John Lounsbury

The Riskiness of Bonds

Chris B and snake driver - - -

I agree that shorting treasuries is looking attractive. However, using TBT has high potential risk.

Answering snake driver's question (Is there a scenario where treasuries continue to go up ?) reveals the risk. One such scenario is that the three-day stock rally fizzles, stocks move lower in the coming several weeks, and the November 20 bottom fails to hold. That could prompt a further flight to safety and more dollars piling into treasuries.

On January 2, the U.S. Treasury web site reports that the 20 year treasury yield closed at 3.22. If a further flight to safety were to drive the yield down to 1.6%, $1000 invested at the close on January 2 would drop to $500. The leverage for interest rate changes to price increases as rates get very low. If you use TBT, you multiply the leverage by two. So buying TBT at the Jan 2 close of 39.00 could see the price drop to as low as 9.50 to 10.00 if the 20-year yield dropped to 1.6%.

On the up side, if the 20 year treasury rises to the 4.8% area, TBT will approximately double.

I use the word approximately because TBT has the objective of tracking double the price moves on a daily basis and price changes over longer time periods of time suffer tracking errors which can accumulate.

Disclaimer: I am down approximately 30% on my TBT position entered about two months ago.

Corporate Bonds Haven’t Been This Cheap Since 1932

For me, the only explaination for the extreme spread (corporate to treasuries) is an expectation of deflation with some corporate failures. An expectation of inflation would narrrow the spread. Therefore, if you want to bet against deflation continuing, go short treasuries and long corporates. You could also go long munis.

Disclosure: I have a small position short treasuries and no current corporate or muni bond positions.