks to track Barclay’s 20+ Year U.S. Treasury Bond Index.
There are, of course, important differences between the two. TBT carries more risk because of its leverage, shorting characteristics, and tracking error. Like most leveraged ETFs, it seeks to track daily results, which over time, in a volatile environment, may mean big losses even if your thesis is right. If you don’t understand tracking error, stay away from this ETF or talk to your advisor. It isn’t suitable for most investors.
TLT is a bit more straight-forward since it isn’t leveraged. Its fees are much lower than TBT's, which is natural considering the make-up. However, some investors may not feel comfortable holding this as a short. If your thesis depends on a short-term catalyst, as I believe, you won’t fully capitalize due to the lack of leverage. Not only that, but you have a dividend to worry about as a short.
I’ve been long TBT for some time now. I’m not currently concerned with tracking error because it's been a slow grind upwards in its price since last fall. That could change at a moment’s notice, though, and investors in TBT need to stay vigilant.
If you agree with my thesis, now is the time to begin to make your investment decision. If the debt ceiling may be reached in late March (although a more likely time period is May), the debate regarding this will begin in earnest next month, and the market will begin discounting that debate soon. Don't be right, but late.
It’s my belief that the debate alone will drive up yields on all federal debt, not only because of the threat of default (which is non-existent despite Secretary Geithner’s inane threats), but also because it will highlight just how dire the situation truly is. The federal debt can’t be controlled simply by cutting a few programs. Entitlements must be fundamentally reformed in order to put the U.S. on solid footing. The debt ceiling debate, which will be led on the Republican side by Rep. Paul Ryan with his Roadmap for America’s Future, will zero in on entitlements.
By the way, Congress waited three months after the debt ceiling deadline in 2002 to authorize an increase and four and a half months in 1995. Bondholders won’t be affected. America won’t be harmed over the long-term, and this brinksmanship should help to sober the drunken spendthrifts in Washington. Use this as an opportunity to make some money, but don't believe the rhetoric from Washington.
Disclosure: I am long TBT.
